[ProfileOou]

The New Zealand 2009 Budget was a surprise on many levels. First and foremost, the Government forecast deficits for up to ten years, and were a lot wider and persist for a lot longer than market expected. The OBEGAL (operating balance excluding gains and losses) is expected to peak at around -4.8% of GDP in 2010/11.

Net debt is expected to peak at around 35% of GDP in 2016/17, easing only very gradually back to 30% of GDP by 2022/23. The Government’s attempt to prove fiscal austerity is embodied in a chart in the Budget papers, suggesting that without policy changes, net debt to GDP would be closer to 62% of GDP by 2022/23.

After digesting the string of deficits and very sticky net debt profile (especially when compared with Australia) it was reasonable to conclude that the ratings agencies would remain concerned about weak fiscal discipline. However, a few short hours after the budget was released, S&P not only didn’t downgrade New Zealand’s foreign credit rating from AA+ to AA, but actually upgraded the outlook from negative to stable, re-affirming the AA+ credit rating.

Surprisingly, S&P claimed that the Government was successful in “returning the operating position to surpluses over the cycle and maintaining low debt” when justifying the upgrade. Using the Government’s projections of a return to surplus by 2018/19 as a basis for an improved credit outlook requires a substantial leap of faith.

It’s been some time since “twin deficits” were part of everyday discussion for Australia and New Zealand. New Zealand is firmly back in that camp, with the current account deficit at -8.9% of GDP at the end of 2008 (or even with an improvement to -8.3% forecast for March qtr 2009) and now joined by a budget deficit of -4% of GDP. That combination is an unsustainable position and requires massive funding from a tiny country with no savings record. It is not unknown that New Zealand heavily relies on foreign capital to fund private activity, and now there appears to be a similar assumption that “offshore” will now also fund public activity.

The bottom line: the tick of approval from the ratings agencies (Moody’s and S&P) should not be interpreted as a green light for the current Budget stance, or for assuming that net foreign debt of 90% of GDP is acceptable. There is no room for complacency on either front. Any slippage on the fiscal front should again be considered for a negative outlook, especially if the much-awaited improvement in the current account deficit again fails to materialise.

While there are few direct implications for monetary policy and strategy on the back of a Budget update, we remain of the view that the short end of the yield curve remains underpriced for further RBNZ easing, and the NZD remains overvalued compared with the otherwise poor macro environment.

[AndrewWoo]

The New Zealand budget was an important first test for the newly elected conservative government. A prolonged recession has reduced tax revenues and driven the budget into deficit. A few months ago, the ratings agencies cautioned the government that its deteriorating fiscal position threatened a potential downgrade its foreign currency debt rating. Today's budget, however, saw the government pass this test. Following the budget, Moody's announced that the outlook on New Zealand's Aaa sovereign credit rating remains stable, and S&P improved the outlook to stable. Net debt is forecast to reach 30.9% of GDP by 2013, up from the December forecast of 26.7%. However, the government is forecasting GDP to fall by 1.7% in 2010, which is very pessimistic. New Zealand's debt is higher than Australia's but much lower than all of the major economies. Overall, the budget and responses from the ratings agencies was a NZD positive in some's view.