RBNZ highlights vulnerability

New Zealand is in a highly vulnerable macroeconomic position and may require a difficult transition, the Reserve Bank of New Zealand warns in a submission to the Government's Savings Working Group.

"No-one is quite sure how much vulnerability a net international investment position of around 90 per cent of GDP implies," the RBNZ says.

"But we are not aware of any other advanced country having had an NIIP position that high in modern times without some fairly difficult subsequent transitions," the RBNZ said, referring to countries such as Portugal, Iceland, Spain, Greece and Hungary, many of which are currently making such difficult transitions.

New Zealand's net international investment position was at 86.5 per cent of GDP at the end of the June quarter, up from 85.9 per cent in March.

The RBNZ notes that the main adjustment risk for New Zealand comes from the fact that the economy has gone through a debt-fuelled asset price boom and a period of strong consumption. A further challenge is the result of the government moving from a surplus to significant structural deficit. What makes this worse is the fact that this was financed by foreign capital in relatively short-term debt.

New Zealand's saving grace, however, is its floating exchange rate and well-hedged debt, the RBNZ said.

But more than macroeconomic vulnerability, it is the country's financial vulnerability that could have a serious impact, the RBNZ believes.

While the RBNZ judges that New Zealand banks and their Australian parents are well-capitalised so can cope with economic shocks, it can't ignore the fact that both are heavily dependent on foreign wholesale funding.

However, if confidence in these banks were to be materially undermined, or if global markets were to seize up again because of wider concerns about adjustment pressures in Western countries, this could result in a substantial disruption to the flow of credit and risk. This would be a rather nastier real economic adjustment, the RBNZ said.