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Treasury: This is what NZ's next financial crisis could look like

Treasury: This is what NZ's next financial crisis could look like

Scenario shows businesses need to manage exchange rate changes, but can expect an earlier recovery than consumers

Equity and property markets plummet in Treasury's next crisis scenario

Equity and property markets plummet in Treasury's next crisis scenario

Treasury modelling of a scenario for the next global financial crisis, one driven by a "sharp unwinding" of vulnerabilities in China, includes ugly impacts including falling property values and 60,000 more unemployed.

Treasury's scenario, revealed in papers released to Parliament this week, starts in July, when a China crisis leads to reduced global growth, disruption in global bank funding markets and a sharp decline in commodity prices.

The modeling runs through until 2022.

"Reduced global growth softens demand for our exports and leads to a 20 per cent drop in New Zealand’s terms of trade," Treasury states. "The NZ$-trade weighted index depreciates by 13 per cent and remains around this level for the rest of the forecast period."

Due to disruption in global funding markets, New Zealand funding costs increase by approximately 300 basis points, suppressing credit growth and, combined with the much weaker New Zealand outlook, driving falls in property and equity markets.

Assets and liabilities are revalued down by around $30 billion, $19 billion from equity prices in both New Zealand and other developed markets and $12 billion from falling property prices. A depreciating NZ dollar, however, helps to offsets these fall by $2 billion.

"The soft outlook and uncertainty drives a decline in consumer and business confidence and leads to a delay in spending," the model shows.

Consumer spending and business investment both fall, by two percentage points and five percentage points respectively in the December 2019 year.

Firms also slash their work forces by 60,000 people in the December 2019 year and the unemployment rate rises to 7.4 per cent, the highest rate since 1999.

Reseller failures were rare locally in the wake of the 2007 crisis, with that of McLean Computing a standout, but even then the GFC was only one factor among many.

Meanwhile, distributors had already tightened their processes ahead of the crash, ensuring any issues did not spread through the channel ecosystem.

They used credit searches and increased due diligence as well as sometimes taking insurance out against default. As long as those processes haven't loosened in the interim, both resellers and distributors should be well placed to manage another slump.

Given another of the forecast scenarios, they will also need to prepare for significant and possibly quick changes in local and global exchange rates.

Impacts of a new GFC, starting in July, were modeled through to 2022
Impacts of a new GFC, starting in July, were modeled through to 2022

One issue that shouldn't reoccur, thanks to new financial market regulations, is the wholesale collapse of heavily geared and sometimes badly operated finance companies. A count by Interest.co.nz says 67 of these collapsed up to 2012, exacerbating the local crisis.

Under questioning before Parliament's Finance and Expenditure Committee earlier this month, Tim Ng, deputy secretary and chief economic advisor at Treasury, said a crisis similar in scale to the 2008 GFC would be needed to generate the kinds of effects modeled.

"It’s probably more than catching cold, I’d say, is the scenario we have in mind," he said. "What we have in mind is a realisation of the chatter about the Chinese financial system and the credit exposure in the Chinese financial system."

Treasury modeled three crisis scenarios in all to stress-test the fiscal system: a foot-and-mouth disease outbreak, a major earthquake, as well as an international financial downturn.

"We’re trying to characterise the big shocks that could hit New Zealand, like the ones we saw a few years ago— and we had two at once, actually — and so it’s using that experience and trying to be more quantitative about how much room do you have, how much room should you keep, and how much petrol you should keep in the tank, type of thing," Treasury adds.

The model also includes likely response and recovery scenarios.

To stimulate demand, the Reserve Bank reduces the cash rate by 50 basis points in the September 2019 quarter, before continuing to reduce it to zero per cent over following six months.

However, easier monetary conditions would not be expected to prevent the New Zealand economy from entering into recession in the March 2019 quarter.

While demand for goods exports remains low, the depreciation in the NZD, means the annual value of goods exports recovers in early 2020. Record low interest rates and an improvement in the economic outlook leads to a pick-up in business confidence, driving a strong increase in business investment.

However, employment growth, whilst turning positive in the later years, and consumer spending remain soft throughout.

Overall, nominal GDP is a cumulative $92 billion lower over the forecast period, driving tax revenue down by $30 billion, while overall fiscal losses to government are $127 billion.


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