Analysis - New Zealand sees an early warning in Greece's debt woes

WELLINGTON (Reuters) - New Zealand has strong reason to fervently hope that debt-laden Greece never goes bankrupt as a fresh crisis in global financial markets would be a real blow to recovery for the earthquake-hit country.

With a foreign debt that's about the same percentage of gross domestic product as Greece has, plus 60 percent of the government bonds held offshore and the freely floating kiwi dollar hostage to carry and commodity trades, New Zealand is exposed to outside shocks.

The country, weakened by the devastating February earthquake in Christchurch, has been working hard to contain a debt-funded housing boom and overspending since the global financial crisis.

Still, the banking sector continues to rely heavily on foreign borrowing to close the funding gap because of the country's chronic low levels of household saving.

"The New Zealand major banks have a structural reliance on the wholesale funding markets," Moody's financial institution analyst Marina Ip told Reuters.

Even as the banks managed to reduce their reliance on wholesale funding to around 35 percent of total funding, from 40 percent previously, the level remained high.

"This does make them somewhat vulnerable to shocks in the offshore wholesale debt markets, as around two-thirds of their wholesale funding is sourced offshore," Ip said.

Trying to nip the problem in the bud, the Reserve Bank of New Zealand (RBNZ) introduced a prudential liquidity policy for banks last year to cut their reliance on short-term funding.

The move, which requires banks to secure a certain share of funding from stable deposits or longer-term wholesale funding, has lengthened the maturity of their borrowing profile.

"However, short-term external debt remains high at 50 percent of GDP, exposing the economy to funding risks," the IMF said in May in its latest country report on New Zealand.

POST-LEHMAN CRUNCH

In December 2008, when financial markets were hit by a liquidity crunch because of the collapse of Lehman Brothers, New Zealand's proportion was 64 percent of GDP.

A fresh strain in the global markets would also push up the yields on government bonds. Two-year securities shot up to more than 7 percent during the crisis, compared to current yields of around 3.23 percent.

Helping improve the local banks' stability was the struggling economy, which kept credit demand low and allowed them to skip raising funds offshore.

Indeed, the annual rate of increase in total borrowing was stuck at record low levels of 1.2 percent in May, the same rate of growth for the past three months.

But the picture could change when the economy picks up as expected, powered by the Christchurch rebuilding.

The New Zealand government, which has pledged to rebuild the second-largest city, said on Monday it will spend NZ$17.1 billion (8.8 billion pounds) over the next four years on infrastructure projects.

The banks may again need to raise short-term offshore funds to support credit expansion.

Reflecting the risk of reliance on offshore wholesale funding, Moody's in May cut the credit ratings of ANZ, Commonwealth Bank of Australia, National Australia Bank and Westpac Banking Corp by one notch.

Their New Zealand units dominate the local banking market.

Thanks to their strong capital base, the major Australian banks helped New Zealand weather the global financial crisis well, unlike Britain, the United States, Germany, Greece, Austria, Belgium and Ireland which bailed out their banks with taxpayer cash.

The banks have funded a savings shortfall with commercial paper issues, which need to be renewed every few months. They minimized risk by hedging their foreign exchange exposure in the futures market.

SAVINGS SQUEEZE

New Zealand, squeezed by low savings, has been running current account deficits for almost four decades, resulting in net foreign debt of NZ$148 billion in March 2011. That's about 77 percent of GDP, down from a peak of 90 percent in 2009 but still NZ$33,600 for every one of New Zealand's 4.4 million people.

Other developed countries with similar sized debt include Greece, Portugal, Spain and Ireland -- all of whom have suffered credit rating downgrades. Apart from Spain, all have also sought financial assistance from international lenders.

But analysts said that double A-plus rated New Zealand, unlike the debt-ridden euro zone countries with no own currency, has a credible fiscal consolidation plan, a flexible currency and economy and an independent central bank.

"If we ever got into that situation, we would be able to adjust a lot faster than what Greece is going through," said Goldman Sachs economist Philip Borkin.

"We have our own vulnerability around external sector debt, but we're a long way from being in a Greece situation."

Still, the strong fiscal position New Zealand enjoyed before the recession in 2008 has now diminished. In the fiscal year that ended June 30, the budget deficit ballooned to an estimated 8.4 percent of GDP -- the worst on record -- partly due to the earthquake.

The government hopes the budget will return to black in four years, if the economy recovers smoothly.

Pre-recession, a series of governments produced budget surpluses, which peaked in 2005 at 4.6 percent of GDP. With the recession and global crisis, tax revenue fell and in 2009 there was the first budget deficit in 15 years.

In November 2010, rating agencies Standard & Poor's put New Zealand on negative outlook, rather than stable, partly on concerns about the country's high foreign debt.

"We are still relying on offshore markets and that will remain a risk," said ANZ-National head of markets economics Khoon Goh. "But it will only become a real issue if the entire global financial system starts to seize up."

(Reporting by Mantik Kusjanto; Editing by Richard Borsuk)