Why are we not seeing real stress across the economy? We hear about lots of stress, and it is apparent in areas. But is it really that bad? Those with very long memories likely say no.
Based on some of the economic data, we should be seeing a lot of stress. The economy has contracted in four out of the past six quarters, gross domestic product (GDP) per capita has fallen 2.4% in the past year, equivalent to the global financial crisis and other shocks such as experienced in the 1970s. Food banks and social agencies are reporting pain. So too are many rural communities.
Yet bank non-performing loans (NPLs) are 0.7 percent of total loans. That compares to more than 2% in 2011. NPLs are less than half what they were during the global financial crisis of 2009.
NPLs across the agriculture sector currently stand at 1.8% of total loans. We’ve seen that hit 4.5%.
There are are a few possible reasons.
The economy is actually not that bad on many levels. The unemployment rate is still 4.3%, though predicted to rise to more than 5%. That peak is not high either.
Households have saved more than $20 billion since before covid-19 hit, boosted by a government wage subsidy transfer. That savings buffer is not yet being eaten into in aggregate, though we know cost of living pressures are huge in parts of society. Term deposits at banks have risen more than $50bn in the past two years with 6% rates on offer. Baby-boomers are spending.
During the period of low interest rates, many kept their payments unchanged, paying more in principal and getting ahead of debt repayment requirements. The full impact of refixing at higher interest rates has yet to hit. Dairy farmers have been amortising debt.
The economy has stalled, under the weight of higher interest rates, but a fair chunk of the pullback has been moderation from extreme highs in areas such as construction. It has only been in 2024 where work is running out.
A lower NZD/USD has been somewhat of a saviour for the primary sector and looks set to remain so.
While GDP per capita is down, GDP is basically flat on a year ago, helped by a large surge in migration.
Debt burdens are lower in certain sectors such business and agriculture. Agriculture debt has risen a slow 5% between the end of 2016 and 2024. Dairy debt, which accounts for a huge share of agriculture debt, has fallen 10%. This has somewhat mitigated the impact of higher interest rates. Regulatory restrictions such as loan-to-value ratios have reduced credit excesses.
Banks now always take security on lending because of their credit risk models. Security provides a second way out and ensures a lower loss given default and commonly no loss or a writeback of a provision. That is taking less risk.
It might just be question of timing. The real economic stress lags economic outcomes as we saw after the global financial crisis. Asset values are taking time to realign to the impact of higher interest rates and profitability. There is a standoff between buyers and sellers.
An improved economic outlook, which is projected for 2025, could take time to get growth back to levels needed to sustain many business operations. The same with some commodity prices (income) relative to cost structures.
How quickly will demand recover for red meat in China is a key question. The extent of the rise in farm cost structures in recent years will remain a problem for 2025 at least. Cost curves tend to flatten, not decline, and there are costs that are still rising rapidly from areas such as local authorities.
This business cycle is more than a downturn. It is a realignment with huge structural changes interplaying with near-term drivers such as inflation and interest rates.
The government has altered the environmental landscape in the near-term. This has bought farmers time; it has not altered the long-term challenge.
A lot of investment and change is required to transition to a lower emission environment. Trade connectivity and deals are being aligned to achieving environmental and sustainability standards.
How much risk have banks been carrying with their lending? They price for risk through their interest margins. However, as banks’ appetites for writing home loans over agriculture and business loans in recent years has increased, so too has the strength in their lending portfolios. That can be a good thing in times of difficulty but at what cost for growth and productivity?
The pricing and taking of risk is one element of a well-functioning economy and that requires strong credit intermediation and risk appetites. Are the current low levels of NPLs symptomatic of less tolerance for risk in recent years and the preference for home lending? If so, has less tolerance for risk be matched by narrower lending margins?
We also have less visibility on financial pressure beyond the banking sector, especially in areas such as consumer finance.
The bottom line is that there is stress across the economy but not of the intensity we have seen in previous cycles. That might just be a function of timing, more conservative lending, the fact this downturn has yet to reach the nadir, the extent of economic risk in bank lending portfolios, or that we have yet to see the full impact of level shifts in things such as costs, structural shifts around the globe such as Chinese demand, and downwards pressure on asset prices.