On the road to a no-debt policy

Robust economic management, aimed at reducing government engagement in the economy and lowering government debt, has made New Zealand’s participation in international money markets a rare event.

The government’s long-term strategy of avoiding debt as a way of financing government activities and actively retiring existing obligations as fast as possible has significant implications for the markets.

This debt policy ­ actually a non-debt policy ­ will inevitably lead to smaller and smaller issues of new government paper. It means that fund managers needing this kind of New Zealand security could well have to buy on the open market to fill out portfolios.

Given the current yield on government bonds (about 8%) and the probability of rates in New Zealand declining, as forecast by Bankers Trust New Zealand among others, fund managers could well interpret the impending scarcity of new government paper as a “buy now” signal.

While the government has been unloading its own debt, its policies have also brought a number of new players into the market. Its strategic disengagement from business activities by selling off enterprises has created a group of non-government but nevertheless favourably rated issuers.

Although these do not fill the gap left by the progressive withdrawal of the government from the money markets, they have been quite active in both domestic and overseas markets, and seem likely to continue being so.

Many of the government’s sales of commercial activities have been to investors, but others have been sold to government-owned corporations that are required to carry on business at arm’s length from the government and to trade on the same commercial basis as private enterprises.

These relatively new issuers in the capital markets are just one outcome of a process of economic reform that has been going on for 12 years. From a country that was on the verge of financial collapse in 1984, New Zealand has emerged, after a long period of painful reform, as one of the world’s most open and strongest economies. Its open-door policy has made it one of the most assured avenues of international investment.

Major foreign investors have directly purchased government business enterprises, such as banks, power companies and telecommunications but the equity, bond and capital markets are also attracting international interest.

Although New Zealand suffers from all the inherent difficulties of a small market ­ its population is just below 4 million ­ it has attracted strong investment inflows in the past three years. In 1992 it had a net outflow of portfolio investment of NZ$396 million ($274.58 million), but by 1993 the tide had turned, with foreign portfolio investment rising to NZ$1.087 billion and surging to NZ$5.645 billion in 1994 .

Direct foreign investment

Direct foreign investment in New Zealand assets has also grown fast. In 1992 direct net foreign investment totalled NZ$2.026 billion, rising to NZ$4.405 billion in 1993 and NZ$4.449 billion in 1994. By May this year 51.6% of New Zealand government
securities, totalling NZ$14.148 billion, were held by non-residents.

The rising value of New Zealand’s currency has undoubtedly been a factor in the overseas appetite for paper denominated in New Zealand dollars. The Commonwealth Bank of Australia had led two issues on the New Zealand market, one of NZ$50 million for itself and another for NZ$100 million for the World Bank.

Clearly offshore investors like what they see in New Zealand’s economic management and the reform process begun in 1984 by then minister of finance Roger Douglas (now Sir Roger Douglas) and pursued and amplified by successive governments. Faced with a financial crisis in 1984, Douglas responded by initiating the deregulation of the financial sector and floating the New Zealand currency.

The Labour Party initially followed the Douglas line but, after being re-elected in 1987, lost its appetite for reform, forcing Douglas to resign in 1988. The government proved itself unwilling to tackle labour market reform and to restrain the expansion of government services. In 1990 the National Party gained power and pursued areas left untouched by the previous government, but immediately ran into the 1991 recession.

The road for economic reformers has never been smooth, and the dividends from the New Zealand reforms were relatively slow in arriving. Many New Zealanders, raised in a protectionist, cosseted, subsidized and regulated society, suffered considerable pain as the government proceeded to strip away these supports.

The reform process is by no means complete: New Zealanders still have to blunt their appetite for income and welfare support. In 1995 income support absorbed 11.5% of GDP, compared with 11.3% in 1985: in 10 years there has been virtually no progress. But the biggest threat to the pursuit of further reforms is the new electoral system, which seems likely always to elect minority governments, with small populist and single-issue parties holding the balance of power.

For the time being, however, the pain has brought considerable gain. Unemployment, which touched 10.9% in September 1991, had fallen to 6.2% by March 1996. Since March 1993 employment has grown by 13%. The fall in unemployment, coupled with a rise in employment, points to a high level of new job creation and a higher rate of participation by the workforce.

Running down domestic debt

A significant statistic is the continuing growth in the government’s fiscal surplus: NZ$765 million in the financial year 1993-94; NZ$2.695 billion in 1994-95; NZ$2.929 billion in 1995-96; and projected to reach NZ$4.92 billion in 1998-99, assuming the continuation of present policies. The government’s success in reducing its expenditure is shown by the fall from 41.2% of GDP in 1992-93 to 35.2% in 1995-96.

With the proposed sale of some of its forest interests, by the end of this calendar year the government will have zero net foreign debt. It proposes then to apply any returns from asset sales and its own surplus funds to the redemption of domestic debt.

An important part of the government’s economic management is control of inflation and it has charged the Reserve Bank with this task. Murray Sherwin, deputy governor of the bank, says: “Our focus is obviously on inflation, and we have some uncomfortable pressures coming through over the next couple of quarters: our underlying inflation rate projected to peak at 2.6% for the year to September. “Our target is zero to 2%, so we are outside that, which is a matter of some discomfort.”

A 2.6% inflation outcome would be satisfactory in most economies and Sherwin concedes that New Zealand’s targeting has been formidable. “We set ourselves a deliberately ambitious target and it has been effective in anchoring inflationary expectations. But it is tough ­ particularly when you are five or so years into what has been a strong recovery.” Shirwin believes the problem areas where price pressures threaten to overshoot the inflation targets are goods and services not subject to international competition, and the rising price of residential and rural real estate.

And it is in residential real estate that one of the corporatized entities, Housing New Zealand Ltd, operates. Housing New Zealand is one of the relatively new boys on the capital market block: it was established in 1992 to own and manage the government housing portfolio and is New Zealand’s biggest landlord, leasing 67,000 homes to low-income tenants.

During the past year the company has restructured its balance sheet by repaying NZ$600 million to its shareholders in the form of a share buy-back. This was facilitated by a valuation which lifted the value of its property assets from NZ$2.6 billion to NZ$4.7 billion. The company has transitional debt to the government of about NZ$1.9 billion and Peter Garty, general manager finance, has put together a borrowing programme to refinance this debt.

On April 4, the company issued a prospectus for a cocktail issue of various kinds of bonds of varying maturities which are open to negotiation in order to raise a maximum of NZ$1.5 billion. Joint lead managers are CS First Boston and the National Bank of New Zealand. Bankers Trust New Zealand is co-manager.

The company has a rating of A-1 for short-term debt and a rating of A+ for long-term debt from Standard and Poor’s (S&P), and Peter Garty expects a favourable rating soon from Moody’s.

With Deutsche Bank as lead manager, Housing New Zealand is also preparing an issue for the European transferable note market, but the timing of this has not yet been decided.

Deregulation of industries has produced many success stories for New Zealand, but one of the enterprises that is still regulated ­ the New Zealand Dairy Board ­ has been more successful than most. The board handles all of the country’s export dairy products, which account for 18% of all exports. It has successfully penetrated markets all over the world and the success of dairying is one of the reasons for the rural land property price boom.

Mike Clarke, the dairy board’s capital markets manager, has an unusual financing task, having to issue mainly short-term paper over 30, 60 and 90 days. This hits a peak of NZ$1.2 billion after the spring and summer production periods, falling to a low of usually NZ$300 million in the late winter months. This capital raising provides working funds for the acquisition of butter and cream products, milk powder and other products from dairy cooperatives and factories. The New Zealand Dairy Board covers these borrowings with stand-by facilities and by hedging since it has large foreign currency earnings.

To handle its financing task, it has satellite treasuries in Reigate, near London, and another in Singapore, and uses nine dealers on the European market, 12 handling global commercial paper and two dealing in US commercial paper. The board’s longer-term borrowings are smallish, amounting to NZ$250 million and maturing in 1999.

The rating agencies seem to approve the board’s conservative financing arrangements. Standard and Poor’s rates its short-term debt at A1+ and long-term debt at AA minus. Moody’s rating is similar: A1 for short-term debt and AA2 for longer-term debt.

An equally high-rated issuer is national electricity grid company Trans Power which is rated AA+ by S&P and Aa1 by Moody’s. Trans Power is one of the larger government-owned companies, with assets of NZ$53 billion and annual revenue of NZ$550 million.

Trans Power treasurer Graham Turley supervises a borrowing programme to finance expansion and to replace existing debt. Since April last year Trans Power has had eight domestic issues and 10 in Europe, including two Swfr100 million ($82.4 million) note issues.

If ­ as seems likely ­ the New Zealand government continues to pursue its policy of running down its borrowings, offshore investors who wish to profit from a strong New Zealand currency will have to look to issues of the kind offered by Trans Power from time to time.

Getting the banking reform balance right

The new deregulated banking supervision process in New Zealand has gained qualified approval from the industry, but there are still hurdles for it to cross.

The regime, which came into force on January 1, requires banks to make quarterly disclosures of key financial data, to display summaries of this data in all bank branches and to publish comprehensive financial reports for shareholders, analysts and the financial press.

It also imposes on directors the responsibility of ensuring that banks comply with the conditions of their registration, adequately monitor and control risks, and ensure that exposure to controlling shareholders is not contrary to the interests of banks. Finally, the directors have to attest that the quarterly disclosures are not false or misleading. Penalties for breaches could be quite severe.

The disclosures required of the banks are similar to those required for half-year reports but include such things as credit ratings, capital ratios, and information on exposure concentration, asset quality, shareholders’ guarantees and profitability.

Initially, the banks made their quarterly disclosures in private to the Reserve Bank of New Zealand, but for the June quarter the disclosures went public. Peter J Ledingham, the Reserve Bank’s chief manager banking systems, says the new regime has worked well, with any teething problems being sorted out between the Reserve Bank and the banks concerned. One breach by the National Bank, a subsidiary of Lloyds Bank, hit the headlines in New Zealand but was soon resolved. A side-effect noticed by Ledingham has been that bank directors are better informed than before.

For the September quarter, the Reserve Bank will require disclosure of exposure to market risk, but this requirement, always intended to be part of the disclosure regime, is causing disquiet in the banking community. Executive director of the New Zealand Bankers’ Association Simon Carlaw thinks there is a risk that commercial confidentiality will be broken by this requirement. His view is that in the small New Zealand market, astute observers of the data will be able to work out who is borrowing what from whom.

Another problem for Carlaw is the inherent conflict between the disclosure rules of the Reserve Bank and the company reporting standards for all public companies ­ including banks ­ which come into force in 1997. Carlaw says the accounting rules, which will have the force of law, do not harmonize with the Reserve Bank rules. Banks will be at a disadvantage in being required to comply with two sets of regulations, the requirements of which will not satisfy the demands of the other authority. He says the outstanding task for the industry is to get the two sets of regulations working in tandem.