The IMF suggests the Reserve Bank adopt a debt-to-income limit to reduce the risks from a still-heavily indebted household sector. Thomas Coughlan reports.

New Zealand has enjoyed strong economic expansion and housing-related vulnerabilities have recently stabilised. 

But the IMF is still concerned about household debt and the effects of the country’s inflated housing market despite the strong economic outlook, said Thomas Helbling, IMF Division Chief for Asia and Pacific.

The Foundation is also lukewarm in its support for the Government’s currently restrictive stance of reducing net Government debt to 20 percent of GDP.

“Household debt remains high under the baseline outlook and would amplify the impact of large downside shocks, notwithstanding recent improvements in its risk structure after macroprudential policy intervention. Such shocks could also trigger a disruptive housing market correction,” the IMF said in its Article 4 consultation statement.

Helbling said the Reserve Bank’s use of loan-to-value ratio (LVR) restrictions had succeeded in moderating the housing market, but suggested that the further restrictions to LVRs would be less effective and suggested the bank add a debt-to-income instrument to its toolkit instead of tougher LVR rules.

Independent economist Cameron Bagrie agrees. 

“If the market keeps going up, it dilutes the power of the LVR tool, whereas a debt to income instrument doesn’t get caught up in the movements of the property market per se,” Bagrie said.

“If the market is still as strong as an ox then an LVR instrument just gets seriously diluted because the market keeps moving up,” he said. 

Bagrie agreed with the overall positive characterisation of the economy.

“If you look at NZ in spirit the foundations of the house look pretty good, but we do have a couple of problem children. That doesn’t mean they’re unruly children, they’re just challenging children,” Bagrie said. 

“Household debt levels are high and that is a vulnerability across New Zealand,” he said. 

But the combination of LVRs and the banks reining in credit through “tough love” had taken some of the heat out of the housing market, which was a positive sign.

“It’s really important because historically New Zealand tends to go a little bit too hard for too long at the top of the cycle. And if you go too hard for too long at the top of the cycle, it tends to require a visit from the Grim Reaper,” he said. 

The IMF identified the main risks to New Zealand as an economic slowdown in developed countries and China, or the fallout from increasing protectionism.

Budget responsibility rules all about trade-offs.

Helbling also expressed lukewarm support for the Government’s budget responsibility rules, specifically its goal to get Government debt to 20 percent of GDP. The target has come under fire recently with economists saying that the Government should take advantage of extremely low borrowing costs to invest in much-needed infrastructure. 

“There’s a trade-off between prudence and macroeconomic needs,” said Helbling.

New Zealand has a very low ratio of Government debt to GDP, a standard measure of comparing national debt internationally. New Zealand’s debt-to-GDP ratio reported in last-year’s HYEFU from Treasury was around 22 percent of GDP. Government debt in developed countries sits around 70 percent of GDP on average. 

But Helbling suggested the Government’s prudence could be justified by factors unique to New Zealand. 

“We understand the preference for prudence and to be able to respond to shocks. New Zealand given the size of its economy and location is a bit more vulnerable, and in that sense to have some fiscal prudence is useful,” he said.

Higher debt target would be ‘chump change’

But Bagrie disagrees.

“I just cannot understand this fixation with debt of 20 percent of GDP,” Bagrie said. 

“The RB is supposed to have inflation around 2 percent. We give them a fair bit of wriggle room, why don’t we have the same wriggle room in regard to the debt objective?” he said. 

Bagrie said that there was a danger that the “debt narrative” had shifted discussion away from what good Government policy should be about.

“Good policy should never be sacrificed for a debt target when you’ve got debt levels at this level,” Bagrie said.

“New Zealand’s debt levels are absolutely world class, even if its 25 percent of GDP it’s chump change,” he said.  

Helbling said it was positive that the Government was looking at other ways of funding infrastructure.

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