Academic journal article The Reserve Bank of New Zealand Bulletin

International Capital Flows, External Debt, and New Zealand Financial Stability. (Articles)

Academic journal article The Reserve Bank of New Zealand Bulletin

International Capital Flows, External Debt, and New Zealand Financial Stability. (Articles)

Article excerpt

Financial Markets Department (1)

New Zealand is unusually dependent on foreign capital. Many of these substantial external liabilities are denominated in foreign currency, yet it is often correctly noted that we are not very exposed to the impact of changes in the exchange rate on the value of net external liabilities. This article goes beyond the aggregated data to further our understanding of the capital flows into and out of New Zealand, and to try to get a little closer to understanding who is taking the foreign exchange risks in these substantial cross-border flows. We then extend the analysis to examine potential points of vulnerability for the New Zealand financial system.

1 Introduction

This article examines the nature and composition of capital flows and the possible implications for New Zealand financial stability.

Heavy reliance on foreign capital is one characteristic New Zealand shares with many (though not all) of the countries that have experienced financial crises over the last 10-20 years. Being able to draw on foreign capital to help finance investment, or indeed to consume in anticipation of expected future income growth, is attractive. However, there are also risks.

New Zealand differs from typical crisis countries in many important respects, but this does not mean that we are invulnerable. Whatever the general lessons of international financial crises, our points of vulnerability may be rather more specific to New Zealand.

The aim of this article is threefold. First, we briefly describe the overall trends in capital flows into and out of the New Zealand economy over the past decade, and put this, and the overall level of net external indebtedness, into some sort of international perspective.

Official statistics break down the stock and flow of capital according to the international standards for balance of payments accounting. (2) It is also useful -- and the second objective of this article -- to think about capital flows from a different viewpoint, that of the component markets (the bond market, equity market, government issuance, and so on). Doing so offers insights on what drives capital flows and, by extension, on the potential points of vulnerability.

Finally, we discuss the implications of the analysis, and characteristics of the sorts of capital flows New Zealand has experienced, for the stability of our economy and financial system.

In many respects, the material in this article should be thought of as something akin to "work in progress". (3) The Reserve Bank has an ongoing commitment to build its understanding in these areas, but on many points the data are relatively fragmentary and the sorts of issues of particular relevance to New Zealand are not covered well in the burgeoning international literature.

2 Background

Since the mid-1970s New Zealand has consistently imported more goods and services than it has exported. It has, in other words, consistently run a current account deficit. Each of these deficits had to be financed by capital inflows (a "financial account surplus" in the official jargon). Figure 1 shows the accumulated current account deficit since 1975 and indicates how each deficit has added to a net stock of external liabilities. (4) The best official measure is Statistics New Zealand's International Investment Position (IIP) data. (5) At the end of June 2001 this showed a net liability (of New Zealand resident firms and households to non-residents) of $87.5 billion, or just over 75 per cent of GDP. Figure 2 illustrates that our level of (net) dependence on foreign capital (also known as net foreign assets or NFA) is high by world standards, especially for a well-developed and relatively mature economy. (6)

At a very simplified level (and things are never quite that simple in reality), foreign investors can provide capital either as debt (New Zealanders owe a fixed amount of money) or as equity (the investor takes a claim on some percentage of the earnings of operating businesses). …

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