Keywords: Macroeconomics & Money;
Overseas debt had a significant role in the Long Depression of the 1880s and 1890s and the Great Depression of the 1920s and 1930s. This suggests it would be helpful to be able to forecast New Zealand’s overseas liabilities, especially as it enters what is expected to be another period of exceptional economic difficulty.
After setting out some broad features of the overseas assets and liabilities, this paper derives a forecasting method which is then applied to current macroeconomic forecasts, and ends up discussing a related policy rule.
Its broad conclusions:
– in March 2009 the Net International Invest Position (NIIP) was 51 weeks (or 98 percent of annual GDP ) implying that it would take the production of almost an entire year to pay off net foreign liabilities;
– the ratio been rising in recent years, and is expected to rise further in the next five years. In March 2013 it seems likely that it would take over 13 months of production to pay off the NIIP.
– the implication is that New Zealand may come out of the world recession in worse shape in overseas liabilities than it entered, and even more vulnerable to the next international crisis;
– in March 2008 Gross Foreign Liabilities were about a quarter of New Zealand’s Domestic Assets (Appendix I);
– there is a policy rule that suggests that if New Zealand does not want its NIIP to GDP ratio to rise further it needs to keep its current account deficit below 1.3 percent of GDP over the next few years and below 4.8 percent in the medium term (Appendix II not included on this website). The CAD is forecast to average 5.8 percent of GDP over the next five years.
The paper is only possible because in recent years Statistics New Zealand has been collecting far more data on foreign assets and liabilities. There is still insufficient data to set out a full national balance sheet which would further assist analysis.
A Role for Balance Sheets in Economic Evaluation
Over the next few years the government debt position will deteriorate, largely as a result of the change in fiscal stance as a consequence of dealing with the expected long recession. The Treasury Budget 2009 forecasts think that net core crown debt will rise from 5.7% in June 2008 to 30.9% of annual GDP in June 2013.
The way this ratio is usually presented ignores that it is in units of time, greatly offending an applied mathematician, so I will report it as 3 weeks of GDP in 2008 to 16 weeks in 2013, a change of 13 weeks over the five years. (However I acknowledge the non-mathematical by including the conventional percentage of annual GDP in brackets.)
Measured as Gross Sovereign Issued Debt (excluding liquidity management) government debt is expected to change from 9 weeks of GDP (17.5%) in 2008 to 20 weeks (38.7%) in 2013, an increase of 11 weeks. (Another way of assessing the crown debt forecast is that it represents almost an doubling of the gross debt burden per person over the period.) 
In one way it is disappointing that there is going to be a such deterioration after 15 hard years aimed at reducing the relative level of government debt. But those who supported a low and falling public debt path argued that this would place the government in a stronger position when there was the sort of systemic crisis which the world now faces. (Another argument was that low government borrowing puts downward pressure on the exchange rate, thereby stimulating economic growth through the tradeable sector.)
How far should the debt ratio be allowed to rise? An easy answer is ‘enough to maintain high employment’. While I am not unsympathetic to that response it, is not sufficient. There is an interaction between the government balance sheet and the private one. An increase in government debt which is offset by a reduction in private net liabilities is rather different from an increase in all liabilities as the result of a consumption binge.
Further analysis really requires the private sector balance sheet for New Zealand. Alas we do not yet have one, certainly not one which is consistent with national accounts definitions. Bits and pieces of the household balance sheet are known, but the complex interaction with the business balance sheet has yet to be sorted out.
There are a few items in the national balance sheet known reasonably well. One is the ‘Net International Investment Position’. The NIIP represents the difference between all the overseas assets owned by New Zealanders – including the government and businesses – and their overseas liabilities. These liabilities are owed to non-New Zealanders. Note that NIIP less the public debt is equal to the private liabilities of New Zealanders (although this requires that local authorities be treated as ‘private’.) .
How are we to judge the magnitude of the NIIP? The same absolute level of NIIP in a large economy is less significant to it (but not to the world as a whole) than in a small economy; a NIIP which is 2 percent of the aggregate domestic assets is a very different proposition from one which is 20 percent of assets. It is therefore usual to scale NIIP relative to annual GDP (as was done above in relation to government debt).
A more sophisticated reason is that this. GDP is a consequence of the assets in the balance sheet. For instance if we knew the return on all assets was 5% p.a., we could calculate aggregate assets by multiplying GDP by 20. Then NIIP as a proportion of twenty times GDP would give an indication of the importance of foreign liabilities relative to the items in the whole balance sheet.
There are some subtleties to this analysis. First, the previous paragraph should have been in terms of GNP, since the relevant assets are those owned by the nation. Today, GNP is about 92 percent of GDP so the change to the ratio is small (but it would be higher). This paper uses the GDP denominator, only because it is the current convention. However in the longer run the ratio to GNP should be used; especially if NIIP is rising faster than GDP, then GNP will be rising slower than GDP and so the NIIP to GNP ratio will be rising faster.
Second, we do not know the rate of return on New Zealand assets. But since the return is unlikely to change much in the medium term, changes in the ratio allow the monitoring of changes in the importance of the NIIP. Note there may be a case for using a cyclically adjusted GDP/GNP, since the economic value of the assets will not change as much over the business cycle as production does. During a recession the ratio will appear higher than during a boom (all other things equal).
The third caveat is that the capital in the balance sheet is implicitly valued by National Accounting standards which may not be the market price. .
Fourth, since we are comparing NIIP with all production, it follows that we have in mind all the assets which contribute to production. That includes human capital. This may be appropriate in policy terms; for instance if the additional public spending was entirely on education and training, then the rise in public debt would be offset by a rise in private human capital. However for some purposes one may want to match the NIIP against the physical and financial assets only.
(For reasons which are explained in Appendix I, it was not possible to progress the relation between Gross Foreign Liabilities (GFL ) and capital as much as was hoped.)
The official overseas liabilities series are available annually from March 1992 (currently to March 2009), although there seems to be a change in the data base in 2000.
the size of the liabilities have been rising. In March 1993 they amounted to $70.0b; fifteen years later in March 2008 they amounted to $178.8b, a nominal growth rate of 6.4 percent p.a. Total NIIP seems to have been accelerating since about 2004, although the fixed interest securities began their acceleration from 2000. (There was some substitution between equities and the fixed interest securities which may obscure the turning points of the component.) Fixed interest securities have been growing faster than the equities.
The relationship between the NIIP and the current account deficit (CAD) can be summarised as:
NIIP at the end of the period = NIIP at the beginning of the period + CAD during the period + the effects of revaluations of the price of assets and liabilities.
Since the first two terms are well measured (and the CAD is routinely forecast), the revaluation effect can be measured. But can it be predicted?
Treating the reevaluation effects as a proportion of the total NIIP, the equation modifies to
NIIP at the end of the period = (1 + the effects of revaluations) * (NIIP at the beginning of the period) + CAD during the period
The ‘effects of revaluation’ measures the average increase (or decrease) in the prices of the liabilities represented in the NIIP (after the CAD has added to them).
An exploration found no evidence that the exchange rate affected the revaluations. Perhaps further torturing of the data could have found a relationship, but one would have had little confidence in any finding for forecasting purposes.
Clearly some of the revaluation effects are independent of the exchange rate. For instant changes in the values of equities reflect changes in share market sentiment. The exchange rate may impact on the sentiment or on the profits of some of the businesses which the equities represent.
But why do not foreign sources loans appear to be affected by the exchange rate? What is critical here is the degree of hedging. If the foreign loan is hedge (offshore) for changes in the exchange rate or if it is denominated in New Zealand dollars (which is much the same thing), exchange rate variations will not effect the value to the borrower and hence the level of debt which appears in the accounts. The SNZ statistics show that over half the net international liabilities are in New Zealand dollars (and about a quarter are in US dollars). A 2007 SNZ survey found that most loans raised in foreign currency had foreign exchange cover.
This does not mean the exchange raterhas no effect on individual items. But it is not implausible that the aggregate effect is small as the econometrics seems to suggest.
Because the foreign owned physical assets and equities are under a third of total NIIP – the rest being fixed interest liabilities – we would expect the effect to be, on average, less than a third of asset inflation . The average annual revaluation effect of the Net Capital Stock was about 3% over the period, so we might expect the ‘effects of revaluation’ parameter to be about 1 percent p.a.
Measured over the fifteen years beginning with 2000 the annual effects of revaluation averaged 0.7%, which is not inconsistent with the 1% guestimate .
This is a brief account of a lot of mucking about. In summary the following equation seems to be a reasonable predictor of future NIIP (or it has been since 2000).
NIIP at the end of the period = (1.007 )*( NIIP at the beginning of the period + CAD during the period)
However, the 0.7 percent annual revaluation could easily be in the range from 0 to 2 percent and we cannot rule out that in some years it could be outside it.
It may be that further investigation at the component level will reduce the estimation error. Lengthening of the series would be helpful.
Forecasting the Net Foreign Liabilities
If we know the NIIP at the beginning of the period and the CAD during it, we can now forecast the NIIP at the end of the period. We have the NIIP for March 2008 and the Treasury provides forecasts of the CAD out to year ended March 2013. By chain linking the NIIPs for each March we can forecast the NIIP to March 2013. The results are shown in the following table.
Net Overseas Liabilities: Forecasts
* = Treasury Forecast (Budget 2009). CAD and GDP.
The Treasury forecasts of the Current Account Deficit suggest a sharp rise in NIIP in the March 2009 and March 2010 years, followed by some slowing down. Even so, the rise means Net Overseas Liabilities are expected to be nearing a quarter of a trillion New Zealand dollars in four years time.
The NIIP to GDP ratio rises from 51 weeks of GDP in March 2008 to 59 weeks in March 2013. Since the central government debt ratio is projected to rise by 11 or 13 weeks (depending on the measure) the implication is that there is no deterioration in the relative net savings record of the private sector – that is, private domestic consumption and expenditure are not rising faster than private domestic incomes. (However the impact of New Zealand Superannuation needs to be disentangled.)
How sensitive are these estimate to the revaluation parameter set here at 0.7% p.a.. Were it 1 percentage point pa. higher or lower NIIP would be 3.5 percent higher or lower. There is still a substantial deterioration. The public discussion is correct to focus on the current account deficit as the main contributor to net overseas liabilities.
This analysis of savings and investment contributions could be progressed using the forecasts at a more disaggregated level than is currently available. Moreover, as Appendix I explains, it has not proved possible to track the value of domestic assets, so it is not possible to say whether this is due to improvements in savings or reductions in capital investment.
Forecasts involve implicit assumptions about continuities of trends. They may not apply, especially for the current year to March 2009, which has been one of great financial turmoil. The exchange rate has fallen dramatically, as has the share market here and overseas. A number of financial institutions have collapsed (although the amount of foreign investment exposed in them is probably minimal), and housing prices are sinking. Implicitly in the projection based on the Treasury forecast is the assumption that these effects are unlikely to persist through to 2013.
The total of New Zealand’s Overseas Liabilities are high. These ratios have risen markedly in recent years, and are expected to rise further mainly, according to the Treasury forecast, because of the government’s borrowing program. However, there is evidence in the forecast that the Treasury expects the private sector balance sheet is recovering at the same time.
One of the main reasons that the New Zealand faces particular difficulties in the current world recession is excessive debt in the pivate sector. One would have thought any successful policy response would be to address this.. On current forecasts it seems likely that New Zealand will come out of the world recession in a weaker position than it entered it, so it will be even more vulnerable were a later crisis to occur, or if this crisis proves more prolonged than is currently expected.
APPENDIX II: A POLICY RULE FORMULA
This appendix is available by request from the author.
 This is an updated and condensed version of an earlier paper using a slightly different data base. copies available on request. I am grateful to a number of economists who reviewed the earlier draft, including Andrew Coleman, Dennis Rose and Bill Rosenberg.
 Excluding the NZ Superannuation Fund
 Note that the GDP measure used is for the preceding year – e.g to March – while the debt is at end of the March year (i.e. on 31 March). This paper uses this convention because it is so widely held, but under an irritated sufferance because the GDP at end of March would make more conceptual sense.
 These figures omit the New Zealand Superannuation Fund which reduces the ratios by about 4 weeks (7.9 percentage points) in 2008 and 7 weeks (13.8 percentage points) in 2013.
 The one serious omission seems to be assets held overseas by New Zealand households. This is unlikely to seriously change the conclusions of this paper but it does lower the NIIP ratios.
 Using the longest available series.