Could NZ’s economy survive if faced with a China crisis?
I
n July 2018 China’s economy falters sending shockwaves through the global banking sector. Commodity prices plunge and the world faces its first global financial crisis since the meltdown of
2008.
What happens next is pretty ugly for most New Zealanders — job losses, soaring mortgage rates, falling house prices and a sharp recession.
As a forecast it would be unnecessarily gloomy, although not implausible.
But the grim situation painted by NZ Treasury is not meant to be a prediction — it is a model designed to offer a stress test of our economy under extreme conditions.
A Chinese financial crisis is one of three “large but plausible shocks” modelled by Treasury in its 2018 Investment Statement, along with a major Wellington earthquake and an outbreak of foot and mouth disease.
So what happens next in the event of a Chinese economic meltdown?
The first thing that New Zealand would see is a dramatic fall in demand for our exports. The terms of trade drop 20 per cent. The value of the Kiwi dollar plunges 13 per cent.
For most New Zealanders that means the cost of imported goods, like iPhones and overseas travel spikes.
But that’s not the really ugly bit. Disruption to global debt markets would push local funding costs up by
3 per cent, Treasury says.
In other words interest rates would soar — bad news for homeowners who aren’t on fixed rates.
Treasury’s model sees this flowing through to sharp falls in property prices and on the sharemarket.
In fact they estimate the cost of the revaluation to assets and liabilities at $30 billion.
Nearly $20b of that would be due to a 40 per cent crash on the stock exchange both here and around the world — devastating news for KiwiSavers.
For homeowners the immediate price fall would be about 10 per cent — as we saw in the last GFC — survivable for most unless you are under pressure to sell.
But similar falls in commercial property and farm prices would put additional stress on the economy.
Meanwhile, the uncertain outlook would drive a decline in consumer and business confidence. Both retail spending and business investment would fall. Then firms would start cutting jobs.
Some 60,000 jobs would be lost in
2019, with unemployment spiking to
7.4 per cent — the highest level since
1999. It is currently 4.4 per cent. The Reserve Bank (RBNZ) would attempt to ride to the rescue of course.
You could expect to see the RBNZ cut rates by half a per cent in its September review to 1.25 per cent, Treasury estimates. The RBNZ would likely keep cutting over the next six months until the official cash rate was at, or near, zero.
From here the news gets a little better. And — as we saw during the
2008 GFC — the economy has the strength and flexibility to bounce back.
The rate cuts couldn’t prevent a recession in the March quarter of 2019.
But while demand for goods exports remains low, the depreciation in the dollar means the annual value stays on target.
“Record low interest rates and an improvement in the economic outlook leads to a pickup in business confidence, driving a strong increase in business investment,” Treasury says.
Life would still be tough for workers.
“Employment growth and consumer spending remain soft throughout.”
In the final wash-up, the financial downturn would cost the Crown $157b across five years.
Net debt would rise to 33 per cent of GDP after five years — 15 per cent higher than 2017 forecasts.
But ultimately the economy would pass the test.
Treasury notes that these stress tests are designed to assess whether severe but plausible shocks could have impacts that are beyond the financial capacity to absorb, thus putting the provision of public services at risk.
“The scenarios chosen are almost certain not to accurately reflect any future shock or combination of shocks that occurs.”