Why the RBNZ’s balance sheet has become such a behemoth
Manalysis
uch has been made in the lead-up to the May 30 Budget of the fact the Government’s books are “structurally” in deficit.
It issued a whole lot of debt in response to the pandemic. It’s been unable to repay that debt, so has renewed it at an increasing cost, as interest rates have risen.
The books need to get back in surplus for the Government to start paying down debt.
Anyone reading this is probably broadly aware of the situation.
The thing that’s less understood is how the plumbing of the financial system has fundamentally changed since Covid.
The value of assets held by the Reserve Bank (RBNZ) has quadrupled since 2019, peaking at $104 billion in February last year, and inching down to $95b by March this year.
By way of context, $95b is almost five times that which is spent on New Zealand Superannuation every year and is equivalent to nearly a quarter of the country’s gross domestic product (GDP).
There arguably isn’t too much need for your average person to concern themself with this behindthe-scenes stuff.
But as is the case with our electricity system or network of water pipes, it pays to keep tabs on the state of critical infrastructure, as the consequences of something going wrong can be major.
So, why has the RBNZ’s balance sheet become such a behemoth?
1 Covid-era money printing to lower interest rates Bond-buying
In 2020 and 2021, the RBNZ created money to buy $59b of debt (New Zealand Government Bonds and some Local Government Funding Agency bonds) from banks via its “Large-Scale Asset Purchase” programme.
This helped calm traders in financial markets, who were worried at the start of the pandemic about what would happen to the bond market if the Government issued a seismic amount of debt to pay for the pandemic response.
The RBNZ becoming such an active player in the bond market also helped suppress bond yields, which ultimately affect mortgage and term deposit rates. The RBNZ wanted rates to be low to encourage more borrowing and less saving.
Once the RBNZ realised its work stimulating the economy (too much) was done, it got the Treasury to agree to start buying the bonds back and retiring them.
By 2027, all the bonds bought with the money the RBNZ printed will either have matured or been bought back by the Treasury.
This will shrink the size of the RBNZ’s balance sheet, making it more palatable for it to print money again in a future crisis.
The issue is, this whole exercise, which supported the economy through the peak of the pandemic, is now costing taxpayers.
The Treasury is having to borrow more (in a high interest rate environment) to get the funds to buy the bonds back from the RBNZ. The rise in interest rates has also seen the value of the bonds the RBNZ bought fall. The Treasury is sending money the RBNZ’s way every month to cover the cost of these losses, ultimately expected to total about $11b.
Lending to banks
The RBNZ also created $19b, which it lent to banks through 2021 and 2022. It charged them interest at the official cash rate, which was initially very low.
Banks have since started repaying these loans, issued under the “Funding for Lending” scheme, which is boosting the RBNZ’s assets.
Taking a step back, it’s highly debatable whether going as big on money printing as the RBNZ did was worth it.
The Funding for Lending programme is deemed by many experts to have been unnecessary, while some have argued — in hindsight — the RBNZ didn’t need to buy as many bonds as it did.
2 Building of foreign reserves
The second reason why the RBNZ’s balance sheet has grown is because of something entirely different.
The RBNZ is buying up foreign currencies, or assets tied to foreign currencies, to give itself the firepower to intervene in the currency market if there’s a crisis.
In March, the RBNZ’s foreign currency intervention capacity sat at nearly $21b — a big jump from March 2023, when it sat at $12b.
The RBNZ is partly buying the foreign assets using money it’s printing. It hasn’t told the market how much it ultimately wants to increase its intervention capacity by, but the market expects the process to take some years.
The RBNZ’s gradual buy-up is being executed with little fanfare or debate. It’s working within a framework agreed to with the former Government, which is publicly available. A central bank having the ability to intervene in the currency market if necessary is generally seen to be prudent.
So what?
Like with the bonds the RBNZ bought during the pandemic, the risk is that its foreign assets fall in value, and the Treasury (ie the taxpayer) is called upon to cover the cost of the loss.
The RBNZ would argue it’s minimising the risk using hedging and any losses are the price one has to pay to take out what’s effectively insurance for a crisis. Again, this is serving an entirely different purpose to the bond-buying or lending to banks done in response to Covid. But in all cases, the RBNZ has become a very active player in the market.
A larger balance sheet means it’s more exposed to interest rates and foreign exchange rates changing.
The RBNZ would argue taking on this risk is worth it, if not necessary, to give itself the muscle to do its jobs maintaining price stability and financial stability.
Provided the Treasury keeps buying the bonds back from the RBNZ without any problems, banks keep repaying the RBNZ for the loans they took out, and the RBNZ continues buying foreign assets without upsetting the market, there shouldn’t be any problems going forward.
However, growing a balance sheet as quickly as the RBNZ did, before unwinding it, is unprecedented for New Zealand, and not risk-free.