Whither the New Zealand Dollar Dr. Shamim Shakur Dept. of Economics and Finance College of Business Massey University Palmerston North Tel: 06 350 5799.
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Whither the New Zealand Dollar
Dr. Shamim ShakurDept. of Economics and Finance College of BusinessMassey UniversityPalmerston NorthTel: 06 350 5799 x 2556email:s.shakur@massey.ac.nz
Presentation to Professional Development Programme for Economics Teachers, Palmerston North, 19 November 2008
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
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Chronology of NZD/USD1840-1967: The pound was the currency of NZJuly 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
NZD-USD Exchange Rate (1967-2008)Source: Global Financial Data. 2008 figures as of 14/11/2008
0
0.2
0.4
0.6
0.8
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1.2
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1.6
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Yr end closing
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ZD
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NZD-USD Exchange Rate (1967-2008)Source: Global Financial Data. 2008 figures as of 14/11/2008
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0.2
0.4
0.6
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Yr end closing
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ZD
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
19/11/2008 Dr S Shakur 7
The current accountThe current account
NZ’s current account records trade in goods NZ’s current account records trade in goods and services. It consists of balances onand services. It consists of balances on– merchandise trade (goods)merchandise trade (goods)– services (e.g. tourism, education)services (e.g. tourism, education)– income (e.g. dividends and interest paymentsincome (e.g. dividends and interest payments))– transfers.transfers.
19/11/2008 Dr S Shakur 8
How Bad is NZ’s Current How Bad is NZ’s Current Account Deficit?Account Deficit?
BadBad
TerribleTerrible
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NZ’s dismal Current Account BalanceThe last time that New Zealand had a current account surplus was 1973
19/11/2008 Dr S Shakur 10
The Problem is The Problem is notnot NZ’s Merchandise TradeNZ’s Merchandise Trade
19/11/2008 Dr S Shakur 11
Are current account Are current account deficits a bad thing?deficits a bad thing?
NZ has experienced a current NZ has experienced a current account deficit (CAD) in every account deficit (CAD) in every year since 1980.year since 1980.
This means New Zealanders spend This means New Zealanders spend more than the income they more than the income they generate, so foreigners are generate, so foreigners are accumulating NZ assets.accumulating NZ assets.
19/11/2008 Dr S Shakur 12
Should we be concerned?Should we be concerned? The amount of foreign liabilities is not a concern The amount of foreign liabilities is not a concern
provided the debt can be provided the debt can be servicedserviced (just like a (just like a housing loan). This is more likely if liabilities housing loan). This is more likely if liabilities have been incurred to generate income.have been incurred to generate income.
In NZ, foreign debt has been used to feed In NZ, foreign debt has been used to feed consumption expenditure or purchasing houses. consumption expenditure or purchasing houses. That can be a problem.That can be a problem.
How does Current Account Deficit affect NZ dollar?
What does history tell us? Lessons from the Asian Economic Crisis of 1997-98
19/11/2008 Dr S Shakur 14
NZ's Current Account Deficit Problem- ThenNZ's Current Account Deficit Problem- Then
-16
-14
-12
-10
-8
-6
-4
-2
0
CA
B/G
DP
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Countries with Current Account Problems during Asian crisis
-12
-10
-8
-6
-4
-2
0
2
1991 1992 1993 1994 1995 1996 1997
CA
D/G
DP
Australia
Indonesia
Korea
Malaysia
New Zealand
Thailand
19/11/2008 Dr S Shakur 16
NZ: A tale of two halvesNZ: A tale of two halves
What about the Other Stuff?What about the Other Stuff?
Recall the four causes of exchange Recall the four causes of exchange rate variations:rate variations:
changes in current accountschanges in current accounts
changes in relative incomeschanges in relative incomes
changes in relative price levelschanges in relative price levels
changes in real interest rates.changes in real interest rates.
18
Relative GDP growth (1990-2008)
19/11/2008 Dr S Shakur 19
U.S. recession alone may affect ANZAC currenciesU.S. recession alone may affect ANZAC currencies
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)…”
19/11/2008 Dr S Shakur 21
Recession and growth forecastRecession and growth forecast
““The economy has contracted in each of the The economy has contracted in each of the first three quarters of this year and ANZ first three quarters of this year and ANZ National Bank expects next year to be National Bank expects next year to be weaker still, with unemployment to rise to weaker still, with unemployment to rise to 6.5 per cent (from 4.2 per cent now).”6.5 per cent (from 4.2 per cent now).”
Source: NZ Herald, Tuesday Nov 18, 2008Source: NZ Herald, Tuesday Nov 18, 2008
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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.
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NZ Inflation (1970-2008)
19/11/2008 Dr S Shakur 24
Inflation is hitting max (3%) tolerance levelInflation is hitting max (3%) tolerance level
NZ CPI INFLATION
-1%
0%
1%
2%
3%
4%
Mar-93 Mar-97 Mar-01 Mar-05
Source: Stats NZ, ASB
P er quarter
From same quarterlast year
(f)
%
19/11/2008 Dr S Shakur 25
Exchange ratesExchange ratesand inflationand inflation
30
50
70
90
110
74 78 82 86 90 94 98 02
0.4
0.6
0.8
1.0
1.2
1.4
US/NZ INFLATION & NZ DOLLAR
Source: ASB Bank
%
Year End NZD(rhs)
USD
US Prices per NZ Prices (lhs)
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NZ’s Interest rate
• In the past, high interest rate, highest among OECD countries contributed to high NZ dollar
• This is changing fast.
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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.
19/11/2008 Dr S Shakur 28
Recent literature on carry tradeRecent literature on carry trade
Galati and Melvin (2004): AUD and NZD, Galati and Melvin (2004): AUD and NZD, two currencies with relatively high interest two currencies with relatively high interest rates, simultaneously had extended periods rates, simultaneously had extended periods of appreciation against low-interest-rate of appreciation against low-interest-rate currencies, such as USD and the yen. currencies, such as USD and the yen.
McGuire and Tarashev (2006) supports this McGuire and Tarashev (2006) supports this view. view.
19/11/2008 Dr S Shakur 29
Yen carry tradeYen carry trade
The NZ dollar is a favourite of yen carry The NZ dollar is a favourite of yen carry trade. Investors borrow money in Japan, trade. Investors borrow money in Japan, where the benchmark interest rate is 0.5 where the benchmark interest rate is 0.5 percent and invest in nations with higher percent and invest in nations with higher borrowing costs. NZ's key rate (OCR) hit a borrowing costs. NZ's key rate (OCR) hit a record 8.25 percent (Bloomberg, 2 Aug. record 8.25 percent (Bloomberg, 2 Aug. 2008).2008).
The interest rate gap is narrowing.The interest rate gap is narrowing.
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Interest rate gap is narrowing
0
2
4
6
8
10
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J an-93 J an-96 J an-99 J an-02 J an-05
0
2
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90-DAY BANK BILL YIELDS(actual and futures pricing)
Source: ASB
% %
NZ
US AUS
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NZ short term interest rates (1999-2008)
OCR predictionsOCR predictionsRESERVE BANK OCRRESERVE BANK OCREarly 1999: 4.5 per cent (minimum).Early 1999: 4.5 per cent (minimum).Mid-2007 until July 2008 it was 8.25 per cent Mid-2007 until July 2008 it was 8.25 per cent Currently (Nov 2008): 6.5 per cent.Currently (Nov 2008): 6.5 per cent.
HOW LOW WILL IT GO?HOW LOW WILL IT GO?*ANZ National Bank: 4 per cent by April 2009.*ANZ National Bank: 4 per cent by April 2009.*Bank of New Zealand: 4.5 per cent, maybe lower.*Bank of New Zealand: 4.5 per cent, maybe lower.*Deutsche Bank: 4.5 per cent, maybe lower.*Deutsche Bank: 4.5 per cent, maybe lower.*ASB: 5 per cent, then wait and see.*ASB: 5 per cent, then wait and see.
Source: NZ Herald, Tuesday Nov 18, 2008Source: NZ Herald, Tuesday Nov 18, 2008
What does all these mean?
NZ dollar is expected to depreciate, a process that has already started in 2008
34
Currency depreciation mythsA 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
19/11/2008 Dr S Shakur 35
International CompetitivenessInternational Competitiveness
Michael Porter’s definition:Michael Porter’s definition:
“…“….goods and services that meet the test .goods and services that meet the test of international markets while of international markets while simultaneously maintaining or expanding simultaneously maintaining or expanding real incomes of its citizens.”real incomes of its citizens.”
Currency depreciation will not necessarily Currency depreciation will not necessarily enhance New Zealand’s international enhance New Zealand’s international competitiveness. competitiveness.
19/11/2008 Dr S Shakur 36
THANKSTHANKS
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