1. Whither the New Zealand Dollar Dr. Shamim Shakur Dept. of Economics and Finance College of Business Massey University Palmerston North Tel: 06 350 5799 x 2556 email:s.shakur@massey.ac.nz Presentation to Professional Development Programme for Economics Teachers, Palmerston North, 19 November 2008

2. 2 Published articles on exchange rate Pech, A, Obben, J. and Shakur, S. (2006) “Analysis of the relationship between the Share Market performance and exchange rates in New Zealand: A cointegrating VAR approach,” New Zealand Economic Papers, Vol 40, No. 2, pp. 147-180. Shakur, S., Obben, J., and Nugroho, A. (2005) “Financial Sector Reforms and Currency Crisis: The Indonesian Experience,” Review of Applied Economics, Volume 1, No. 2, pp. 171-182. Shakur, S. (2002) “Asian Financial Crisis and Bangladesh”, Jahangirnagar Economic Review, Vol. 12, No. 1, pp. 1-9

3. 3 Chronology of NZD/USD 1840-1967: The pound was the currency of NZ July 1967: US$1.39=NZ$1 (NZD’s initial peg to USD); Dec 1971: US$1.216=NZ$1. March 1985 US$ 0.4444 = NZ$1 (NZD floated); 22 November 2000: US$ 0.3922=NZ$1 (post-float minimum) 27 February 2008: US$ 0.8213 = NZ$1 (post-float maximum) 18 November 2008: US$ 0.5505 = NZ$1

4. 4 NZD-USD Exchange Rate (1967-2008) Source: Global Financial Data. 2008 figures as of 14/11/2008

5. 5

6. 6 Why Would the Value of NZD Change? Four possible causes: –changes in current accounts –changes in relative incomes –changes in relative price levels –changes in real interest rates

7. 19/11/2008Dr S Shakur7 The current account NZ’s current account records trade in goods and services. It consists of balances on –merchandise trade (goods) –services (e.g. tourism, education) –income (e.g. dividends and interest payments) –transfers.

8. 19/11/2008Dr S Shakur8 How Bad is NZ’s Current Account Deficit? BadTerrible

9. 9 NZ’s dismal Current Account Balance The last time that New Zealand had a current account surplus was 1973

10. 19/11/2008Dr S Shakur10 The Problem is not NZ’s Merchandise Trade

11. 19/11/2008Dr S Shakur11 Are current account deficits a bad thing? NZ has experienced a current account deficit (CAD) in every year since 1980. NZ has experienced a current account deficit (CAD) in every year since 1980. This means New Zealanders spend more than the income they generate, so foreigners are accumulating NZ assets. This means New Zealanders spend more than the income they generate, so foreigners are accumulating NZ assets.

12. 19/11/2008Dr S Shakur12 Should we be concerned? The amount of foreign liabilities is not a concern provided the debt can be serviced (just like a housing loan). This is more likely if liabilities have been incurred to generate income. The amount of foreign liabilities is not a concern provided the debt can be serviced (just like a housing loan). This is more likely if liabilities have been incurred to generate income. In NZ, foreign debt has been used to feed consumption expenditure or purchasing houses. That can be a problem. In NZ, foreign debt has been used to feed consumption expenditure or purchasing houses. That can be a problem.

13. How does Current Account Deficit affect NZ dollar? What does history tell us? Lessons from the Asian Economic Crisis of 1997-98

14. 19/11/2008Dr S Shakur14 NZ's Current Account Deficit Problem- Then

15. 15 Countries with Current Account Problems during Asian crisis

16. 19/11/2008Dr S Shakur16 NZ: A tale of two halves

17. What about the Other Stuff? Recall the four causes of exchange rate variations: changes in current accounts changes in current accounts changes in relative incomes changes in relative price levels changes in real interest rates.

18. 18 Relative GDP growth (1990-2008)

19. 19/11/2008Dr S Shakur19 U.S. recession alone may affect ANZAC currencies

20. 20 Latest forecast on NZ growth and OCR http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10543431 Recession in NZ will 'hit trough mid-2009' The NZ Herald, Monday Nov 17, 2008. Goldman Sachs JB Were predicting lower economic growth and the official cash rate (OCR) to be at 3.5 per cent by the middle of 2009. It was also hinting at the possibility the OCR will be cut by 1.5 per cent next month. "Consensus forecasts (of economic growth) for 2008 and 2009 are 0.5 per cent and 0.6 per cent respectively (from 3.2 per cent in 2007)…”

21. 19/11/2008Dr S Shakur21 Recession and growth forecast “The economy has contracted in each of the first three quarters of this year and ANZ National Bank expects next year to be weaker still, with unemployment to rise to 6.5 per cent (from 4.2 per cent now).” Source: NZ Herald, Tuesday Nov 18, 2008 Source: NZ Herald, Tuesday Nov 18, 2008

22. 22 Inflation: Purchasing Power Parity (PPP) “ Exchange rates would adjust until a basket of tradable goods cost the same in all countries” PPP is a long-run phenomenon PPP highlights significance of inflation. NZ’s CPI inflation averaged around 12% in the 1970s and 11% in the 1980s. During1990-2008, this averaged around 2.5% with an upward bias in later years.

23. 23 NZ Inflation (1970-2008)

24. 19/11/2008Dr S Shakur24 Inflation is hitting max (3%) tolerance level

25. 19/11/2008Dr S Shakur25 Exchange rates and inflation

26. 26 NZ’s Interest rate In the past, high interest rate, highest among OECD countries contributed to high NZ dollar This is changing fast.

27. 27 Role of carry trade Under this strategy, an investor borrows a given amount in a low- interest-rate currency (the "funding" currency), converts the funds into a high-interest-rate currency (the "target" currency) and lends the resulting amount in the target currency at the higher interest rate. When interest gap narrows, reverse currency flow to be expected.

28. 19/11/2008Dr S Shakur28 Recent literature on carry trade Galati and Melvin (2004): AUD and NZD, two currencies with relatively high interest rates, simultaneously had extended periods of appreciation against low-interest-rate currencies, such as USD and the yen. McGuire and Tarashev (2006) supports this view.

29. 19/11/2008Dr S Shakur29 Yen carry trade The NZ dollar is a favourite of yen carry trade. Investors borrow money in Japan, where the benchmark interest rate is 0.5 percent and invest in nations with higher borrowing costs. NZ's key rate (OCR) hit a record 8.25 percent (Bloomberg, 2 Aug. 2008). The interest rate gap is narrowing.

30. 30 Interest rate gap is narrowing

31. 31 NZ short term interest rates (1999-2008)

32. OCR predictions RESERVE BANK OCR Early 1999: 4.5 per cent (minimum). Mid-2007 until July 2008 it was 8.25 per cent Currently (Nov 2008): 6.5 per cent. HOW LOW WILL IT GO? *ANZ National Bank: 4 per cent by April 2009. *Bank of New Zealand: 4.5 per cent, maybe lower. *Deutsche Bank: 4.5 per cent, maybe lower. *ASB: 5 per cent, then wait and see. Source: NZ Herald, Tuesday Nov 18, 2008

33. What does all these mean? NZ dollar is expected to depreciate, a process that has already started in 2008

34. 34 Currency depreciation myths A low dollar is not a solution to economy’s problems: Price competitiveness and non-price competitiveness Short-term and long-term competitiveness Effect on primary commodity exporters like NZ is a mixed bag

35. 19/11/2008Dr S Shakur35 International Competitiveness Michael Porter’s definition: “….goods and services that meet the test of international markets while simultaneously maintaining or expanding real incomes of its citizens.” Currency depreciation will not necessarily enhance New Zealand’s international competitiveness.

36. 19/11/2008Dr S Shakur36 THANKS