New Zealand households are being urged to improve the quantity and quality of their savings to help the rebalancing of the economy, particularly away from external debt.
Reserve Bank governor Alan Bollard told the Wellington Chamber of Commerce yesterday that New Zealand had taken action to address some of its imbalances but households and banks could do more to reduce risks inherent in the external imbalance.
Resilience of bank funding had been bolstered by a liquidity policy imposed by the Reserve Bank and the Government accounts had a "credible and improving track".
But households remained the most obvious source of imbalance with balance sheets heavily skewed to housing, high debt ratios and very low savings, he said.
"We believe New Zealanders have decided they are over-exposed to property assets and to high debt and they are prepared to constrain consumption to improve their savings.
The question is how much rebalancing they contemplate and for how long."
Much would depend on how those extra savings were invested and whether that was domestically or internationally, Dr Bollard said.
Financial markets did not judge the savings balance directly, but rather through its funding implications and its contributions to the external balance.
On the external account, the trade balance had improved with strong export prices and less demand for imports from consumers, farmers and businesses.
However, a large deficit on the investment income balance was showing no signs of enduring improvement.
The strong New Zealand dollar had not helped.
"Indeed, it will be difficult to improve this metric as it will require us to get our net external debt position on to a downward trend."
The financial consequences of years of running external deficits meant that foreigners had more than twice as much invested in New Zealand as New Zealand had invested overseas, he said.
That meant the country was running a sizeable net investment deficit of about 90% of gross domestic product (GDP).
Most of the debt was in the private sector, not the public sector, Dr Bollard said.
A significant proportion of that related to the banking system which did most of the country's offshore borrowing - effectively on behalf of households and businesses.
The Reserve Bank's forecasts saw that external deficit continuing to grow.
Financial markets and credit rating agencies used a range of indicators to form their assessment of a country's viability or fragility, he said.
At the moment, most of the focus was on sovereign debt and the fiscal accounts.
But as the recent credit downgrade of the Spanish Government showed, overall external indebtedness could play a role.
New Zealand was one of the very few developed countries with net external liabilities so high, Dr Bollard said.
"Our external liabilities cannot keep increasing with impunity. Ultimately, either the markets will penalise us by requiring a larger premium for continued funding and/or the sheer size of servicing our obligations will become an intolerable burden to the country."
Rather than await such painful punishments, New Zealand should be looking to improve the situation.
Some of it was outside the control of the country, he said.
That included the relative valuations of major currencies.
Some of the things that could and were being done were designing fiscal and tax policy to reduce vulnerabilities, putting in place cautious bank regulation and improving access to a range of investment opportunities.
