The Auckland Country, New Zealand: Economic Bubble Situation

By Prakarsh Jain

Edited by Liz Maria Kuriakose, Associate Editor, The Indian Economist

NZ’s economy is known to be one of the safe-haven economies for years and especially after it emerged from the Financial Crisis relatively unharmed. Regrettably, research has now found that many of today’s safe-havens are undergoing bad economic situations that are similar to those that led to the financial crisis and New Zealand is one of the concern countries today.

Here are some of the reasons why NZ’s economy is heading for a crisis:

• Interest rates have been at all-time lows

Ultra-low interest rate atmospheres are known for fueling credit and housing bubbles. NZ’s interest rates have been at record low for nearly 5 years, more than enough time for foams and related imbalances to form.

NZ’s interbank rate, base lending rate, and 10-year bond yield are also at near an all-time low. NZ’s low interest rates (all of those mentioned) are a by-product of global money flows from the US and Japan, both of which have had near zero interest rates and quantitative easing programs until now since the crisis to boost their economies. Low interest rates in this economies stimulated capital to flow into higher yielding investments in other countries, which in turn led to reduced yields and an increase in the value of the NZ dollar against the US dollar. To fight the export-harming appreciation in currency and to strengthen the economy, NZ’s central bank reduced its interest rates to all-time lows.

• Property prices have doubled in the past decade

Following the pattern of nations outside the hard-hit US, Europe, and Japan, NZ’s housing prices have doubled in the decade, forming a probable property bubble:

• Economy has world’s 3^rd most overvalued property market

The doubling of NZ’s housing prices in the decade far surpassed household income growth, making the country’s property market one of the most overvalued in the world. Home price to rent ratio is ~75 percent above its average and home price to income ratio is ~25 percent above.

• NZ’s mortgage bubble has grown by ~150% since 2002

NZ’s housing bubble is driven by mortgage bubble that grew from NZD 70 Bn in 2002 to NZD 186 Bn in 2013. Debt bubble grew at a rate faster than its economy during this time, causing the total outstanding mortgage debt to GDP ratio to rise from ~60 percent to ~85 percent.

• Approximately half of mortgages have floating interest rates

NZ’s low interest rate atmosphere has encouraged the home-buyers to make the same mistakes that the US buyers did during last decade. One of the gravest being the use of floating rate mortgages, which will reset at higher rates when the low interest rate situation ultimately ends.Almost 50% of the mortgages currently have floating rates, which is up significantly in the past decade:

• Mortgages account for more than half of the banks’ loan portfolio

It’s as if the fact that NZ’s mortgages have floating rates isn’t scary enough, that we know mortgages account for ~60 per cent of the banks’ loan portfolios, which means that financial sector is heavily exposed to the popping of the bubble.

• Not Agriculture, but Finance is NZ’s largest industry

NZ is generally considered to be an agricultural economy, but this is not far from truth. Agriculture as such accounts for only 5 percent of the GDP, on the other hand finance, insurance and business services sector is the country’s largest sector, contributing ~30 per cent to the GDP. Moreover, banks account for ~80 per cent of the total assets of NZ’s financial system. This leads to a conclusion that not only is the banking system hazardously exposed to the property and credit bubble, but so is the entire economy.

• Exposure to Australia’s bubble

NZ’s banking system is dominated by four banks, which are wholly owned subsidiaries of Australian Banks, which means banking system of the country is highly exposed to the inevitable popping of Australia’s credit bubble. Australia’s debt to income ratio rose to ~180 per cent in recent times from ~110 percent in 2000, and on the other hand housing prices increased ~150 per cent (nominal terms) and 85 percent (real terms). Australia’s housing market is now the fifth most overvalued housing market in the world.

• Neighbouring buyers are inflating the property bubble

A flood of foreign home-buyers in recent times have contributed to the inflation of NZ’s housing bubble. Australians and Chinese, both hailing from countries that are experiencing bubbles, account for ~40 percent of these buyers, which means that the false prosperity booms in those countries are spilling over into NZ’s housing market.

Few Statistics about China’s Economic Bubble: Total domestic credit more than doubled to ~$23 trillion from $9 trillion in 2008. Borrowing has risen as a share of national income to >200 percent, from 135 percent in 2008. Credit growth rate of the economy is now faster than Japan before its bust and US before financial crisis, with ~50 per cent of that growth in the shadow-banking sector.

NZ and Australia, both are exposed to the popping of China’s bubble because their economies rely heavily on exports to China.

• Household debt problem

NZ has the fourth worst household debt to GDP ratio, surpassing even the US:

NZ’s household debt to disposable income ratio soared from ~100 percent in early 2000s to ~ 150 per cent in recent years, thanks to the mortgage bubble. NZ’s low interest rates have prevented its large household debt from becoming an even greater problem, but this situation can change dramatically when interest rates eventually rise again.

• Overseas debt has nearly tripled

NZ’s government took advantage of the dropping yields on its bonds after the Financial Crisis to nearly triple its borrowing:

Global bond bubble has provided NZ’s government with a low cost borrowing opportunity that is unlikely to be replicated anytime soon, especially now that the US is scheduled to taper or end its Quantitative Easing program this year.

• NZD is overvalued

Money inflows into NZ after the crisis helped the NZD to strengthen by ~85 per cent against the USD:

After strong appreciation against USD over the past decade, NZD is now overvalued by as much as around 20 per cent. NZ’s Finance Minister stated that overvalued dollar is a concern because it risks harming the exporters. If overvaluation was to abruptly correct and overshoot to the downside, NZ’s central bank may be forced to hike its interest rate to prevent further declines.

How will NZ’s economic bubble pop-up?

NZ’s bubble will probably pop as a result of increase in interest rates across the yield curve, which would put pressure on the property and credit bubbles. Key interest rate is expected to continue increasing after its hike due to rising inflationary pressures, and on the other hand bond yields are likely to rise as an effect of the Fed’s taper.

The popping of Australia and China are two other external factors that have a high probability of contributing to NZ’s bubble.

What to expect when economic bubble truly pops?

• Property bubble
• Banks will experience losses on their mortgage portfolios
• Credit boom will turn into a bust
• Default by over-leveraged consumers
• Fall in stock and bond prices
• Weakening of New Zealand Dollar (NZD)
• Reversal in growth
• Rise in unemployment

Prakarsh Jain is a graduate in Commerce from Jai Hind College, post-graduate in Master of Global Business-Investment Banking & Wealth Management from S P Jain School of Global Management and a Chartered Accountant (CA). Currently, Mr. Jain is working with Mizuho Securities, a wholly owned subsidiary of Japanese investment Bank in Corporate Advisory team. From an early age, Prakarsh has been actively involved in various competitions & debates at national/international level and in recent time has represented UAE at the KPMG International Case Competition (KICC 2013) held in Spain. In addition, he has also acted as a delegate at the World Islamic Banking Conference: Asia Summit held in Singapore.