Guest Post: Our high exchange rate

A guest post by Anthony Morris:

There is something we could do about our high exchange rate

New Zealand hasn’t paid its way in the world since 1973. Every year since then we have had to take on extra debt and sell off assets to fund the gap between our exports and imports. Yes, the Government had paid off most of its debt before the global financial crisis hit in 2008. This means government borrowing is not high by international standards despite recent increases. However, private sector external debt is worryingly high.

The Reserve Bank recently looked at our net international investment position as a percentage of GDP, and came up with a figure of negative 86% as at 2008. Against a selection of 21 OECD countries New Zealand was 18th with only Portugal, Hungary and Iceland having a worse position. Even Greece appeared to be in a slightly better position than New Zealand in 2008! See

New Zealand has got into this position because we have had a chronically over-valued exchange rate. Year after year our export revenues have failed to cover our imports.

The high exchange has been blamed on the Reserve Bank since it became independent in 1989. Apart from some supervision of financial institutions, the Reserve Bank’s only task has been to keep inflation under control and its only levers for the job have been monetary ones. Relatively high interest rates have been required to tame inflation and a side effect has been a high exchange rate as foreigners have rushed to deposit money in New Zealand.

However, there are other factors that affect the exchange rate. The attractiveness of foreigners lending money to New Zealand financial institutions depends on the whole return and not just the ‘raw’ interest rate. Tax can be withheld from the interest paid. New Zealand’s tax treaties allow for a 10% or 15% interest withholding tax.

However, since 1991 the approved issuer levy (AIL) scheme has allowed financial institutions to pay a 2% fee in return for not having to deduct any withholding tax from the interest on foreign deposits. Recently the Government has gone even further and lowered the levy to 0% in some cases. Meanwhile, New Zealanders have tax deducted from the interest on their savings at their marginal tax rate, which for middle to high income earners is 33%.

It is no wonder we have high capital inflows funding our way in the world when we go out of the way to make it attractive for foreigners to put their savings here but not for New Zealanders to save. Other countries have implemented various measures to discourage passive investment from foreigners because they know it pushes up the exchange rate and harms the productive parts of the economy. Here in New Zealand we don’t seem to care.

I suggest that the solution is to allow the Reserve Bank some control over the level of tax on interest payments, and to give it an objective that incorporates sustaining economic growth for the long term benefit of New Zealanders. If AIL was abolished and we went back to an interest withholding tax of 10 or 15% on foreign deposits then the demand for the $NZ would likely to drop a little and the exchange rate fall. This would make imports more expensive and exports more competitive, helping the balance of payments.

Discouraging the inflow of foreign savings could encourage banks to raise their deposit interest rates to raise more money, which would tighten monetary conditions. However, the Reserve Bank can ease monetary conditions if it thinks they are too tight. It has various tools like the official cash rate which effectively allow the creation of more money.

The global financial crisis did disrupt the power of the usual monetary instruments. In some countries, central banks had to turn to new instruments such as quantitative easing (essentially printing money) to increase the money supply. Quantitative easing definitely creates more money without having to borrow it from foreigners!

Making monetary conditions too loose causes inflation and I am not advocating that. But why borrow overseas when more money can be created internally?

Prior to their entry into the Euro zone the Greeks tended to have high inflation and a depreciating currency, no doubt from loose monetary conditions to grease the wheels of their economy. In recent times the Greeks couldn’t do anything to create extra money internally to help fund their excess consumption so had to borrow externally. That is why they racked up huge debts to foreign banks which they now can’t pay back.

It seems ludicrous that NZ should be getting itself into a similar situation to some European countries like Greece (in having high foreign debt) when we have our own currency, our own central bank and a reasonable tax system! It is simple economics to lower the demand for $NZ to lower the exchange rate to stop the need for foreign borrowing. That could, however, mean a fall in living standards as those big screen TVs become more expensive. I suspect that is the real reason why no one wants to bite the bullet and give the Reserve Bank the powers and responsibilities I am suggesting. Just like the Greeks of several years ago, we like to think the day reckoning will never come!


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