Sudden stops, external debt and the exchange rate

Release date
Vol. 74. No. 4. December 2011
David Hargreaves; Elizabeth Watson
New Zealand has accumulated substantial liabilities against the rest of the world reflecting persistent current account deficits over the past 30 years. International evidence suggests that when international creditors become unwilling to continue to fund a country’s external liabilities (a situation known as a ‘sudden stop’), the consequences for an economy can be severe. Adjustment has tended to be more painful and disruptive for countries where debt is foreign currency denominated, or in those without an independently floating national currency. This article argues that a disruption to New Zealand’s access to external funding could be less disruptive due to the country’s freely-floating exchange rate and the fact that the external debt is, in effect, denominated primarily in New Zealand dollars (NZD). The nature of New Zealand’s exports suggests that an exchange rate depreciation would help to adjust New Zealand’s trade balance relatively rapidly, which would assist in placing the country’s net foreign liabilities on a more sustainable path and rebuilding market confidence in New Zealand investments.