This Selected Issues paper analyzes the underlying factors that explain the behavior of the Kiwi dollar. The findings suggest that the factors influencing the New Zealand dollar have been changing. The paper discusses that as New Zealand has become more integrated in global capital markets over time, the Kiwi dollar has become less of a commodity currency and more of a global currency that is influenced by interest rate spreads and global risk factors. The paper also looks at the strong preference for housing over financial assets exhibited by New Zealand households.


This Selected Issues paper analyzes the underlying factors that explain the behavior of the Kiwi dollar. The findings suggest that the factors influencing the New Zealand dollar have been changing. The paper discusses that as New Zealand has become more integrated in global capital markets over time, the Kiwi dollar has become less of a commodity currency and more of a global currency that is influenced by interest rate spreads and global risk factors. The paper also looks at the strong preference for housing over financial assets exhibited by New Zealand households.

III. Analysis of Vulnerabilities30

52. This chapter assesses New Zealand’s economic vulnerabilities from two angles: the external position of the country, and the financial health of the different sectors of the economy. These two angles are related, because the willingness of foreign investors to continue to finance New Zealand’s external position hinges on the financial health of the various economic sectors. The health of the banking sector is especially important, given the large share of banks in recent external borrowing.

53. New Zealand does not face major vulnerabilities, although the high and growing exposure of some economic sectors to the housing market needs to be closely monitored. Foreign liabilities continue to grow, but liquidity and currency risks are contained, as borrowers are predominantly highly-rated banks, about half of external debt is denominated in domestic currency, and almost 90 percent of the remaining foreign currency debt is hedged. Banks and non-bank lending institutions are financially sound and have proven in the past to be resilient to large swings in exchange rate and interest rates. Nevertheless, their growing exposure to the household mortgage sector needs to be closely monitored. Households are also highly exposed to the housing market, and their debt service burden has grown considerably, implying greater vulnerability to increases in interest rates, rises in unemployment, and falls in house prices. Nonetheless, aggregate balance sheets of the households are strong, and these vulnerabilities should not pose a threat to systemic stability.

A. External Position

54. Driven by the private sector, net foreign liabilities and gross external debt continue to edge up. Net foreign liabilities increased from 77 percent of GDP at end- March 2003 to 89 percent at end-2006 (Table III.1). This level is high compared to other industrial countries, but similar to the level that prevailed in New Zealand during most of the 1990s. Gross external debt increased from around 84 percent of GDP in late 1990s to around 117 percent in 2006.31 This growth in debt was on account of the private sector, as gross external debt of the official government fell from 20 percent of GDP in 1998 to 10 percent in 2006. The current account deficit peaked at 9.7 percent of GDP in June 2006, and then declined slightly later in the year. This is larger than most estimates of the “sustainable” current account deficit, and increases the probability of an abrupt and costly external adjustment in the future (Edwards, 2006).


Net Foreign Liabilities in Percent of GDP, End-March 2006

Citation: IMF Staff Country Reports 2007, 151; 10.5089/9781451830354.002.A003

Table III.1

New Zealand: Key External Vulnerability Statistics

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Sources: Statistics New Zealand and Fund staff estimates.

55. Banks account for most of the recent external borrowing. Much of the recent increase in debt is due to New Zealand banks’ funding of mortgage lending, typically by tapping international capital markets in U.S. dollars (USD).32 The highly liquid swap market in New Zealand dollars (NZD) enables banks to manage their exchange rate and interest rate risks. Most new mortgage loans have interest rates that are fixed, yet New Zealand banks tend to borrow at floating rates. To match liabilities and assets, the banks use cross-currency swaps, selling the USD funds they have raised for NZD, and at the same time, exchanging their USD floating rate debt for NZD debt with a fixed interest rate. The swap rate that banks pay on the NZD debt represents the marginal cost of New Zealand dollar funding for banks and is used to price fixed-rate mortgages. Banks now account for almost 60 percent of total gross external debt, as their external debt more than doubled as a percentage of GDP since late 1990s, to reach 66 percent of GDP at end-March 2006 (Table III.2).

Table III.2

New Zealand: Decomposition of Gross External Debt 1/

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Sources: Statistics New Zealand; and Fund staff estimates.

Based on the International Investment Position and the “Overseas Debt Survey” comprising all official organizations known to have external debt, and corporates with external debt greater than $NZ 50 million.

Breakdown unavailable for data published in the IIP of March 2000. Thus, prior to 2001, ratios to total debt from the Overseas Debt Survey of March 2000 are applied to the revised total debt data.

From 2001, short-term maturity data reclassified to include debt maturing in one year.

56. Despite the high level of external debt, liquidity and foreign currency risks are contained by a number of factors. In December 2006, 51 percent of external debt was short-term, similar to the average level of the past five years. However, liquidity risks are limited by the financial strength of banks (Section B). The foreign currency component of external debt has declined slightly to 46 percent of total debt at end-2006. The risks from foreign currency exposure are mitigated by a substantial degree of foreign exchange hedging33 In March 2006, 89 percent of New Zealand’s total foreign currency denominated external debt was hedged, either by financial derivatives or against financial assets or receipts.

B. Sectoral Analysis of Vulnerabilities

Banking Sector

57. The banking sector dominates the New Zealand’s financial system (Table III.3). Banks account for about 74 percent of total financial system assets, and this share is now higher than in the early 1990s (around 70 percent). The health of the banking system is therefore critical for the overall stability of the financial sector. The system remains concentrated, with the largest bank holding 35 percent of total assets, and the four largest banks (all Australian-owned) holding 88 percent of total assets of the banking system.

Table III.3

New Zealand: Structure of the Financial System

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Source: Reserve Bank of New Zealand (RBNZ)

58. New Zealand’s banking sector continues to perform strongly (Table III.4). Despite continued competitive pressure on lending margins, banks remained solidly profitable in the first half of 2006, with an aggregate return on assets of 1.2 percent, and an aggregate return on equity of 14.6 percent. The banks are well capitalized, maintaining total capital adequacy ratios above 10 percent, and tier-one capital averaging above 8 percent of risk-weighted assets.34 Banks maintain high asset quality, with the ratio of impaired assets to total assets remaining at 0.2 percent during the past four years, well below levels in other developed countries. Those impaired assets that do exist are adequately provisioned. Efficiency indicators have been improving, with the ratio of operating costs to income decreasing from 55 percent in 2000 to 46 percent in 2006.

Table III.4

New Zealand: Financial Soundness Indicators of the Banking Sector

(In percent)

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Source: RBNZ.

Data for end-June.

Tier I capital includes issued and fully paid common equity and perpetual non-cumulative preference shares, and disclosed reserves.

For systemically important banks.

59. The overall strength of the banks in New Zealand is reflected in their high credit ratings. Banks accounting for 95 percent of total banking system assets have a rating of AA-from Standard and Poor’s, implying the cumulative probability of default of less than 1 percent over a 5-year horizon.35 In addition to sound asset quality and strong capitalization, these high credit ratings reflect in part the strength of Australian parent banks, for whom the New Zealand operations comprise about 15 percent of total assets.36 The share performance of the largest banks was strong in 2006, with the banking component of the NZX50 index outperforming the index as a whole.


S&P Credit Ratings for Registered Banks

Citation: IMF Staff Country Reports 2007, 151; 10.5089/9781451830354.002.A003

Source: RBNZ

New Zealand Banks’ Share Performance in 2006

Citation: IMF Staff Country Reports 2007, 151; 10.5089/9781451830354.002.A003

Source: New Zealand Exchange (NZX)

60. The main potential vulnerability of the banking system is related to the increase in banks’ exposure to the household mortgage sector. Residential mortgage loans increased at an average annual rate of about 16 percent during the last four years, and the share of mortgages in the aggregate credit portfolio of New Zealand banks increased from 35 percent in 2001 to 45 percent in 2006. This concentration of loans exposes the banking system to any event that damages the ability of households to service debt (such as an increase in interest rates or unemployment), and to a large and rapid depreciation of property values. In addition, intense price competition in the mortgage market has diminished banks’ margins, and there are concerns that lending competition may have led to a decrease in lending standards. However, while banks have recently begun to use more actively new higher-risk lending products, such as “low doc” and “100 percent” loans, the extent of subprime lending appears to be on a relatively limited scale.37 Another area of concern is lending for investment properties, especially in the circumstances where many properties are expected to generate negative cash flows, an issue that also arises in the farm sector.38

61. There is little concrete evidence to date that the quality of existing loans has deteriorated, but the situation needs to be closely monitored. Corporate and mortgage lending increased by about 23 percent between January 2005 and June 2006, and NPLs increased at a similar rate, so the impaired assets ratio remained stable, which is typical during periods of strong credit growth. Nonetheless, there is some risk of a deterioration in bank asset quality if the economy slows. However, the results of the Financial Sector Assessment Program (FSAP) and more recent stress testing suggest that even quite large shocks should not create problems for stability (see section on stress testing below). Bank lending practices ended to be very conservative in the past, and many mortgages have features that forestall foreclosure in case of temporary income reductions or unemployment, reducing risks to collateral values. Most important, the aggregate level of impaired assets is extremely low, and aggregate regulatory capital (Tier I and Tier II) covers over 12 percent of all mortgages, allowing the banks to withstand a significant deterioration of loan quality.

Non-bank Lending Institutions

62. Non-bank lending institutions are small, and at the moment do not pose a systemic risk. Deposit taking and lending in New Zealand is done by over 200 non-bank institutions, such as building societies, the Public Service Investment Society (PSIS), finance companies, and credit unions. Although their share in the financial system has grown significantly over the past 5 years, they remain small, with total assets of about 10 percent of banking system assets (Table III.3). The differentiation between the bank and non-bank sector is clearly perceived by the public, so problems in non-bank lenders are unlikely to undermine the confidence in banks. This lack of contagion risk was underscored by the failure of three finance companies in 2006, which had no noticeable impact on the banking system. All three failed companies specialized in secured lending on second-hand cars, and their failures appear to have been caused primarily by poor credit risk management.

63. The main concerns for the soundness of non-bank lending institutions are related to their high exposure to the housing sector. The share of housing loans in total NBFI lending increased from 26 percent at end-2004 to 33 percent in late 2006 (Table III.5). The exposure of some finance companies to high-risk property development lending is seen as a potential risk by the RBNZ.39 In addition, the funds of non-bank lending institutions have on average shorter maturity than their assets: 81 percent of liabilities have maturity of less than 1 year, compared to 62 percent of assets (Table III.6). While it is not unusual for financial institutions to have a maturity mismatch, the mismatch appears to be particularly large for the savings institutions, many of whom have over half of liabilities with maturity of less than three months. However, given that most these institutions have stable profits and low impaired assets, these problems should not present a significant risk in the near future.

Table III.5

New Zealand: Lending by Non-Bank Financial Institutions

(Share of total NBFI lending, in Percent)

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Source: RBNZ.
Table III.6

New Zealand: Maturity Structure of Claims and Funding by Non-Bank Financial Institutions

(Share of total, in Percent)

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Source: RBNZ.

64. The proposed changes to the regulatory framework for NBFIs should help the public better assess the relative risk of different institutions. As part of the Review of Financial Products and Providers, a number of consultation papers outlining proposals for the reform of financial sector regulation (including NBFIs) were released in September 2006.40 With respect to non-bank deposit takers, the proposals would involve a two-tiered structure of Authorized Deposit Takers (ADTs) and other deposit-takers. Any deposit taker would be able to become an ADT, provided they meet the licensing and other supervisory requirements. ADTs would then be supervised by the RBNZ using a framework similar to that for registered banks. Other deposit takers would be supervised by trustees under strengthened trustee arrangements, and would be required to disclose prominently that they do not have an ADT status.

Corporate Sector

65. New Zealand’s corporate sector appears to be in good financial health. Rates of return on assets and on equity have eased from their peaks in 2002, but remain at comfortable levels (Table III.7). Capitalization is strong, aggregate liquidity is sufficiently high, and interest coverage is healthy. In the second half of 2006, business confidence rebounded to 18-month highs, driven by lower oil prices and by the economic slowdown turning out to be short-lived. Nevertheless, profit margins have come down as the cycle matured, and corporate financial health can be expected to decline somewhat in near term, but this is unlikely to fundamentally affect companies’ liquidity and solvency.

Table III.7

New Zealand: Corporate Sector Indicators

(Aggregate Ratios for Non-Financial Companies, in Percent)

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Source: Statistics New Zealand, and Fund staff calculations.

Earnings before interest, taxes and depreciation divided by interest payments


66. Household indebtedness continues to grow. Driven by a combination of favorable financial conditions and rising house prices, household indebtedness increased by about 50 percentage points since 2000, to reach 160 percent of disposable income in 2006 (Table III.8). Housing accounted for about 75 percent of total household assets and over 90 percent of household debt in 2006, while holdings of equity and other financial assets were relatively low by OECD standards (see Chapter II). Household gearing has remained relatively stable, with total debt of around 20 percent of total assets. Debt servicing costs increased from 8½ to 13 percent of disposable income, one of the highest levels among industrial countries (OECD, 2006). Debt service burdens are likely to increase further in the near-term, as about one third of all mortgages are due to be re-priced at higher rates during 2007.

Table III.8

New Zealand: Household Sector Balance Sheet Indicators

(As of December, in percent of annual disposable income)

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Source: RBNZ; Statistics New Zealand; and Fund staff estimates.

Figures refer to year beginning in April, and ending in March of the subsequent year. The household savings data are under review by Statistics New Zealand.

67. Heavy exposure of households to the housing market is a cause for some concern. High leveraged exposure to a “lumpy” and illiquid asset increases the vulnerability of households to rises in interest rates and unemployment and falls in house prices.41 Some analysts suggested that the recent rise in house prices can be fully explained by an adjustment to a new set of fundamentals, such as the higher top personal tax rate and the lower long-term interest rates.42 Nevertheless, affordability of housing has decreased dramatically in recent years, with the median house price reaching 7½ times the average annual income by end-2006. House prices are also at historically high levels relative to rents. Given the likely increase of mortgage servicing costs in the near-term due to increasing interest rates as mortgages re-price, there is a possibility that house prices may decline in the future. However, until now the housing market has proved to be quite Source: Real Estate Institute of New Zealand (REINZ), SNZ, and RBNZd resilient, with house price inflation remaining at 9 percent in early 2007.

68. However, this vulnerability should not present a threat to systemic stability. Rising house prices have increased the value of housing assets from 332 percent of disposable income in 2001 to 574 percent in 2006, substantially raising the net worth of the households. Research shows that in the short-run, financial wealth and housing wealth reduce the effect of household indebtedness on arrears – in other words, wealth tends to be used as a buffer in case of unexpected shocks (Rinaldi and Sanchis-Arellano, 2006). Even if house prices fall, the banks should be able to recoup the mortgages, as long as borrowers have positive equity in their houses. In New Zealand, strong growth of housing values in recent years has created a substantial buffer, so that house prices would need to fall by over one third to reduce the aggregate net housing assets to the end-2001 level.

69. Vulnerability to interest rate pressures is concentrated in a small share of households. Similarly to other OECD countries, most household debt is held by higher-income households, who have the lowest debt service ratios (OECD, 2006). The 2004 Household Economic Survey reported that only about 8 percent of total household debt was held by households in the lower 40 percent of income distribution. Furthermore, only one-tenth of borrowers (representing about 3 percent of households) had total spending on housing exceeding 50 percent of disposable income, and were therefore highly sensitive to mortgage rates.43

Stress Tests

70. The results of stress tests conducted during the FSAP indicated that, although some households were vulnerable to interest rate increases, this did not present a threat to financial system stability. Stress tests from the FSAP concluded in 2004 indicate that banks would be resilient to significant market and credit risk shocks (IMF, 2004). In particular, a stress test scenario with a 20 percent decline in house prices, combined with a 4 percentage point rise in unemployment and a 4 percent decrease in households’ real disposable income was found to result in a loss of 28 percent of annual bank profits on average, and at most half of annual bank profits in the case of the most affected banks.

71. The authorities have been working on updating and refining the stress tests. During the FSAP, participating banks calculated the impact of a given macroeconomic shock on their performance independently, sometimes using different approaches and methodologies. Recent work at RBNZ suggested a number of improvements to the methodology, including the development of a more structured approach to stress testing, and using simulations to estimate probabilities of certain outcomes occurring (Hampton and Harrison, 2006). Preliminary results obtained from applying this different methodology to recent bank data suggest that the main conclusions of the FSAP are still valid. The New Zealand banking system should be able to handle some inevitable deterioration of asset quality during a slowdown (caused, for example, by rising unemployment and stagnating or falling house prices) without major difficulties.

72. The RBNZ is planning to make the stress tests an integral part of bank supervision. The RBNZ intends to conduct comprehensive stress tests every one or two years, using several different models to ensure the robustness of results. The results of stress tests will be discussed with banks and published in the Financial Stability Report and other RBNZ publications. In addition, banks are expected to use the same models to conduct their own stress tests, in the context of the Basel II supervisory framework.


  • Aitken, A., A. Grimes, and S. Kerr, 2003, “Housing and Economic Adjustment,” Motu Economic and Public Policy Research Trust Working Paper No. 03-09.

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  • Edwards, S., 2006, “External Imbalances in New Zealand,” in B. Buckle and A. Drew (Eds.): Testing Stabilisation Policy Limits in a Small Open Economy: Proceedings from a Macroeconomic Policy Forum, Reserve Bank of New Zealand and The Treasury.

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  • Hampton, T., and I. Harrison, 2006, “A Structured Approach to Stress Testing Residential Mortgage Portfolios,” Reserve Bank of New Zealand.

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  • International Monetary Fund, 2004, “New Zealand: Financial System Stability Assessment,” IMF Country Report No. 04/126.

  • OECD, 2006, “Has the Rise in Debt Made Households More Vulnerable?” Economic Outlook No. 80 Special Chapter.

  • Rinaldi, L., and A. Sanchis-Arellano, 2006, “Household Debt Sustainability: What Explains Household Non-Performing Loans?” ECB Working Paper No. 570.

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Prepared by Dmitriy Rozhkov (Ext. 3-9745).


Data from 2001 are not fully comparable to earlier data due to methodological changes.


There has been a rapid expansion in offshore issues of NZD denominated Eurokiwi and Uridashi bonds over the last few years. The buyers of these bonds are mostly retail investors in Europe and Japan looking for high yields. The issuers (typically foreign entities with a high credit standing) profit by swapping the proceeds for foreign currency borrowed abroad by New Zealand banks.


Hedging information is collected by Statistics New Zealand from a survey of corporations that covers almost all external debt. In 2006, the survey covered 91 percent of foreign currency debt.


Registered banks in New Zealand are required to maintain a minimum tier-one capital ratio of 4 percent and a total capital ratio of 8 percent of risk-weighted assets.


Standard and Poor’s ratings cover all banks operating in New Zealand. The largest banks have similarly high ratings from Fitch and Moody’s as well.


New Zealand banks are required to have credit ratings independent of their foreign parents. Nevertheless, rating agencies often mention the high probability of parental support in their reviews.


Market estimates indicate that only 3-5 percent of mortgage loans outstanding are to subprime borrowers (see, for example, “Subprime Woes: Should NZ Be Worried?,” ANZ Market Focus New Zealand, March 2007).


Parts of agriculture are seen as relatively vulnerable because of rising debt leverage relative to farm profits (RBNZ, Financial Stability Report, November 2006). However, exposure of banks to agriculture is relatively low, at around 10 percent of total lending.


RBNZ, Financial Stability Report, November 2006.


The full text of the consultation papers can be found at


In addition, regional house prices in New Zealand appear to be strongly influenced by economic cycles, making housing a poor hedge against local household income security (Aitken, Grimes, and Kerr, 2003).


See, for example, “Bubble, Schmubble – House Prices Have Been Pushed Up by Tax Rates and Interest Rates,” Westpac Bulletin, March 2007.

New Zealand: Selected Issues
Author: International Monetary Fund