The risk of a sharp slowdown in China's economy is the biggest external threat to New Zealand's growth, due to its export exposure across the Asia region, according to the International Monetary Fund.
New Zealand's growth prospects have improved in the near-term with strong business and consumer confidence and high commodity prices, though the growing reliance on China buying kiwi exports is a worry if the world's second-biggest economy started struggling, the IMF says in its concluding statement on the nation.
"New Zealand's growth prospects remain exposed to external developments, and in particular, a sharp slowdown in growth in China," the IMF said. "Any adverse development in the region would have a substantial impact on New Zealand's terms of trade."
The IMF warning echoes a similar fear in the Reserve Bank's November financial stability report, which cited a "disorderly slowing" in China as a potential risk to the local financial system, which could cause a fall in commodity prices "significantly impacting the indebted parts of the agriculture sector."
China trumped Australia to become New Zealand's biggest trading partner last year, accounting for about 22 percent of exports and supplying about 17 percent of imports. Last month Prime Minister John Key and Chinese President Xi Jinping set a goal for the nations to reach $30 billion of two-way trade by 2020.
The IMF said if China did start slowing down, a weaker New Zealand dollar would help ease the transition, provided the world's major central banks continued to scale back their quantitative easing programmes. If they didn't and the kiwi dollar remained elevated, "a bumpy exit and repeated episodes of financial market volatility could lead to widespread contagion and raise the cost of New Zealand banks' offshore borrowing," it said.
The IMF estimated New Zealand's currency was overvalued, despite the 40-year high terms of trade, and that the nation's non-agricultural exporters "will need to continue to adapt by further increasing efficiency to remain competitive."
Rising house prices in New Zealand were still a concern for the IMF, though it was upbeat about the Reserve Bank's response by limiting low equity mortgage lending, and its shift to tighter monetary policy. The IMF has previously estimated New Zealand housing was overvalued by about 25 percent.
Both the Reserve Bank and government have policy space to respond to any economic shocks, and the IMF said measure to address housing supply "will continue to play an important role in containing price pressures and increasing affordability."
Speaking ahead of the IMF report's release yesterday, Prime Minister John Key said he was "not of a view there will be a sharp slowdown in China."
The Chinese government had cash reserves of US$4 trillion available that would allow it to undertake financial system bail-outs, if necessary, and had "a number of levers" it could use to calm its financial system.
"You will more defaults and you may well see a slowdown in credit" to prevent a credit bubble forming, but he expected China "to achieve growth of 7 to seven and a half percent."