Peter Fu: A Macroeconomic Trade Spanning Over a Decade—Observing Small Open Economies from New Zealand [Peter Fu’s Insights 5]

A Macro Trade Spanning Over a Decade: Observations on Small Open Economies from New Zealand

Observing the world from the trading desk—this is Finance Commentary by Peng Fu. This episode was recorded on September 24, 2026.

Some time ago, I went skiing in New Zealand. Many people might guess—does this mean I’m paying renewed attention to New Zealand? In fact, there’s no need for extra attention, because New Zealand’s current feedback loop has already lasted over a decade. Although it may take a few more years to truly complete this long cycle, we’ve really experienced it in full over ten years of our lives. I’m sharing this as it’s one of the most fundamental models, and we’ve witnessed it first-hand through years of experience.

I began to closely follow New Zealand for a very simple reason: it is a classic example of a small open economy.

2. The Basic Framework of a Small Open Economy: Current Account, Interest Rate Differential, and Mortgages

The framework for small open economies is actually quite straightforward: the current account and the capital & financial account need to remain balanced—the two should be roughly equivalent.

Let’s first look at New Zealand’s current account. Its trade and commodity structure are highly concentrated, with dairy being at the core—skim milk powder, whole milk powder, with Fonterra as the flagship enterprise. There is also beef and lamb, logs and wood pulp (which is related to domestic pulp futures), and kiwi fruit as New Zealand’s signature produce. That’s essentially it.

Regarding New Zealand’s period of strength in exports, we have to mention the 2008 Sanlu milk powder incident in China. Without this event, New Zealand’s dairy exports would not have been as robust, nor would the global dairy market have been as strong.

On the import side, New Zealand is highly dependent on foreign goods. Lacking a modern heavy industry base, it relies almost entirely on imports for automobiles, machinery, electronics, and even energy—essentially all industrial goods. In essence, New Zealand’s trade structure is about exchanging primary agricultural products for advanced industrial goods and energy. This makes its trade balance highly susceptible to shocks—with energy and crude oil making up a large proportion of imports, New Zealand is extremely sensitive to imported inflation. Its exports have some resilience, but in recent years dairy products have also been in a commodity cycle downturn. Ultimately, New Zealand’s export growth is closely tied to China.

Currently, the New Zealand government is making every effort to strengthen relations with India and actively promote a free trade agreement, aiming to boost exports through access to the Indian market. However, none of this fundamentally changes the structural current account deficit.

A current account deficit requires a surplus in the capital and financial account for balance. To maintain this, New Zealand’s interest rates must remain higher than those overseas. The logic is simple: without high interest rates, how can capital be attracted?

Higher interest rates create a two-way cycle. First, a positive interest rate differential helps keep the NZD (New Zealand dollar) stable—not appreciating, but stable. Second, currency stability in turn supports net inflows into the capital and financial account. The fundamental equation is: New Zealand’s interest rate differential with the rest of the world must be positive, and this differential must be sufficient to offset depreciation expectations for the NZD held by offshore capital. If depreciation expectations are too strong, swap costs—that is, hedging costs—will become very high and the balance becomes unsustainable.

There’s another point to stress: a current account deficit indicates a lack of domestic savings in New Zealand.

Why emphasize this? Because it inevitably involves residential mortgages. With insufficient domestic savings, local residents purchasing homes cannot rely on local savings for mortgages; they have to depend on capital and financial inflows—in other words, overseas financing. New Zealand’s four major banks—ANZ, ASB, BNZ, and Westpac—are all subsidiaries of Australian parent banks, with Westpac New Zealand being a good example. Thus, New Zealand’s domestic mortgage funding largely comes from overseas financing by neighboring Australia.

This means that the larger the mortgage scale, the higher the annual external interest payments New Zealand has to make; the profits banks earn, and their dividends, also flow back to the Australian parent banks. These are all significant components of capital outflows. The larger the mortgage scale and the higher the interest rate, the broader this outflow becomes, and the greater the pressure to attract capital inflows, since only with inflows exceeding outflows can a financial account surplus be maintained to offset the current account deficit. Once this cycle deteriorates, the consequences can be severe.