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CIAO DATE: 2/00
Adjusting to the Asian Crisis
October 2, 1998, New York
Thank you for the opportunity to talk today about the Asian crisis, its impact on New Zealand, and the management of the risks that flow from it.
New Zealand is not a large country. Geographically, we are a long way from most of our main markets. But we are a trading nation, and exports play a critically important role in the health of the economy.
Because we very strongly favour an open, flexible economy, you may find it interesting to examine how the crisis is impacting on New Zealand, and how our present right of centre minority Government has gone about handling it.
First, a few baseline figures. New Zealand exports about 22% of gross domestic product compared with the United States, exporting 8.1% of GDP, Japan on 8.8%, and Australia still well below us on 15.6%.
Some 40% of those New Zealand exports ordinarily go to Asia. That figure compares with 10% of exports or less in the case of the major European countries and 30% for the United States.
In short, New Zealand has, by average OECD standards, a relatively large exposure to trade risks of Asian origin.
A reasonably up–to–date picture of the extent of the fall in our sales to Asia in the last year or so is provided by the latest merchandise trade figures comparing the three months to July 1998 with the same period last year.
Declines range from 32.6% in the case of Malaysia and 31% for Korea through Thailand at 18% and Taiwan 11.3% to China, down by the somewhat more modest figure of 7.6%.
Twenty years ago, declines of that magnitude would have implied, for New Zealand, quite serious economic and social damage, including significant business failures, and some quite massive rises in unemployment.
Twenty years ago, New Zealand had one of the most excessively protected and, as a result, inflexible economies in the western world. That greatly limited our capacity to absorb serious international economic shocks.
Since mid–1980s, as you will know, strenuous action by successive Governments has transformed the character of the New Zealand economy.
Through the 1990s, Government policy has been driven consistently in line with five fundamentals: We have steadfastly pursued:
In response to those policies:
Those gains improved the buffer available to New Zealand as a safeguard against international shock, and our ability to manage them.
Our economy had already begun a normal cyclical economic slow down before the Asian crisis began to impact on international trade.
The Kiwi dollar had, between March 1994 and 1997, appreciated by 22%. Economic growth slowed, in that period, from an unsustainable 6.3% to 2.7%.
Then, late last year, with the cycle expected to bottom out during the first half of 1998 at better than 2%, we were suddenly hit by a drought said, in some areas, to be the worst for 150 years.
Immediately on top of that natural calamity came the Asian crisis.
The drought not only slashed primary and processing output short term. It also reduced the breeding stock available to as a launch pad for recovery for quite a number of years into the future.
The turmoil in Asia impacted with particular severity on forestry and tourism, the two sectors most exposed to the influence of the Asian crisis.
Those events and the finance market volatility accompanying them, led in combination with weak household and business spending, to a reduction in confidence.
The New Zealand economy contracted by 1.0% in the March quarter of 1998 and, as expected, March quarter figures released about a week ago showed a further contraction in the June quarter of 0.8%.
The economy is now forecast to return to growth in the second half of 1998, but quite possibly not fast enough to deliver a positive annual figure, for the full year to March 1999.
Beyond that, moving into 1999–2000, Treasury’s latest central forecast shows progressive pick–up to 2.8% for that year, rising beyond that to 4% in 2000–01. Those are high figures. What is the rationale sustaining them?
Talking numbers of any kind about global growth is a risky business at the moment. Consensus Forecasts figures for the growth of our top 10 trading partners in 1998 have reduced month by month from 2.6% last February to 1.3% by September.
Clearly, Moody’s, to take one example, isn’t totally happy about the prospects they see for us. They lowered our rating one notch last week from Aa1 down to Aa2.
That puts New Zealand now on the same level as Australia, Sweden and Canada, which is not, as company goes, really too bad.
Moody’s express concern that domestic conditions and a sharp deterioration in our external environment have led, in the last 18 months, to quite a sharp increase in our current account deficit.
They expect that deficit to narrow significantly in coming years, but constrained by adverse and maybe worsening external environment.
The New Zealand Government is more optimistic than Moody’s, and I think with good reason, in anything short of a quite substantial collapse in the major US and European markets.
The New Zealand Government is not a contributor to the current account deficit. We have no net public foreign–currency debt. The deficit substantially reflects private sector use of foreign savings to fund future economic growth.
In our view, the strength and flexibility of our current economic policy framework has given New Zealand greatly improved adjustment potential.
That capacity has been evident for some time now.
From January 1991 to April 1997, when the Kiwi dollar appreciated on a trade–weighted basis by 28%, continuous effort was required from exporters to remain internationally competitive.
Since then, a falling Kiwi dollar has moved the TWI 17% in favour of exporters since April ’97. The Reserve Bank, responding to reduced inflationary pressure, has sanctioning a major easing of monetary conditions.
The bank’s nominal monetary conditions index, having risen from minus 422 in September 1992 to plus 1000 at the end of 1996, has eased rapidly. It stood in fact at minus 289 on Monday, 28 September, just before I left New Zealand.
The tradeables sector is in a position now to capitalise on both efficiency gains made while the dollar was rising, and currency gains from its more recent fall.
The monetary policy framework and flexibility of labour markets should operate to ensure that these competitiveness gains are not eroded over time.
Initial evidence of resource–switching in response to those market and exchange rate signals is already apparent.
Primary producers are clearly limited by the drought–induced run–down in their breeding stock and current low world prices for commodities.
The contribution of total manufacturing to GDP in the June quarter was down 3.8%, reflecting conditions in both Asia and the domestic market.
But non–commodity manufactured export values, 3–monthly year on year, which were negative in mid–1997, have been showing a very strong 10.5% average gain throughout the last 12 months.
Non–commodity manufactures, a highly diversified sector, now represent 25% of total New Zealand goods exports. Those manufacturers, moving to capitalise on improved competitiveness, are delivering growth in both value and volume.
In the year to August, the value of exports to Korea and Thailand was down by $190 million and $54 million respectively.
Simultaneously, however, exports to the US rose by $540 million, to Belgium by $175 million, Italy $133 million and Germany $115 million.
A similar switch is evident in tourist earnings. Large falls in Asian short–term arrivals have been offset by robust growth in non–Asian visitors.
Initially, the upturn in exports is unlikely to be broad– based, but the New Zealand Treasury expects a gradual pickup during the next few quarters.
As the forecast upswing in both export and domestic sectors eventually puts pressure on existing capacity, business confidence will improve. Investment deferred earlier will come back on stream.
That is the analysis which underpins the Treasury’s central forecast last month that the growth rate will rise to 3% in 1999–2000, with a broader– based 4% to follow in the year to March 2001.
Treasury seems that process driving a gradual but continuous improvement in the current account deficit from 7.7% in December 1997 to 5?% in March 2001.
The Reserve Bank expects trade performance stronger than the Treasury, and sees the external deficit falling to 4% of GDP at that date.
Clearly, any New Zealand recovery is intimately linked to levels of economic momentum in the United States, Australia and Europe very roughly in line with current expectation.
Risks exist not merely for the emerging economies in Russia, Latin America and Eastern Europe, but also around the future level of activity in the major western countries.
Treasury’s forecasts last month therefore include a lower world growth scenario assuming that demand for New Zealand exports goes on contracting until towards the end of 1999.
On that basis, the growth forecasts fall to -0.9% for l998–99, rising to a +1.4% in 1999–2000 and +3.7% in 2000–01—still a strong and positive economic story for New Zealand.
In short, on the economic side, even if the Government took very little further action, assuming anything short of a significant western collapse, our picture is quite a bright one.
Even on Treasury’s low world growth scenario, the 1990s are a very successful economic performance decade for New Zealand. The fiscal front is, however, a bit more to think about.
Growth, instead of bottoming around 2% as expected when the 1998 Budget was written, could now quite possibly be slightly negative overall for 1998–99.
Recovery occurs from a lower base and, when it happens, occurs more slowly.
There is a wedge of healthy tax–paying economic growth which no longer occurs. The lost revenue is not clawed back later. Basically, it just disappears forever. We never get it back.
Before the Asian crisis, New Zealand was projecting eight healthy operating surpluses in succession. Surpluses, with accompanying tax cuts, just about as far as the eye could see.
By the time of the Treasury’s forecasts in August 1998, if you ignore the gains likely to be made from asset sales and include a few cyclical elements which will reverse over time, the 1998–99 surplus is down to 0.1% of GDP—followed by deficits of 0.7% and 0.3% of GDP in the two ensuing years.
They would be our first fiscal deficits since 1992–93—not a prospect any of us enjoy greatly in New Zealand.
Net debt, already down from 52% of GDP in the early 1990s to 24.4%, had been expected to reach 19% by 2001. By August, the new Treasury forecasts showed net debt rising for a couple of years back up to 26%.
Those figures were on Treasury’s central scenario. Their low world growth scenario suggested operating deficits as high as 1.5% and 1.6%, with net Crown debt rising to 29.1% by the year to March 2001.
We had kept fiscal policy prudent in New Zealand. Consistent surpluses have halved net public debt, eliminated net public foreign currency debt, and left a cushion of around 2–3% of GDP annually, as a buffer against any shocks.
That policy has done its job well. We have absorbed the impact of the drought and the Asian crisis to date without much damage—but in the process, we used up the buffer originally provided.
There are still significant external risks ahead—weak banks in Japan, pressure on China’s currency, problems in emerging markets, and uncertainty surrounding world economic growth.
But with so much at stake on unreliable data, the priorities for economic managers has to be prudence, transparency and flexibility, in systems that facilitate market–led adjustment.
The Government has, therefore, adopted the view that, without any panic at all, we will consciously and deliberately act to improve that fiscal position.
We aim to get out of deficit in an orderly but determined way in a sensible timeframe, and re–establish a useful fiscal buffer for New Zealand.
During May, June and September, the Government has taken three successive steps to reduce our 3–year limit on new policy initiatives from $5 billion to $4.4 billion, and boost savings by close attention to spending quality.
New Zealand, as you probably know, currently has a minority Government led by National, with the support from two minor parties, ACT, United, plus eight independents from our former NZ First coalition partner.
Mixed Member Proportional Representation, the system introduced in 1996 after a referendum, has been a new experience for politicians who grew up with First Past the Post.
A lot of New Zealanders have been sceptical about minority Government. The fear was that, unable to exert full caucus discipline over members, it would prove weak, vacillating, and unable to accomplish anything useful.
The MPs involved have, howeverr, since the Treasury produced its August forecasts, reviewed the situation in what I see as a very responsible way.
They have looked at it as far as possible on merit, without imposing too many preconceptions on policy formation.
As a result, the Government’s third savings package since May, announced on Tuesday, 29 September, was successfully announced this week.
That is very heartening to me, and augurs well for New Zealand.
We are not looking to rebuild the surplus by slash and burn tactics. We have agreed five guiding principles. They are:
We have, over the years, reduced or removed many of our tariff barriers and other obstacles to free trade in goods and services.
In May this year, for example, New Zealand abolished tariffs on motor vehicles, saving purchasers an average $3000 per new car.
This week’s package extends that by establishing a timetable for the removal of all remaining tariffs over the next six years.
We are currently midstream with major changes in the structure of our electricity generation and distribution industries.
The dominant State–owned generating company is being split into three separate competing units to improve efficiency and lower prices to users.
Until recently, a Coalition Agreement signed in 1996 placed artificial limits on asset sales by arbitrarily defining some state businesses as strategic assets which were, by definition, not for sale.
The demise recently of the original 1996 Coalition now clears the way for case–by–case consideration on merit of the benefit of particular asset sales, to remove unreasonable risk from taxpayers, reduce debt, or improve efficiency.
One major State–owned generator, Contact Energy, previously regarded as a protected strategic asset, is now being scoped for possible future sale.
Among them is a reduction in our state retirement income pension from 65% to 60% orf the average wage, which generates nominal savings of $2.6 billion over the next 10 years.
Having set out our fiscal objectives and principles in response to the Asian crisis, let me conclude now by returning to the economic side of the policy equation.
It is obviously important to let the automatic stabilisers set in place during the last ten or 15 years do their job to improve international competitiveness without political interference.
On the other hand, where we can enhance or reinforce the performance of market–led adjustment mechanisms, then clearly this is the right time to do it.
With that in mind, the Government’s May 1998 Budget laid out what is probably the most substantial programme of micro–economic reform ever seen in New Zealand to date.
That programme aims to:
In this category come the simplification of tax law, reviews of resource management regulation, local body powers and rating systems, water and waste water systems, occupational regulation and a host of other impediments to a better life.
If we can accomplish these programmes in an effective, timely manner, the Asian crisis will certainly not be, at the end of the day, all bad news for New Zealanders.
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