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.
Ratio of current account to GDP
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.
Net international investment to GDP
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%.
Sustainability of New Zealand’s current account
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:
- Unlike the situation in early periods, New Zealand’s deficits in the 2000s are the result of private borrowing rather than official borrowing to fund fiscal deficits.
- A liberal international financial system makes it easier for New Zealanders to raise capital in offshore markets to fund domestic consumption and investment.
- Safeguards such as a floating exchange rate and an independent central bank have been introduced to help correct large deficits.
- A glut of savings in many Asian and oil-producing countries means they have been happy to lend to New Zealanders in exchange for receiving the relatively high interest payments on New Zealand debt.
- Larger proportions of New Zealand’s borrowings are now in New Zealand dollars, which reduces the impact of changes in the exchange rate on the country’s ability to service debt.
- There is a high level of Australian investment in New Zealand, but almost 50% of it is direct investment – for instance in banks, most of which are Australian-owned – and is therefore likely to be stable.
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.