OREANDA-NEWS. Fitch Ratings has revised the Outlooks on New Zealand's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Stable from Positive. New Zealand's Long-Term Foreign-Currency IDR is affirmed at 'AA' and Long-Term Local-Currency IDR at 'AA+'. The issue ratings on New Zealand's senior unsecured foreign and local currency bonds are also affirmed at 'AA' and 'AA+' respectively. The Country Ceiling is affirmed at 'AAA' and the Short-Term Foreign-Currency IDR at 'F1+'.

KEY RATING DRIVERS

The revision of the Outlook on New Zealand's IDRs to Stable reflects the following key rating drivers:

- Fitch has revised down its assessment of New Zealand's near-term growth prospects, as the outlooks for the prices of the country's agricultural exports have deteriorated. Fitch estimates GDP growth (production measure) slowed to 2.3% in 2015, no longer outperforming 'AA'-rated peers. Fitch expects GDP growth to pick up to 2.4% and 2.6% in 2016 and 2017 respectively, a slower pace than forecast in our July 2015 review. Fitch expects a slight rebound in business investment from its currently subdued level, and continued high net immigration levels to support consumption growth. We assume this will be partly offset by lower dairy production and slower residential investment growth, with stronger construction activity in Auckland unable to fully replace a decreasing contribution from the Canterbury rebuild. Uncertainty over the external environment, migration rates and the impact from El Nino weather conditions represents risks to our forecast.

- Weaker growth prospects have translated into a slower-than-expected path of debt reduction. Prior to Fitch's revision of the Outlook on New Zealand's IDRs to Positive in July 2014, the government had projected Net Core Crown debt to decline to 23.8% of GDP by the fiscal year ending 30 June 2018 (FY18), from 25.8% in FY14. However the government now projects Net Core Crown debt to rise to 27.1% of GDP by FY18, in the latest Half Year Economic and Fiscal Update. Fitch's unconsolidated measure of New Zealand's gross general government debt is estimated at 36% of GDP in 2015, in line with the 'AA' median.

- Fitch revised to Negative the New Zealand Banking Sector Outlook, an assessment of the underlying fundamental trend in the industry as a whole, capturing the operating environment. The revision reflects a potential deterioration in asset quality caused by the softening economic environment, particularly in the dairy sector. A second season of low dairy prices has affected the debt-servicing ability of farmers, with around half of the dairy sector estimated to be facing negative cash flow during the 2014-15 season. Delinquent loans have remained low so far, as banks have supported farmers deemed to be viable. However a prolonged period of low dairy prices could lead to a rise of non-performing loans (NPLs) from the sector, as well as sharper cutbacks in production and investment. The sector's Rating Outlook remains Stable, reflecting the sector's strong capitalisation, stable funding and high net interest margins, which provide buffer for the banking system against dairy-sector vulnerabilities. The banking system has a standalone Fitch Banking System Indicator score of 'a', the second-highest score globally.

The sovereign rating of 'AA' for New Zealand also reflects the following key rating drivers:

- New Zealand's sovereign rating reflects a credible and flexible economic policy framework, supportive business environment and high standards of governance. External finances are a longstanding weakness to the sovereign credit profile, although the risks are partly mitigated by the sovereign's ability to borrow freely in local currency, effective hedging of foreign-currency exposures and a large proportion of external debt owed to related parties.

- The government's commitment to fiscal consolidation remains firmly in place despite the challenging economic environment. New Zealand achieved its first budget surplus in seven years in FY15, based on the operating balance before gains and losses (OBEGAL) measure. Fitch expects lower tax revenues and higher social welfare expenditures to push the budget back into deficit in FY16, and budget surpluses in subsequent years are likely to be lower than the government previously forecasted. Based on Fitch's general government measure, the deficit is forecast at 1.4% of GDP in 2016 and 1.1% of GDP in 2017, compared with 0.4% of GDP in 2015.

- Fitch estimates that the current-account deficit remained at 3.4% of GDP in 2015, despite weaker terms of trade. Weaker business investment constrained import growth, while services exports surged as a result of booming tourism spending. The income deficit also narrowed in the first half of 2015. However Fitch expects the current account to widen to 4.8% of GDP in 2016, as dairy production falls and imports pick up with investment activity. Net external debt has fallen as a proportion of GDP even with a current-account deficit, in part due to valuation changes.

- Fonterra Co-operative Group Limited, New Zealand's largest dairy co-operative, has recently supported farmers by electing not to reduce its advance-rate milk payments in line with the decline in milk prices in FY15, and subsequently implementing a loan scheme for farmer-shareholders to ease cash-flow strain linked to weak dairy prices. As a result, some of the burden of lower dairy prices has been absorbed by Fonterra's balance sheet, as opposed to farmers'. Fitch downgraded Fonterra's Long-Term Foreign Currency IDR to 'A' from 'AA-' in October 2015, reflecting the weakening of Fonterra's business profile.

- The Reserve Bank of New Zealand estimates standalone dairy losses for the banking system to be manageable even in a severe scenario. However this scenario does not assume a more broad-based economic slowdown, or any concurrent correction in the housing market. A combined stress scenario could have a much greater impact on the health of the banking system.

- National house price growth accelerated to an annual rate of 15.0% in 3Q15, with prices rising fastest in Auckland. House prices have been boosted by strong demand from investors, who tend to have higher debt-to-income ratios. The RBNZ has acted proactively to contain financial stability risks from investor loans by tightening loan-to-value (LVR) limits for Auckland, while easing broader limits in other regions. Fitch expects these policies to slow house price growth in Auckland at the margin, but continued low interest rates and fast population growth could continue to add upward price pressures.

RATING SENSITIVITIES

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

- A faster reduction in the general government debt-to-GDP ratio than Fitch currently projects.
- A structurally narrower current-account deficit than Fitch presently forecasts without a material 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 impact on growth, employment, public finances and the health of the banking system, such as a steep rise in external borrowing costs, prolonged weakness in the dairy sector, or sharp reversal in house prices.
- Evidence of net external indebtedness becoming unsustainable, such as a wider and longer-lasting current-account deficit than currently projected leading to higher external indebtedness than the historical range, or undesirable shifts in foreign investor sentiment.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to a number of assumptions:
- Fitch assumes the outlook for the global economy will remain broadly in line with the projections laid out in its December Global Economic Outlook.
- Fitch assumes Farmgate Milk Prices will not remain well below historical averages over the rating horizon.