Fitch Ratings has today affirmed New Zealand's (NZ) foreign currency Long-term Issuer Default Rating (IDR) at 'AA+', local currency Long-term IDR at 'AAA', foreign currency Short-term rating at 'F1+' and the Country Ceiling at 'AAA'. The Outlook on the ratings is Negative.

"The notable turnaround in NZ's large current account deficit which dampened rising foreign indebtedness during Q109 to Q110, as well as extensive private sector hedging activities, helped to avert a downgrade," notes Ai Ling Ngiam, Director in the agency's Asia-Pacific sovereign team. "However, Fitch has maintained the Negative Outlook as prospects for a sustained structural improvement in New Zealand's external finances remain unclear, and yet to be observed, following more concerted initiatives by the authorities to address the issue," added Ms. Ngiam.

The key to reducing external financing risks is a sustained correction in the domestic savings-investment (S-I) imbalance, driven to a large degree by household dis-saving. To date, however, evidence of NZ's household balance sheet rebalancing is mixed and non-conclusive. Alongside a relatively mild GDP contraction of 0.5% in 2009, due partly to a larger-than-expected 6% of GDP reduction in its current account deficit (CAD), the net international investment position (NIIP) nevertheless increased from 88% in 2008 to 91% of GDP in 2009. On a four-quarter rolling sum basis, NZ's CAD widened marginally from the smallest deficit in nine years of 2.4% of GDP in Q110 to 3% in Q210.

Nonetheless, the 2009 CAD adjustment was partially distorted by lower banking sector tax-related investment income outflows. More importantly, the CAD adjustment stemmed from a sharp decline in domestic investment activity instead of an improvement in domestic savings. Plagued by the poor jobs market and low wage gains during 2008-09, NZ households' savings worsened to minus 13.7% in March 2009 from minus 11% of household disposable income in March 2008. By comparison, Fitch estimates that on average, OECD member countries' household savings rate rose on a calendar year basis from 5.1% in 2007 to 7.1% of household disposable income in 2009, with notable gains in other 'AA' rated sovereigns including Australia and Ireland.

In the context of a possibly protracted structural adjustment process on household savings, public savings provide the other key to the sustainability of NZ's S-I imbalance. Due to more rigid spending requirements in the form of higher benefit payouts and higher interest costs, fiscal spending is unlikely to be cut back in line with the decline in revenue to reduce the fiscal deficit until FY2012. At the current pace of fiscal consolidation, Fitch estimates that general government (GG) savings will likely continue to decline by 0.3-0.5 percentage points to register a low of less than 2% of GDP in 2011 before recovering back closer to pre-2008 levels in 2013. Fiscal consolidation would help to improve public savings, and create fiscal space to help the sovereign deal with future shocks and lower GG debt after 2012.

On an optimistic note, the NZ tax authorities have undertaken credible and extensive structural reform initiatives aimed at fundamentally restructuring the local economy away from borrowing, consumption and fiscal spending towards savings, productive investments and exports. Fitch will further assess the macroeconomic impact of these measures, as well as the progress and implementation of further deliberations by the Savings Working Group. The social implications of ongoing tax and benefit reforms suggest they will require strong political consensus to carry forward and time to take effect on household behaviour. In a further positive development, the composition of banks funding has changed, due to the central bank's introduction of the prudential liquidity policy as well as more expensive wholesale funding costs. This should serve as a cap on short-term external financing and put upward pressure on deposit rates to attract more savings.

NZ's ratings remain supported by strong credit fundamentals including the high quality of public institutions and governance, a credible commitment to low inflation, and track record of policy and structural adjustment.

Potential triggers for a downgrade include accelerated household re-leveraging, especially if further external borrowing pushes the CAD and NIIP further into deficit and heighten risks to financial and economic stability. A slower-than-expected pace of fiscal consolidation would also increase pressure for a downgrade. Conversely, the case for a revision of the Outlook to Stable would be supported by the prospect of a sustainable rebalancing of the economy with evidence of a stabilisation or decline in net external indebtedness in line with lower external borrowings and higher net domestic savings.