Greek default may yet prove costly for NZ - Treasury

Tuesday 5th July 2011

Treasury officials say that even though the New Zealand dollar's exchange rates for the currencies of key trading partners may be thriving in the wake of Greece's narrow escape from bankruptcy, the situation could yet take a turn for the worse.

"A further deterioration in the Greek crisis would affect New Zealand through trade and/or financial channels," Treasury said today in a monthly commentary on economic indicators.

So far, the impact on the local economy had been limited, and yields on government bonds suggested that New Zealand sovereign debt was still viewed as a safe investment.

"There is, however, some evidence that the market for commercial bank debt has been affected with one bank postponing a euro-denominated covered bond issue 'given the current market volatility and its limited funding needs'," the Treasury analysts said.

As the euro-zone made up only about 10 percent of New Zealand’s goods exports, the direct effects on trade of a continuing deterioration in the Greek debt crisis "would be somewhat limited" with a general slowdown caused by a "contagion effect" likely to lower demand in the region, impacting on commodity prices and export demand.

"Unless this had a significant confidence effect, spreading elsewhere in the world, we would expect the direct impact to be limited," the official said. "If the contagion effect spread to other parts of the world, the impact on New Zealand could be much greater."

In such a case, Treasury would expect the New Zealand exchange rate to provide a buffer, as it did during the global financial crisis in 2008-2009, when the yield on NZ government bonds fell.

But the effect on New Zealand through the financial channel could be more significant.

"A default by Greece would likely trigger markets to more of a 'risk off' tone, increasing demand for more 'safe haven' assets, such as US Treasury bonds.

Typically, the NZ dollar was is seen as a risk-sensitive currency, so a Greek default could lead to drop in its exchange rates, as happened in May 2010 when Greece’s first bailout was being negotiated.

But there was also potential for increased interest in New Zealand government bonds if they were perceived as safe at a time of risk.

A Greek default could be similar to the Lehman Brothers collapse during the global financial crisis, which left banks unwilling to lend to each other, driving up funding costs for New Zealand banks.

NZPA

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