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Economic analysis for Auckland

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March 2009

Stumbling into the new year

Business confidence and investment intentions have stumbled to all time lows for Auckland city businesses as the international crisis deepens. New Zealand's current account deficit remains very high in a volatile economic environment, which could have far-reaching effects on foreign direct investment, and the future of our economic stability.

We look at the most recent economic indicators for Auckland city and New Zealand, followed by a focus on business sentiment in Auckland city and the potential impact of New Zealand's current account deficit and credit ratings.

Auckland city's economic scoreboard

All values for Auckland city unless specified Year ended (unless specified)
Indicator	December 07		March 08		June 08		September 08		December 08		Time series link
GDP (annual growth)1	3.61%		3.99%		3.41%		2.45%		n/a		See long-term analysis
Unemployment rate (annual average)2	4.2%		4.2%		4.6%		5.0%		5.4%		See long-term analysis
CPI (national rate)3	3.2%		3.4%		4.0%		5.1%		3.4%		See long-term analysis
TWI (national quarterly value)3	71.6		71.6		68.1		63.8		55.1		See long-term analysis
Exports from Auckland airport and Auckland seaport (annual growth)2	11.6%		11.9%		11.9%		12.6%		12.2%		See long-term analysis
Retail sales growth (qoq)2	4.6%		0.9%		0.4%		-0.2%		n/a		See long-term analysis
Business investment intentions (net percentage) (quarterly value)4	-19.0%		-23.5%		-31.0%		-36.4%		-57.7%		See long-term analysis
Net migration (annual growth)2	-13.3%		-5.9%		-6.9%		-5.6%		0.6%		See long-term analysis
Number of residential building consents2	1,747		1,864		1.832		1.561		1,438		See long-term analysis
Value of non-residential building consents ($ million)2	$488		$500		$558		$690		$731		See long-term analysis
1 Infometrics 2 Statistics New Zealand 3 Reserve Bank of New Zealand 4 Quarterly Survey of Business Opinion, NZIER *Net percentage is calculated by subtracting the percentage of business saying the business situation has deteriorated from those saying improved in the last three months.

Focus on: The Auckland city economy

International crises dampens growth

In the last quarter, Auckland city's economy continued its downward trend in the face of global recession. The city's annual GDP growth fell to 2.45 per cent in the year to September 2008, down from 3.41 per cent in the year ended July 2008 and 3.25 per cent in the year ended September 2007. These figures capture just the beginnings of a long drawn out crisis, with further falls expected over subsequent quarters.

A squeeze on businesses

Effects of the crisis are increasingly being seen in the private sector where businesses continue to tighten their belts. In the December quarter, a massive net 70 per cent of Auckland city businesses felt the general business situation had deteriorated relative to the previous quarter. This marks a large drop in business confidence to a new low point not previously seen in this data series ¹. Auckland city business investment intentions also hit new lows in the December quarter with a net 58 per cent of businesses expecting to invest less in buildings in the next 12 months relative to the last 12 months.

A weakening New Zealand dollar not enough for exporters

On the trading front, the New Zealand dollar has fallen further against major currencies, specifically the US dollar, euro and the yen. This is the cause of a large drop in New Zealand's trade weighted index over much of the last year, particularly in the last six months. Ordinarily this would benefit exporters, but stifled growth in the economies of our main trading partners has dampened demand for New Zealand products abroad, offsetting currency gains. This is reflected in a slight weakening of annual growth in exports through Auckland's ports. While total export dollar values are still increasing in nominal terms, at 12.2 per cent, the annual growth is slightly lower than the previous quarter.

Unemployment climbs, net migration remains stable

Auckland city's unemployment rate has continued to rise, reaching 5.4 per cent in the year to December 2008. This is likely to rise further with increased redundancies as businesses struggle in the face of the economic crisis. However net migration has remained largely stable for Auckland city with an annual growth of only 0.6 per cent in the year to December.

Some relief for consumers?

The silver lining of a reduction in global demand is that domestic inflation pressure is subsiding. Inflation fell to 3.4 per cent in the 2008 calendar year, down from a peak of 5.1 per cent in the previous quarter. A reduction in fuel prices is the key contributor to this. Inflation relief has been paramount in enabling the Reserve Bank to undergo a series of large interest rate cuts, which is good news for property owners, and potential property owners (at least those who can afford the larger home deposits which are now required by banks).

The construction sector feels the pinch

The number of residential building consents has fallen further in Auckland city as demand has lowered for the construction of new dwellings. Lower mortgage rates may provide some resistance to this trend, although there is potential difficulty in motivating a response from the construction sector. This is likely to contribute toward anticipated rent increases in the housing sector. Conversely, the value of non-residential building consents has continued to increase to reach $731 million in the year to December 2008.

Focus on: Business sentiment in Auckland city and New Zealand

As the financial crisis continues to ravage market economies across the world, Auckland city businesses are now feeling the full brunt of its force.

The quarterly survey of business opinion (QSBO), which provides a good gauge of business sentiment across Auckland city, makes for grim reading (Figure 1).

The general Auckland city business environment as evaluated by business is at an all-time low, with a net 70 per cent of firms reporting general business conditions to have deteriorated in the last three months. This has deteriorated significantly from 20 per cent in September 2008, making the December quarter the second biggest deterioration over any two quarters since the survey began - a worrying indication for the 2009 business outlook.

The same score for 'profitability' over the last three months has been decreasing with a significant number of firms experiencing declining profitability in 2008. By December 2008, a net 65 per cent of all firms surveyed identified profits to have fallen relative to levels in the third quarter. This is the lowest ever score for profitability, with the next lowest occurring in 1991 when a net 49 per cent of all firms experienced falling profits.

Figure 1: Quarterly Survey of Business Opinion results for businesses view of the general business situation, and profitability over the last three months

Auckland city businesses appear to be feeling the crisis more severely than businesses across the country, in a range of areas highlighted by the QSBO (Table 1). In general, Auckland city businesses are more pessimistic on a range of measures including:

• The overall economic situation over the past three months
• Profitability over the last three months
• Investment in buildings over the next 12 months relative to the last 12 months
• Employment intentions over the next three months.

Table 1: QSBO results for Auckland city and New Zealand for selected indicators

	Net % of businesses
		Auckland city		New Zealand
Overall economic situation		-70%		-64%
Profitability over the last 3 months		-65%		-49%
Investment in buildings over the next 12 months		-58%		-42%
Number employed over the next 3 months		-43%		-32%
Number of replies		150		919
Source: NZIER, Quarterly Survey of Business Opinion

Focus on: New Zealand's current account deficit and the credit ratings

New Zealand be warned, your current account deficit is too high. This was the stern warning from Standard & Poor's following their most recent review of New Zealand's credit environment, when the outlook for the foreign currency rating was revised from stable to negative.

"The negative outlook on the foreign currency rating reflects the likelihood of a rating downgrade if external imbalances begin to pressure the country's investment, growth and fiscal performance," S&P analyst Kyran Curry.

New Zealand's balance of payments problem stems from a current account deficit, equating to 8.6 per cent of GDP. Among OECD nations, our current account (as a per cent of GDP) is ahead of only Portugal, Spain, Greece and Iceland (Figure 2). Iceland has recently entered the sort of economic crisis that has caused a mass exodus of its population, while the other three are being hit hard by the economic downturn.

Figure 2: The current account balance for OECD members

Explaining the current account balance

The current account balance is the balance of two key measures ² (each discussed in detail later):

1. Trade in goods and services (exports less imports)
2. Net international investment income.

The current accounts of all countries must sum to zero, with some country's being net accumulators, and others being net spenders. New Zealand is a net spender, and has been for some time. Over the years we have financed this through inward investment, loans from overseas, sales of overseas assets, and depletion of our currency reserves.

Components of the current account balance:

1. Trade balance: The trade balance is the difference between exports and imports of goods and services. New Zealand's trade balance deficit is roughly equal to one percent of its GDP. New Zealand's negative trade balance can be eliminated through two mechanisms. Firstly, we can change our volume of trade such that we begin to export more than we import. Secondly, there could be a depreciation in the exchange rate such that imports become more expensive, and exports become cheaper. The government has signalled the first mechanism as a priority, while the second is becoming more prevalent as the $NZ continues to depreciate against our main trading partners.
2. International investment income: Investment income accounts for the majority of New Zealand's current account deficit (currently equal to 7.8 per cent of GDP). Net investment income is made up of investment returns, which are generated abroad and brought back into New Zealand, less profits that are generated in New Zealand and taken abroad by investors. There is a double-edged sword to foreign direct investment, in that it can create valuable new employment, output and exports for New Zealand on the one hand, while on the other, such capital inflows can be withdrawn at inconvenient times, creating unsustainable current account deficits.

Deficits inextricably tied

The trade balance deficit has reduced in recent years with a surge in exports relative to imports, however the income investment deficit has continued to widen (Figure 3). This is explained through the relationship between each of these measures. In order to fund the trade deficit, New Zealand has had to maintain exceedingly high interest rates relative to other OECD countries to attract foreign investment.

The high interest paid on these investments then contributes to the investment income deficit in terms of net income outflows. In this way, the trade deficit is largely responsible for the income investment deficit.

However, while interest rates are high (for the purposes of attracting investment), which in turn leads to high exchange rates, it becomes very difficult to reduce the trade deficit (because exports remain artificially expensive for global buyers with the high exchange rate). This is known as a structural current account deficit.

The current account deficit, falling interest rates and the financial crisis

The current climate has New Zealand interest rates falling, meaning investors are withdrawing their New Zealand investments. This has led to excessive exchange rate volatility, and depreciation ³.

These factors, in combination with others such as continued investment in the housing sector, reduced global demand for our exports and a reduced Government tax take imminent for 2009, has led Standard & Poor's to conclude that New Zealand has a negative outlook on its foreign currency rating. This has important implications for Auckland city's economy because the warning from Standard & Poor's may lead to a reduction in New Zealand's credit rating, which would increase the perceived risk of investing on our shores. It is likely that much of this investment would be bound for Auckland city. Furthermore, investors already in Auckland city will find their profits reducing with exchange rate volatility, and falling interest rates. Compared to the rest of New Zealand, Auckland city with its dominant financial sector, is heavily reliant on such flows.

Figure 3: Composition of New Zealand's current account balance

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1 The NZIER Quarterly Survey of Business Opinion data for Auckland city is available since the March 1990 quarter.

2 Current transfer payments make up a third category, but contribute only a small inflow for New Zealand.

3 Exchange rate depreciations are the main component of a self-adjusting system for deficit nations, whereby a lower exchange rate will make imports more expensive, thus helping reduce our current account deficit.

Published February 2009