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The kiwi’s not about to start crying over Fonterra’s spilt milk

A sudden slump in the New Zealand dollar this week as the country’s biggest dairy exporter was hit by a contamination scare put a currency that is one of world’s top investments under the spotlight.

As dairy giant Fonterra was hit by restrictions on its products in China and other countries, the currency got a rare and brief reprieve from its surging strength, plunging to a year low.

But few are betting the respite will last for long as the odds of a wider fallout from the Fonterra episode seem pretty low. The company has said it is not facing a ban on all products, only restrictions on some, and it expects the curbs to lifted soon.

The New Zealand dollar, or kiwi, recovered from its 1.5 percent drop on Monday, when news first broke of contamination in the country’s dairy products, a US$9 billion export market. New Zealand is the world’s leading exporter of dairy products.

In any case, the kiwi would have to fall considerably more if it is to make any dent in its rally since mid-2009, when the world’s major central banks simultaneously eased policy.

The kiwi has rallied 60 percent against the US dollar since March 2009, outstripping other big favorites of recent years, including the Australian dollar, Colombian peso and Swedish crown, which have risen around 20 percent.

As of Wednesday, even after Vietnam, Russia and Thailand had joined China in recalling dairy imports from New Zealand, analysts expected nothing more than a short-lived corrective fall in the kiwi.

“New Zealand is more or less at the top of the pile with an economy that’s picking up, when others are slowing down, interest rates that are going up rather than going down, and more or less the same outlook for commodity prices,” said Bank of New Zealand currency strategist Mike Jones.

“All the fundamentals are aligned and this is quite a good reason why the kiwi has an air of confidence about it and continues to bounce back whenever we go through these bouts of weakness.”

That is not exactly good news for the small South Pacific agricultural economy’s exporters, who have borne the brunt of the loss of competitiveness in external markets as foreign investors rush into the high-yielding kiwi.

A rare bout of intervention by the central bank in May failed to thwart a rising currency, backed by an economy growing at a robust 2.5-3 percent a year and heavy demand for its agriculture exports.

With inflation rising into the top half of the Reserve Bank of New Zealand’s target band, financial markets are also primed for policy rates to rise next year, encouraging more investors to pile into the kiwi. Against the currencies of its main trading partners, the kiwi is up 49 percent since March 2009.

Exports 30% of output

A big drop in dairy exports would, ironically, weaken the kiwi and offer the country’s exporters of other products such as wood, meat, fish and wine, a welcome respite.

New Zealand’s economy relies on exports for 30 percent of annual output and half of all exports are agricultural goods.

Dairy alone accounts for about a quarter of the country’s NZ$46 billion (US$36 billion) annual export earnings. And the country needs to keep exports rising to stop any further deterioration in its current account deficit.

At 4.8 percent of GDP for the year to March 31, it is among the biggest gaps in the Asia-Pacific. The fortunes of Fonterra, the world’s biggest dairy exporter, and particularly its markets in China, are therefore crucial.

Nearly 90 percent of China’s US$1.9 billion in milk powder imports last year originated in New Zealand, with the lion’s share coming from Fonterra.

A weaker kiwi would also help New Zealand claim back some competitiveness from Australia, its biggest export market.

The kiwi has gained 20 percent against the Australian dollar since early 2011, including this year as the Australian currency was driven down by its exposure to a slowing China, a dovish central bank and a flight of foreign money. The central bank cut rates this week to a record low 2.5 percent, its eighth easing since November 2011.

The RBNZ’s hawkishness by contrast could put a floor under the kiwi even while the spotlight is on tainted dairy exports.

“It’s a reputational issue and it could cost them some money this year but there should be no long-lasting effect,” said strategist Sean Keane of Triple T Consulting in Wellington.

“There is a lot of exposure through one mechanism, which is dairy exports. But if you were to choose a market whose currency you want to be exposed to, New Zealand is one you would take.”

The flipside though of currency weakness — should dairy exports be severely affected — would be the attention it would draw to New Zealand’s precarious external debt position and its heavy dependence on foreign investment.

The government’s net debt stood at 26.4 percent of GDP in May. Two-thirds of the NZ$42.6 billion of government securities on issue are held by offshore investors.

Those vulnerabilities have not weighed on the kiwi so far, even as investors preparing for gradual stimulus withdrawal by the Federal Reserve cut back their exposure to other markets.

That, economists say, is because the concerns over New Zealand’s debt are overshadowed by its superior growth.

“Higher currencies are often victims of their own success,” said Jones. “But unless you can see those things changing then there’s no reason to expect the kiwi to fall broadly any time soon.”

 


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