By Charlotte Greenfield and Tom Westbrook
WELLINGTON (Reuters) - The International Monetary Fund (IMF) warned on Tuesday that high levels of household debt tied up in property are a risk to New Zealand's financial stability and backed the central bank's lobby for new tools to deal with the red-hot housing market.
New Zealand house prices, among the fastest growing in the developed world, rose 13.5 percent in the year to February. Officials and economists are concerned that a sudden correction would wipe out household wealth and plunge the economy into recession.
New Zealand household debt was over NZ$260 billion ($182.21 billion) in 2016, at a record high of 168 percent of household income, according to central bank statistics. Almost 90 percent of that is caught up in property loans.
"With high household debt, you worry about the amplification of large external shocks," Thomas Helbling, the IMF mission chief for New Zealand, told reporters in Wellington.
He pointed out that the Pacific Nation's small, open economy was especially vulnerable to global risks and that the chance of a "hard landing" in major trading partner China remained possible in next five years or so.
The Reserve Bank of New Zealand (RBNZ) has been lobbying the government for months to get permission to add debt-to-income (DTI) limits to its macroprudential arsenal to combat the country's "excessive" house price growth. The IMF called on the government to sign off on the request.
Official interest rates are at a record low of 1.75 percent, and the RBNZ has indicated it could hold rates steady for two years or more as it grapples with stubbornly low inflation while trying not to stoke the housing market.
Finance Minister Steven Joyce asked the bank in February to produce a cost-benefit analysis before he decides whether to agree to the DTI measures.
The RBNZ and the IMF had said that the limits would not need to be used immediately given that house prices in Auckland had cooled in recent months. But both cautioned the tools needed to be available if the moderation proved to be temporary.
In the addition, the IMF said in its report that "bank balance sheet resilience should be strengthened."
RBNZ Deputy Governor Grant Spencer flagged potential increases to bank capital requirements in a speech to the New Zealand Bankers Association in Auckland on Tuesday.
"Higher levels of capital would improve the soundness of the financial system by reducing the likelihood of bank failures," Spencer said.
(Writing by Jane Wardell; Editing by Bernard Orr and Leslie Adler)