I wrote this note to clarify some matters to myself; I shant be surprise if they become more prominent in 2011.

Keywords: Macroeconomics & Money; Statistics;

I have been looking at the International Investment Position focusing on the equity to debt ratio, in effect thinking about New Zealand’s external balance sheet as if it were a corporation.

In June 2010 the gross ratio was about 5 to 1 ($307b to $61b) the net ratio was about 18 to 1 ($155b to $8b).

It strikes me that these are rather high. One factor is that some of the debt is between related parties, as when an overseas company advances debt to its local subsidiary with relatively thin equity, often as a consequence of our (tax) laws.

Do overseas lenders (and credit rating agencies) care about this? I would think they are less concerned about equity owned offshore than debt owned offshore, even when the debt is between related parties. (Or do they believe in Modigliani-Miller?)

Suppose that is right. We can perhaps reduce (probably in a small way – but not at great expense) their concerns by the following actions in the private sector:

1. Separating out related party debt in the official measures;

2. Changing the (tax) laws to encourage equity-financing over debt-financing by overseas companies. (Some of the October changes apparently had this effect.)

Additionally, the public sector might change the external debt to equity ratio in its books by

3. Selling off some of its offshore equity in quasi-sovereign funds to reduce the public sector’s offshore debt. Some of the proceeds could be reinvested in New Zealand businesses.

4. Selling off some of its onshore equity to foreign investors.

Some of the later may not be particularly palatable. (It is a kind of privatisation.) However, they are responses to the consequences of past policy failures and an even more serious stomach churning possibility, if the international receivers get called in a la Greece, Iceland and Ireland.

I suspect that the screwed up external balance sheet indicates some severely screwed up internal balance sheets. In general the data is not available to identify and evaluate them.