New Zealand’s Upcoming Election Could Change Investment Climate

The New Zealand dollar has just about everything going for it: high interest rates, a vigilant inflation fighter for a central bank governor and a government running fiscal surpluses.

Everything to make an offshore investor say: “Yummy, I’ll have some of those.” They have done so in droves, pushing the currency to an eight-year high of 69.80 U.S. cents in July, up from around 50 cents in 1993.

The currency has everything going for it--except the assurance that the nation will stick to the economic path of the past 12 years.

There’s a reasonable chance the Oct. 12 national election will result in a government unfriendly to investors, ousting the ruling National Party. The New Zealand dollar’s strength suggests investors don’t think that will happen--which might leave the currency all the more vulnerable if it does.

“The chances of a non-National government remain very high,” said investment firm SBC Warburg in a report this week. “Given that the market seems unduly complacent about this political risk, the currency is vulnerable.”

The election will be the first under a new, proportional representation electoral system that is expected to lead to coalition governments. With National’s support fluctuating around the 40% mark in opinion polls, it’s doubtful that the party will win a majority of seats in the next Parliament.

Nigel Douglas, an economist at Merrill Lynch in Sydney, also believes investors might be too complacent about the election.

“It certainly requires some caution,” Douglas said. A major concern for investors is that opposition parties might have the clout to force a widening of the Reserve Bank of New Zealand’s 0% to 2% inflation band.

With core inflation at 2.3% in the quarter ended June 30, the central bank has little choice but to keep interest rates relatively high. Core, or underlying inflation, excludes credit costs, big swings in the prices of internationally traded commodities and government tax increases.

Those attractive interest rates, and New Zealand’s low rate of inflation, are what lure foreign investors to the country’s bonds, stocks and bank deposits, and the currency they need to invest there. The lion’s share of New Zealand government debt and of shares on the country’s stock exchange are held by offshore investors.

So attempts to tamper with the inflation band are no small matter for investors, or the currency.

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The Labor Party, the main opposition party, wants to widen the inflation target to between minus 1% and 3%. The New Zealand First Party, which opposes foreign investment in the country, wants to change the target to correspond to the average of the inflation rates of major trading partners, currently about 3%.

Both New Zealand First and the left-wing Alliance coalition also want to broaden the central bank’s mission to include the promotion of economic growth and employment, from simply combating inflation.

“With the exception of National, everyone else is calling for a wider [inflation] band, and they have the numbers,” Douglas said.

In recent opinion polls, Labor has the support of between 14% and 21% of the electorate; New Zealand First, between 20% and 23%; and the Alliance, between 10% and 14%.

“If you’re looking at different polls, they give you different answers,” Douglas said. “There’s a question of political stability, coalitions chopping and changing.”

Nevertheless, Douglas says he doesn’t think interest rates will decline significantly.

“We think inflation pressures are still there. The pressure’s going to be there to keep interest rates high. We wouldn’t look for interest rates to decline much below 9%. I don’t see rates below 8%, as some people are calling for,” he said.

The Reserve Bank is expecting inflation to peak at an annual 2.6% rate by the end of September. That’s the reason it’s insisting interest rates remain high.

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Even though the election is looming, “with Japanese rates staying around 0.5% and New Zealand rates staying so high, we can’t see any reason to be negative on the New Zealand dollar in the short term,” Douglas said.

New Zealand 90-day bank bills, the benchmark for other interest rates, were recently at 9.84%, making New Zealand’s rates some of the highest in the world after inflation.

In addition to that attraction, some contend that concern about the election outcome is misplaced.

The New Zealand system “is virtually a carbon copy of the German system and the German system works perfectly well, even with minority governments,” said Steve Roberts, an economist at UBS Australia Ltd. in Sydney, who is betting on the National Party leading the next government.

Roberts dismisses suggestions of a coalition government between the other three biggest parties.

“It’s not going to happen. Coalitions require huge discipline to work,” he said, pointing to the mostly acrimonious relationships between those parties.

Stephen Toplis, an economist at Doyle Paterson Brown in Wellington, agrees that the election outcome isn’t the bogey some see it: “There will be opportunities around election time for the more long-term investor to make money at the expense of those who panic short-term.

“You need to differentiate between political risk and policy risk,” he said.

“The chances are, on election night, we won’t know who the government is and we may not know for days or weeks. But what’s actually going to change?”

Roberts believes key policies such as the Reserve Bank Act and the Fiscal Responsibility Act, which requires transparent economic management from the government, won’t change substantially.

“The New Zealand economy’s going to remain open. Those factors, on a global basis, make us look relatively stable. That’s not to say there won’t be changes at the margin,” Roberts said.

“There will be massive political instability, but I don’t think there will be massive policy instability.”