OREANDA-NEWS. Fitch Ratings has affirmed New Zealand's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA' and its Long-Term Local-Currency IDR at 'AA+'. The Outlook is Stable.

Fitch has also affirmed the ratings on New Zealand's senior unsecured foreign-currency bonds at 'AA' and its senior unsecured local-currency bonds at 'AA+'. The Country Ceiling is affirmed at 'AAA' and the Short-Term Foreign - and Local-Currency IDR is affirmed at 'F1+'.

KEY RATING DRIVERS

New Zealand's 'AA' rating reflects the country's strong macroeconomic policy framework and prudent fiscal management, reinforced by governance standards and a business environment rated among the best globally by the World Bank. However, the country's external finances are a clear weakness relative to rated peers, with one of the highest net external debt ratios in the world and persistent current-account deficits.

Stronger-than-expected net-migration inflows, construction activity in Auckland and a surge in services exports have improved the country's economic outlook relative to our last review, helping offset weak global demand and a fall in dairy production. Fitch raised its forecast for GDP growth to 2.7% for 2016 and 2017, from 2.4% and 2.6%, respectively, in light of these trends continuing. Fitch also expects terms of trade to stabilise and public capital expenditure to rise, with GDP growth slowing to 2.3% in 2018 as net migration inflows moderate and slower reconstruction activity in Christchurch acts as a greater drag.

The current-account deficit and net external debt ratio have been stable, despite a 10% decrease in terms-of-trade between 2Q14 and 4Q15. Strong spending by overseas visitors counterbalanced low dairy prices and weaker agriculture production. Fitch expects the current-account deficit to remain near 2015 levels of 3.0% of GDP for the subsequent two years, as a gradual recovery in dairy output is balanced by capital imports from strengthening domestic demand.

New Zealand's reliance on external financing increases its sensitivity to global market sentiment. Financial conditions tightened in the 1H16, following market volatility, although borrowing costs fell overall due to a cut in New Zealand's official cash rate. New Zealand is also relatively exposed to the Chinese economy through agricultural production and increasingly through services exports. The country is also indirectly vulnerable to a slowdown in Chinese investment through its close ties to Australia, even though its exports cater more to Chinese consumption.

Public finances have improved alongside growth prospects. Nominal GDP growth boosted revenues more than Fitch expected, helping total crown operating-balance-excluding-gains-and-losses (OBEGAL) reach a surplus of 0.2% of GDP in fiscal year ending June-2015 (FY15), compared with Treasury projections of -0.3%. Fitch expects the OBEGAL to stay in surplus in FY16 and FY17, but for gross general government debt to rise to 37.4% of GDP in FY17. This reflects higher capital spending and a build-up of financial assets prior to the maturity of NZD11.5bn of bonds in FY18 and NZD11.8bn of bonds in FY19, rather than a deterioration of the government balance sheet. Fitch projects the government debt ratio to fall steadily after FY17.

There are significant uncertainties around Fitch's base case. Fitch expects the net-migration rate to fall steadily back towards the historical average over the next two years from its current exceptionally high level, continuing to support consumption and the housing market. However, a sharp reversal in migration flows could have a broader negative effect on the economy. A longer period of low-dairy-prices than Fitch assumes could lead to larger falls in production and employment, leading to investment cuts and forced asset sales.

New Zealand's high household debt relative to income and rapid house-price appreciation since the end of 2010 are key vulnerabilities in the country's credit profile. High leverage makes households more vulnerable to employment loss or higher mortgage rates, potentially triggering a house-price correction. This is not Fitch's base case scenario, but if a house-price correction occurs it could have wider economic implications; for example, through consumption and construction activity. Banking sector stress could lead to rapid deleveraging and tightening of lending standards, destabilising the economy, although New Zealand banks' stronger capital and funding positions provide a buffer.

The Reserve Bank of New Zealand has proposed further tightening of loan/value ratio (LVR) restrictions to help safeguard financial stability, particularly for lending to investors. Previous moves to tighten LVR restrictions have only eased house-price pressures temporarily, but have strengthened the banking system's resilience to a housing-market downturn by lowering the stock of high-LVR mortgages on banks' balance sheets.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns New Zealand a score equivalent to a rating of AA on the Long-term FC IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to positive rating action include :

- a sustained decline in the general government debt/GDP ratio, faster than Fitch currently projects

- a structurally narrower current-account deficit than Fitch presently forecasts, without a large slowdown in economic growth, leading to a sustainable downward trajectory for net external-debt as a proportion of GDP.

The main factors that could, individually or collectively, lead to negative rating action are:

- a negative shock with a lasting effect on growth, employment, public finances and the health of the banking system. This could include a steep rise in external borrowing costs, prolonged dairy sector weakness or sharp reversal in house-prices

- evidence of net external indebtedness becoming unsustainable, such as a wider and longer-lasting current-account deficit than Fitch currently projects, leading to higher external-indebtedness than the historical range or undesirable shifts in foreign investor sentiment.