Cabbage Tree Accounting

By: Cabbage Tree Consulting  06-Dec-2011

A ratings downgrade is never ideal. Depending on who you believe, it could be an indictment on the government’s fiscal control of the economy, likewise it could be seen as the ratings agency being more sensitive to total net external debt (that is, private sector debt).

Effectively what it means is that the perceived ability of New Zealand to be able to pay back debt has been impeded from where it sat before the downgrade.

Traditional economics would tell us that the downgrade means an increased credit risk, vis-à-vis an increased cost of borrowing (for us – business and mortgage debt), and capital flight from foreign investors into safe haven countries (those with the highest credit rating). The capital flight would then push down our exchange rate, making it more expensive for us to buy from overseas, but easier for exporters to sell their products internationally.

As I say, that’s what traditional economics would tell us, and sorry if it was getting too jargonesk. What’s more interesting is to study those traditional indicators, and to see what’s really happening.

Before the Standard and Poors, as well as Fitch downgrade, NZ to US dollars were trading around $0.76, today it’s trading at, well, give or take $0.76 – there was a slight dip in the middle there, but it appears the currency has remained materially stable.

What about the thing that matters to most of us – interest rates? Well Darren Gibbs from Deutsche Bank has said that the “a t the margin, it will probably raise the cost of funding but, in the scheme of things, it's not that huge", meaning we may well see a flow on of increased interest rates, but it’s unlikely to be material.

In an interesting turn of events, there is widespread speculation that the credit rating downgrade could keep the Official Cash Rate (OCR) down at 2.50% for a longer period of time. Which could see interest rates staying lower over the medium term – though I cogitate.

Yes, the government is spending too much on areas such as working for families and interest free student loans, and yes, private savings in New Zealand suck. In saying that, in the first time in a decade household consumption as a percentage of income has dropped below 100% (from a peak of 108%).

The reality is, we still hold an AA rating with a stable outlook, and we are just squabbling over the degree of excellence that we enjoy. 

The information in this article was current at 02 Dec 2011

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