FINANCE MINISTER THREATENS TO OVERRULE RESERVE

UNCLAS SECTION 01 OF 02 WELLINGTON 000529

SIPDIS

SENSITIVE
SIPDIS

EAP/ANP, EB, INR, PACOM FOR J01E/J2/J233/J5/SJFHQ

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV PREL AS NZ
SUBJECT: FINANCE MINISTER THREATENS TO OVERRULE RESERVE
BANK GOVERNOR

REF: A) WELLINGTON 452 B) WELLINGTON 365

1) (U) SUMMARY: New Zealand Reserve Bank Governor Alan
Bollard is widely expected to increase the official cash rate
(OCR) to a new high of 8.25 percent this coming Thursday.
Finance Minister Michael Cullen has threatened to override
the Bank's legal mandate to raise interest rates that keep
inflation under three percent. Cullen's threat has created a
political and economic tempest for the Labour government. End
Summary

2) (U) New Zealand's economy continues to grow faster than
expected, pushing housing prices and inflation upward. To
control this expansionary pressure, The New Zealand Reserve
Bank (RBNZ),under Governor Alan Bollard, has ratcheted up
the Official Cash Rate (OCR) to 8.00 percent, one of the
highest levels among OECD countries. This has put exporters
under increasing pressure as the 22-year record high Kiwi
dollar reached 79.45 US cent mark this past week. One analyst
said that the rocketing exchange rate has put the New Zealand
economy in a "death spiral." While most analysts offer a more
moderate assessment, business leaders, the media, and the
political opposition have been loudly attacking the
government for failing to bring this problem under control.

3) (U) In open Parliamentary discussion last Wednesday, July
18, Finance Minister and Deputy Prime Minister Michael Cullen
mentioned that Section 12 of The Reserve Bank Act (RBA),
passed in 1989, did empower the government to override the
Bank's requirement to control interest rates for the sole
purpose of keeping inflation between one and three percent.
His comment came when a member of one of the Labour
Government's supporting parties, New Zealand First, raised
the possibility of amending the RBA to change the RBNZ's
policy targets. The proposed amendment did not have
Government support and received criticism from both sides.
However, Cullen has maintained since then that Section 12
exists for "a purpose" and broadly hinted that he will invoke
Section 12 to prevent a raise in the interest rate if deemed
necessary.

4) (SBU) The Reserve Bank Act (RBA),passed in 1989, was one
of the most important steps the GNZ took to stabilize its
economic and political policy in the wake of what New
Zealanders universally regard as the disastrous and highly
inflationary political management of the economy in the
1980's. For that reason, commentators have expressed almost
horror at Cullen's open discussion of overriding the Act's
disciplines through resort to invoking Section 12. This
section of the RBA gives the Finance Minister the ability to
override the RBNZ's stated policy targets and replace them
for a specified period no longer than 12 months. After the
end of the specified period the policy targets must be
rewritten, but do not have to be the same as the previous
targets (i.e., one to three percent inflation range). In this
way it functions as a safety value for extreme unforeseen
circumstances.

5) (SBU) COMMENT: Prime Minister Clark has stood virtually
alone in saying that Cullen's remarks are worth considering.
This initiative, even if it is only a feint, shows the
increased pressure the Government is feeling from exporters
who are getting squeezed by the rising exchange rate (see
reftels). At the same time, Cullen most likely is hoping that
the mere mention of Section 12 will frighten arbitrageurs
enough to sell now, decreasing pressure on the exchange rate.
The current rate of return for the NZ dollar and the prospect
of even higher returns if the interest rate is increased are
simply too attractive for investors to back down because of
mere force of posturing.

6) (SBU) If Minister Cullen were to intervene it would surely
undermine the independence of the RBNZ and drastically upset
confidence in the GNZ's ability to maintain a stable monetary
policy. The cost would be too high and could possible induce
a hard landing of the Kiwi dollar that the GNZ and the RBNZ
want to avoid. Invoking Section 12 is too politically and
economically costly to be probable. Some political analysts
saw Cullen's willingness to openly discuss Section 12 simply
as a mollifying gesture to its political partner the New

WELLINGTON 00000529 002 OF 002


Zealand First Party, as one the parties whose support Labour
needs to govern. Others see it as just one more indication
that Labour is growing increasing desperate trying to improve
its weak political standing. End comment.


KEEGAN