In his recent speech at Bowmans Restaurant, Mt Eden, Auckland, Trevor Mallard, the Minister for Economic Development New Zealand said that in recent years, government economic development policies have tended to concentrate on the physical rather than the financial dimension of the growth of firms.
The minister said that the New Zealand government has paid a lot of attention to skills and market development, the adequacy of the infrastructure, the funding of its science system, the tax regime and so on.
Sitting in behind this focus has been an implicit assumption that capital markets will operate as an efficient intermediary matching up those who need investment funds with those who seek investment opportunities.
He also said that capital has been seen to be all seeing and all knowing, internationally mobile and stateless, and if a firm has a viable venture, there will be no limit on its ability to find capital to finance that venture. Hence economic development policy develops the ventures.
Trevor Mallard outlined three propositions that have emerged from the research..
Firstly, it has always been accepted that as the demand for investment funds is increased by growing the economy, the capital markets will develop variety and depth. It has not always been acknowledged that this also works the other way.
If this proposition is accepted the developing and diversifying of domestic capital market is itself a driver of economic development and not only a consequence of it. Weak capital market development is therefore likely to be limiting the growth and productivity performance of New Zealand firms.
Second, access to a comprehensive menu of financial services is uneven across the stages of the development of firms. New and emerging firms can find it hard to grow and can re-locate to improve access to finance capital in large and diverse finance markets. This will limit both the rate of economic growth, and the composition of that growth. Transformation through innovation may be the main thing that is held back.
Finally, foreign savings are not direct substitutes for domestic saving. There was a mantra in the neo-liberal argument that domestic savings did not matter.
But from experience it can be interpreted that since New Zealand is small and distant, it is less likely to be cost effective for foreign investors to spend the time and money analysing investment opportunities here than it is analysing them at home.
Partly because of that, they would rather lend to a New Zealand firm than take an equity holding in it, or else take a controlling interest in it. Portfolio equity is seen as involving too much risk and too little control. Both factors make it difficult for small, young innovative New Zealand firms to grow.
The general concern is that in New Zealand investment environment, parts of the capital markets appear underdeveloped relative to those in other countries. Banks dominate the financial system, the stock market is relatively small, there have been few domestic issues of corporate bonds and the venture capital market is not mature. Private equity is growing in importance, as it is globally.
There is quite a high level of informal financing activity by using family and friendship networks, and borrowing against the domestic residence. The cost of capital is high compared with other OECD countries and other significant currency and liquidity premia remain compared with, for example, the USA.
These features are a concern if they limit the ability of firms seeking finance to grow further by raising those funds in New Zealand, or make it difficult or expensive for them to do so.
He added that private equity has played a role in the development of globally competitive firms, and is likely to continue to do so.
However there is some volatility in world capital markets and that may have some time to run. The willingness of banks to lend leveraged debt to private equity deals is probably going through a change of sentiment. Private equity managers may find it difficult to achieve historic returns.
Another worry is the fact that recent large private equity transactions have involved New Zealandn or international investors and some of the best known company names are now owned off-shore like Griffins, Whitcoulls, Hirepool and Tegal.
Regardless of what sort of footprint private equity deals leave in the future, it is the role of venture capital and the need to maintain market growth momentum that is a current challenge.
In the venture capital and early stage markets New Zealand have experienced a good start and steady progress since the New Zealand Venture Investment Fund was established in June 2002.
NZVIF now has made $78m capital commitments to six Venture Capital Funds. The level of matching capital commitments from private investors amounts to $141m. However, in the past year the rate of investment in new companies has slowed. This he said is of another concern.
He said that the investment environment has been difficult and the government is conscious of the issues faced by fund managers trying to secure investment for new funds and the growth in venture capital funds has stalled and the government is keen to find new ways for government to contribute.
The government has been active and collaborative in supporting the development venture capital funds and they have also committed resources and funding to the embryonic business angel market.
In July 2005, the government committed $40m for investment through the Seed Co-Investment Fund. NZVIF co-invests alongside selected business angel networks into early stage businesses on up to a 1:1 basis.
In the 2006 budget the government committed a further $60m for investment through the Venture Capital Programme.
The government commitment to private equity now stands at $200m with $160m for venture capital funds plus $40m to the angel networks through the Seed Co-investment Fund.
The government participation through NZVIF has resulted in the successful emergence of a fledgling venture capital market.
The recent OECD report on innovation in New Zealand noted that New Zealand was heading in the right direction with the programmes managed by NZVIF. But the present level of investment activity is still low compared with similar OECD markets.
Institutional investor participation is an important part of a maturing and sustainable venture capital industry. The government recognises the issue and are working with NZVIF on options.
On broader issues the government has initiatives underway that will impact on the investment markets. Initiatives include:
Kiwisaver, which began operating on 1 July on which the uptake has been encouraging. Treasury forecasts that 345,000 will enrol in the first year, around 30,000 a month. The initial data suggests take-up is well ahead of that level. IRD had received 92,000 enrolments just five weeks after the launch date.
The bill to establish new regime of limited partnerships has been tabled in parliament. It is important to adopt a limited partnership structure that is consistent with international norms and that provides the form of legal and tax structure that is recognised and accepted by investors.
The tax environment has a significant influence on the industry. The government announced a $3.4bbn package of business tax reform this year. It is the big change to business taxation in 20 years.
NZVIF and NZVCA have been active in discussion with Inland Revenue and the Select Committee on aspects of taxation including the Foreign Investment rules.
Government has officials working on a range of economic transformation topic. It include:
Incremental change will probably not allow New Zealand to realise the aspirations outlined by the government in the economic transformation agenda, especially by growing globally competitive firms.
But bold initiatives will take courageous action by government and the community. In some cases the government can only ensure that the right infrastructure and regulatory frameworks are in place. In other circumstances government can invest. The venture capital market has opportunities for both types of initiatives.
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