Fitch affirms New Zealand at 'aa'; outlook stable
Source: FxWire Pro - Ratings / 15 Feb 2018 00:09:36 Eastern Standard Time
Fitch Ratings has affirmed New Zealand's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA' and its Long-Term Local-Currency IDR at 'AA+', both with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
New Zealand's ratings are underpinned by very high governance standards, a strong policy framework and institutions, and a commitment to prudent fiscal management. The country's high external debt burden and elevated household debt levels are the key weaknesses for the credit profile.
A new Labour Party-led coalition government took office in October 2017, with a key focus on addressing social issues, including through increases in minimum wages, tighter immigration policy, and higher fiscal expenditures. The government plans to sharply increase the hourly minimum wage to NZD20 by 2021 from the current NZD15.75. Key expenditure initiatives announced in the Budget Policy Statement (BPS) are the Families Package to provide financial support to low-income households, the Kiwibuild programme to alleviate housing shortages by building 100,000 new homes, and restarting contributions to New Zealand's Superannuation Fund.
As a result of these initiatives, fiscal policy will turn more expansionary. After posting a surplus of 1.7% of GDP in the fiscal year ending June 2017 (FY17), due to higher-than-expected revenues and subdued expenditure growth, the overall general government balance is forecast by Fitch to turn to a deficit of 0.6% of GDP by FY19, on a Government Finance Statistics (GFS) basis.
Adherence to prudent medium-term fiscal management continues despite the near-term expansionary fiscal policy. Fitch expects the gross general government debt-to-GDP ratio (GFS basis) to remain on a downward trajectory. The ratio was 32.7% of GDP in FY17, which compared favourably with the median of 42.2% for 'AA' rated sovereigns. Sustained primary surpluses and positive economic growth dynamics will lower the debt ratio to 29.7% of GDP by FY19, in Fitch's estimates. Importantly, the new government is holding to the tradition of fiscal discipline by maintaining a target for net debt, of 20% of GDP (core Crown basis), which they plan to reach in 2022 from a FY17 level of 21.8%, two years later than the previous government.
Real GDP growth is likely to remain solid over the next two years. While growth (production measure) slowed to an estimated 2.8% in 2017 from a peak of 4.0% in 2016, this was above the 'AA' median. Accommodative monetary policy and fiscal stimulus will bolster growth, which Fitch forecasts at 2.8% in 2018 and 3.1% in 2019. The strong global economy and the recovery in agricultural prices since 2016, particularly in the dairy sector, should help support growth. Net migration flows, a key driver of New Zealand's robust growth, appears to have peaked in early 2017 and is likely to slow gradually over the next two years. Rapid housing price growth has recently slowed, and may weigh on private consumption through wealth effects on household balance sheets.
Inflation pressures remain subdued and headline inflation will likely remain within the Reserve Bank of New Zealand's (RBNZ) target range of 1% to 3% through 2019. Tight labour markets, with unemployment at 4.7% in 2017, and capacity constraints in some parts of the economy have yet to translate into inflationary pressures providing space for the RBNZ to keep policy accommodative. In the context of rising global interest rates, Fitch believes the RBNZ will start increasing rates by 25bp in late 2018, followed by two more 25bp hikes in 2019 as the government's minimum wage increases and continued labour market tightening firm up inflation.
Fitch does not expect the government-initiated review of the RBNZ Act to materially alter RBNZ policy or policymaking credibility. The review is likely to result in the implementation of a dual inflation and employment mandate, and the establishment of a committee structure for RBNZ decisions. The RBNZ's flexible inflation targeting regime already largely accounts for economic conditions and many central banks globally utilise a committee decision structure.
New Zealand's net external debt ratio, at 53.7% of GDP in 2017, is much improved from its peak of 94.5% in 2009. However, the net external debt position is high relative to the 'AA' median surplus of 24% of GDP, leaving the economy exposed to external financing shocks. With rising global interest rates, borrowers are likely to face higher financing costs, which could lead to financial stress. The floating exchange rate, along with external borrowing that is largely hedged or denominated in local currency helps mitigate these risks. Further, the banking sector has reduced its reliance on external funding over the past several years, focusing on building up domestic deposits. Supported by historically high terms of trade and low global interest rates, New Zealand's current account deficit has declined in recent years to an estimated 2.7% of GDP in 2017. Fitch projects that the current account deficit will increase to 2.9% of GDP by 2019 as higher global interest rates increase the investment income deficit.
Elevated household debt levels at 168% of disposable income in 3Q17, resulting primarily from high housing prices, are a key downside risk for the economy. Households' debt burdens have been made affordable through low interest rates and strong labour markets. An increase in interest rates given the likely path of rising global interest rates, or a labour market shock could hamper financially weaker households' ability to service their debts, which may lead to a slowdown in growth and an increase in non-performing loans, although this is not Fitch's base case. Rising interest rates will filter through to households gradually as around 80% of mortgages are fixed rate (typically for a two-year period). Further, national house price growth slowed over the past year to 3.3% year-over-year in 3Q17, the slowest pace since 2012, due to higher loan-to-value ratio (LVR) requirements, tighter lending standards, and election uncertainty.
New Zealand banks are highly exposed to the housing sector, with around 55% of their loan portfolio made up of mortgages. Active use of macro-prudential policies though the implementation of LVR requirements in 2013 and their tightening in 2016 (a modest relaxation occurred in January 2018), have improved the resilience of bank balance sheets to housing price shocks. The ratio of mortgages with LVRs above 80% dropped from 21% to just below 7% in 3Q17. The RBNZ Act review will consider the financial stability policy framework, including a planned review of the macro-prudential policy framework.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns New Zealand a score equivalent to a rating of 'AA' on the Long-Term Foreign-Currency IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could, individually or collectively, lead to a positive rating action are:
- A strengthening of the government's fiscal position through a further reduction in the debt-to-GDP ratio.
- A substantial improvement in New Zealand's external debt sustainability, for example through a structurally narrower current account deficit or a lasting reduction in net external debt.
The main factors that could, individually or collectively, lead to a negative rating action are:
- A negative financial or economic shock that impairs households' ability to service their debt, leading to economic and banking sector stress.
- A sharp and sustained external financing shock, for instance through a rapid rise in global interest rates or market disruption that limits access to external financing and raises the net external debt burden.
- The global economy is presumed to perform broadly in line with Fitch's latest Global Economic Outlook Report.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR affirmed at 'AA'; Outlook Stable
Long-Term Local-Currency IDR affirmed at 'AA+'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F1+'
Short-Term Local-Currency IDR affirmed at 'F1+'
Country Ceiling affirmed at 'AAA'
Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'AA+'
Issue ratings on short-term senior unsecured debt affirmed at 'F1+'© FxWire Pro 2018. All rights reserved. The FxWire Pro content received through this service is the intellectual property of FxWire Pro or its third party suppliers. Republication or redistribution of content provided by FxWire Pro is expressly prohibited without the prior written consent of FxWire Pro, except for personal and non-commercial use. Neither FxWire Pro nor its third party suppliers shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance thereon.