The balance of payments measures the value of New Zealand’s financial transactions with the rest of the world, such as:
The most notorious balance of payments crisis in 20th-century New Zealand occurred in late 1957. It led Finance Minister Arnold Nordmeyer in 1958 to issue a budget that tried to reduce demand for imports through additional taxes on cars, alcohol and tobacco. Since these were among the pleasures of the typical ‘Kiwi bloke’, Nordmeyer earned a reputation as a ‘wowser’ and his budget was labelled ‘black’.
The balance of payments shows whether New Zealand is in overall debt or credit to the rest of the world. The state of the balance influences levels of confidence in the security of investments in New Zealand, and in the country’s overall economic health. New Zealand is usually in deficit on the balance of payments current account, which can make the terms under which New Zealand borrows money to finance that deficit tougher than they would otherwise be.
At times ‘payments crises’ have arisen because overseas income has fallen sharply or overseas payments have risen sharply. Historically, governments attempted to alleviate such problems by cutting public spending, increasing interest rates, lowering the exchange rate or restricting imports – or the demand for them. Since the 1980s governments have not been so interventionist.
In New Zealand the statement on the balance of payments is compiled and published each quarter by Statistics New Zealand, a government department, in accordance with international reporting standards. The statement is broken down and presented in three separate categories or ‘accounts’:
Each account covers different types of international transactions.
Money transactions are reported in the current account of the balance of payments.
The current account has four components:
In the early 2000s money sent from Tongans in New Zealand, Australia and the United States back to their families made up about half the national income of Tonga. Much of the money from New Zealand was sent through Western Union, which had two branches in the Tongan capital, Nuku’alofa.
Each of these balances may be negative (a deficit) or positive (a surplus). Their sum is the current account balance.
New Zealand normally runs a current account deficit. This means that it uses more resources for consumption and investment than it generates at home. New Zealand’s current account deficit (as a proportion of its economy) is amongst the largest in the OECD group of countries.
The shortfall in New Zealand’s current account is financed by borrowing in international capital markets, selling assets or incurring liabilities to foreign residents. Such flows, along with those relating to foreign assets bought by New Zealanders, are recorded in the financial account.
When foreign residents buy more assets in New Zealand than New Zealanders buy abroad (as has been most often the case), more capital flows into the country than out. Then a net surplus is recorded on the financial account.
Three main kinds of flows figure in the financial accounts:
The third component of the balance of payments statement is the capital account, which includes capital transfers. As with current transfers, capital transfers also involve the movement of cash or other items of value, but are intended to be for investment rather than consumption. Such transfers include official debt forgiveness and the money migrants bring into the country. The balance (the difference between the money going in and out of the country) on the capital account is small relative to the current and financial accounts.
In theory, a country’s balance of payments must add up to zero, since any deficits (or surpluses) on the current account are funded by inflows (or outflows) recorded in the financial and capital accounts. In practice there is not normally a zero balance because of small errors in the varied sources used to compile the figures. So an amount called a ‘net error’ or ‘residual’ is inserted to ensure that the balance of payments does indeed balance (add up to zero).
As well as the balance of payments, there are other methods of considering the current account.
The balance of payments statement is closely linked to the statement on international investment position (IIP), the other major statistical record of New Zealand’s financial relationship with the rest of the world.
While the balance of payments collates the flows of funds from and to New Zealand residents each quarter, the IIP describes the value of assets and liabilities held by New Zealanders overseas and by foreign residents in New Zealand at the end of a financial quarter.
The net investment position at the end of a quarter is calculated by adding the balance on the financial account for a given quarter to the net investment position at the beginning of the quarter. In addition, there is some lesser adjustment caused by changes in prices and exchange rates, which influence the value of assets and liabilities.
New Zealand has had a high level of international borrowing for much of its history. In the 1975 election campaign National Party leader Robert Muldoon created a high level of public anxiety about the country’s debt, which had increased fast as a result of the rise in oil prices and the decline in New Zealand’s terms of trade. Muldoon’s ploy was successful, and he became prime minister. However, New Zealand continued to borrow money to finance the gap between overseas income and payments.
A current account surplus in any period reduces New Zealand’s total net foreign debt, and improves its international investment position. However, New Zealand usually has a current account deficit, increasing the country’s total net foreign debt.
The net investment position at any point in time can be considered as the sum of all past current account balances.
In a closed economy – one that has no trade or financial links with the rest of the world – investment would be the same as the economy’s gross savings. An open economy such as New Zealand’s, which has international financial links, may boost investment without increasing domestic savings by borrowing on international capital markets. This produces a deficit on the current account. In this sense, a current account balance is simply the difference between an open economy’s gross savings and investment.
New Zealand has always been heavily reliant on international trade and capital inflows to fund new investment. Because of this, the balance of payments is an important indicator of the country’s economic health.
New Zealand has periodically experienced balance of payments crises. These were episodes of economic instability when overseas income fell sharply, or overseas payments rose sharply, with the risk that the country would be unable to make interest payments on debt or pay for all its imports. Resolution of these crises was painful and featured high interest rates, import controls and sometimes currency depreciation. The threat of such crises weighed heavily on policymakers and the nation.
For much of New Zealand’s history, the balance of trade was virtually equivalent to the current account balance, and so a trade crisis implied a balance of payments crisis.
There were two causes of trade crises:
Before 1890, despite successful exports of wool and gold, New Zealand’s export income was almost always less than its import spending. The colony borrowed large sums of money from overseas to cover the difference. It became difficult to borrow money in the 1880s; the government cut its spending and banks restricted credit to meet interest payments.
As colonial treasurer and premier for most of the period between 1869 and 1876, Julius Vogel tried to kick-start the development of the New Zealand economy with an ambitious plan to increase immigration, purchase Māori land and invest in roads and bridges. To finance these schemes he had to borrow overseas. Twice during these years he went to England to negotiate foreign loans, and from 1876 to 1880 he was agent general in London, where much of his time was spent arranging loans. The need to pay interest on these loans was an additional burden when New Zealand’s export income fell.
Between 1890 and 1930 export income usually exceeded import payments. However, in 1908, 1920 and 1926 the reverse was the case and the government again introduced policies to alleviate the problem.
In 1930/31 export income collapsed, but banks and the government acted so swiftly that there was no payments crisis until the end of 1931, when the government temporarily controlled all export income to ensure it could make loan payments.
In the next payments crisis, in 1938/39, the Labour government – New Zealand’s first – took control of both foreign exchange and imports (by requiring licences for the latter). This system was maintained through the Second World War and after. The immediate crisis was alleviated by the onset of war, which increased demand for exports and limited imports.
High wool prices in the early 1950s led to a surplus in the balance of payments, but by 1957/58 wool and butter prices had fallen and there was another crisis.
Balance of payments crises became increasingly severe from the late 1960s, partly on account of oil shocks (sharp price increases), but also because New Zealand’s export economy was not growing as fast as in earlier years. The last year there was a surplus on the current account was 1973. Between 1967 and 1984 the New Zealand dollar was devalued a number of times in an effort to redress the balance, as it made exports more competitive and imports more costly.
In 1985 the New Zealand dollar was floated, with the aim of ensuring an automatic correction of current account deficits. However, in practice, during periods of expansion such as the mid-1990s and the early 2000s, there were sharp increases in current account deficits.
New Zealand governments have used various methods to try to correct current account deficits.
To correct a current account deficit a government needs to boost exports, restrain imports, or increase net investment income.
From the 1880s the first policy practised by the government was to cut its own spending and encourage banks to restrict credit. This would reduce demand for imports and allow the country to meet its international interest payments.
In 1938, for the first time, the Labour government intervened directly by imposing controls on imports and foreign exchange.
For most of the period between 1938 and 1992, import controls were usually implemented through a licensing regime: governments issued licences to individuals and firms authorising the annual import of a specific quantity of a type of good.
Though effective in reducing imports, the licensing regime could also be inefficient. Long waiting lists developed for the purchase of certain desirable imports such as cars. Licences were allocated on an arbitrary basis, rather than on the value that firms and individuals placed on an import. Worse, import licences could increase the likelihood of a payments crisis because, anticipating a licensing regime – or a more stringent one – individuals might import much more than their current requirements. This occurred in 1957 – import licensing had been suspended in 1952, but was reintroduced in 1958.
Since foreign debts were usually settled in foreign currency, for most of the period between 1938 and 1984 New Zealand governments operated a system of exchange controls to maintain adequate reserves of foreign currency. Exporters had to convert their foreign earnings to New Zealand currency with the Reserve Bank, and, in turn, the bank supplied foreign exchange only for approved purchases. New Zealanders travelling overseas could only take limited amounts of foreign currency, and no bank outside New Zealand would deal in New Zealand currency.
In the 2000s most New Zealanders travelling abroad used credit or bank cards to obtain local currency. But in the 20th century the most common way to obtain local money was by using travellers’ cheques. These were issued by banks in New Zealand before the traveller left, and so provided an easy mechanism for the government to control how much money went overseas with holidaying Kiwis.
A more important and effective tool New Zealand governments used to correct payments imbalances was to devalue the country’s currency against foreign currencies. This made New Zealand exports cheaper and therefore more competitive in international markets, and it discouraged imports by making them more expensive in New Zealand. Usually, New Zealand assets also became more attractive to foreign investors following devaluations, and the resulting capital inflows made a crisis less likely. However, devaluations often triggered inflation (general price rises) as import price increases were passed on to consumers.
The New Zealand dollar was floated in 1985. This should, in theory, ensure that balance of payments crises no longer occur because the currency would self-correct. For example, a high demand for imports increases the demand for foreign currency to pay for these imports. This higher demand increases the price of that currency in New Zealand dollars – a depreciation of the New Zealand dollar. Consequently, a balance of payments deficit, which might have been created by the high import demand under a fixed exchange rate, may be pre-empted by a depreciating New Zealand dollar making the imports more expensive.
In practice, balance of payments deficits have persisted, but New Zealand has been able to borrow to cover them, avoiding payments crises of the kind that were common before the 1980s.
A sustainable current account balance is one that does not cause rapid changes in exchange, interest and growth rates, or require policy action such as restrictions on imports and capital transfers to correct it.
Economists use different methods to measure sustainability.
One important measure of current account sustainability is the ratio of the current account to gross domestic product (GDP). This recognises that a larger economy such as the United States can run larger deficits in dollar terms than a smaller economy such as New Zealand’s.
For New Zealand, a current account deficit higher than about 5–6% of GDP is considered unsustainable by some economists, but it has often exceeded this threshold.
Another way to assess current account sustainability is the ratio of a country’s net international investment position to GDP. Since the net international investment position (IIP) is the accumulation of past current account balances, a deficit can be considered sustainable if it does not excessively increase New Zealand’s net indebtedness to the rest of the world as a proportion of GDP.
In the early 2000s New Zealand’s IIP-to-GDP ratio was among the highest in the OECD, at around 85%.
Despite the fact that New Zealand’s current account exceeds the suggested ratio to GDP, and also has a high IIP-to-GDP ratio, it may not be unsustainable due to the following factors:
As the movement of money between countries increased, some began to run long-term deficits, and others long-term surpluses. Economists developed two new theories to explain this.
People often choose how much they want to spend or invest at any given point in time on the basis, not of their current income, but of expected future incomes over their entire lifetimes. Similarly, a country faced with a temporary boost to its national income – perhaps through better prices for its exports – may gradually, rather than dramatically, increase consumption. This kind of consumption smoothing implies a current account surplus. Current account deficits may result when countries borrow from overseas to smooth the costs of investment over time, rather than making large sacrifices to current consumption. This has been the common New Zealand strategy.
Economists have also explained persistent current account imbalances by linking these to the collective patience of a nation’s populace. If a country is more patient than the rest of the world – that is, it is willing to sacrifice comparatively larger proportions of current consumption for an increase in future consumption – then, it will run long-term current account surpluses. This phenomenon is known as consumption tilting. From this perspective New Zealand is less patient than the rest of the world as a whole.
Despite such perspectives, a comparatively large share of New Zealand’s borrowing is of a very short-term nature, and loan terms need to be renewed often. Renewing this debt may become difficult if international investors become anxious about New Zealand’s ability to service its debt or if international financial conditions deteriorate.
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Kim, Kunhong, Viv B. Hall, and Robert Allan Buckle. ‘Consumption smoothing in a small cyclically volatile open economy: evidence from New Zealand.’ Journal of International Money and Finance 25, no. 8 (December 2006): 1277–1295.