(Corrects to make clear FIAL still has base funding; collaboration funding frozen)
* Lack of state grants, blocks to foreign investment hurting
* Rapidly growing Asian middle class the target
* Innovation needed for high-quality, value-added production
* Chinese investors deterred by uneven playing field
By Jane Wardell
SYDNEY, March 10 (Reuters) - Australia's lofty ambitions to become a "food bowl" for a rapidly growing middle-class in Asia are in danger of falling at the farm gate due to the country's harsh, drought-prone climate and a lack of investment in agricultural innovation.
The federal government has touted the food bowl plan as one way of diversifying the economy as a decade-long mining boom that brought the country riches wanes.
But the industry says it has been left between a rock and a hard place - with state grants denied and foreign investment blocked, it lacks the funding needed to transform Australia into a provider of high-quality, value-added produce.
"There are many companies that are struggling," said Peter Schutz, the chairman of the federal government-funded Food Innovation Australia Ltd. "We need innovation right through the supply chain; not just products, but logistics, packaging and distribution, and we need funding for that."
The idea of transforming a swathe of the sparsely populated Northern Territory into a food bowl for Asia has been around since the 1950s.
Not long after coming to power last year, Prime Minister Tony Abbott commissioned a policy paper into the development of northern Australia, a region twice the size of Alaska, to reach its goal of doubling food production by 2050.
The theory goes that the tropical north of the country not only gets plenty of rain, but is a stone's throw from a multiplying middle class in Asia that is increasingly adopting a westernised diet.
The reality is that there's little infrastructure and little irrigation, undermining attempts at mass production of soft commodities.
A Korean-owned sugar mill closed down in 2007 because there wasn't enough of the crop being produced in the region, while experiments in peanuts, sorghum, rice and cotton have all failed.
Even in its top exporting businesses of wheat and meat, where it ranks among the world leaders, Australia is challenged by both drought and tougher competition from India, Brazil and the United States.
It also simply can't produce enough of any one commodity to make mass exports of staples viable long-term.
Australia's best opportunities for exports to Asia will come in value-added, high quality, certified safe produce to the burgeoning middle class.
China currently accounts for only 4 percent of global middle class spending, but is forecast by the Brookings Institution to catapult up the global rankings to overtake the United States as the largest single middle class market by 2020.
It will account for nearly half of the global increase in food demand by 2050, according to the Australian Bureau of Agricultural, Resource Economics and Sciences (ABARES), with the real value of food consumption in China to double between 2009 and 2050.
"They are starting to move toward a western type of diet, but they are only interested in high value products and that's where we could have an advantage," said Schutz.
The recent hotly contested bidding war for Australia's Warrnambool Cheese and Butter Factory Company Holdings Ltd , which left Canada's Saputo Inc in majority control, was due in large part to Asian demand for the dairy producer's high-tech milk extract lactoferrin.
Warrnambool last month reported it doubled its first half profits, going some way to justifying the rich price Saputo paid to beat off rivals.
But Warrnambool is one of the few success stories.
While agriculture accounts for around 2.4 percent of gross domestic product at around A$50 billion, and exports have surged in recent years, the food industry is comprised almost entirely of small to medium-sized enterprises lacking a cohesive plan.
"Aggregation, machinery, use of technology is critically important," said Doug Ferguson, a Sydney-based partner at KPMG who leads the company's China business practice.
Australia and New Zealand Banking Group Ltd estimates that A$600 billion in additional capital will be needed between now and 2050 to generate growth and profitability in Australian agriculture.
That funding is not readily forthcoming.
Warrnambool Chief Executive David Lord points out that government support for agriculture has not matched previous financial support for heavy manufacturing industries in his company's home state of Victoria.
The federal government rejected a plea from Australian soft drink bottler Coca-Cola Amatil for a A$25 million grant that would go towards a factory upgrade for its struggling SPC Ardmona fruit cannery.
CCL eventually received a smaller grant from the Victoria state government but its difficulties were underscored this month when it posted its worst full-year result for 20 years.
Schutz said Food Innovation Australia has base funding of A$16 million over the next four years, but planned additional funding for industry collaboration, scheduled to rise to A$50 million per year over the same period, has been frozen since Abbott's conservative coalition won the election in September.
The future of the group, established last year by the former Labor government to accelerate commercially driven collaboration and innovation in the food and beverage industry, is unlikely to be decided until after the May federal budget.
KPMG's Ferguson said foreign investors with deep pockets are the only realistic option to meet the food industry's funding requirements. But Chinese investors circling dairy and cattle businesses have been deterred by Australia's tough laws on foreign investment.
"There's concern around the inconsistent treatment for state-owned enterprises," Ferguson said. "There's also a pretty big difference in the approval limits for the U.S., New Zealand, and soon to be Korea, investors."
Private investment deals from those countries are only referred to the secretive Foreign Investment Review Board (FIRB) when they are above A$1 billion. In contrast, the bar for FIRB approvals for Chinese multinationals is just A$48 million, and due to drop even further to A$15 million. All deals involving state-owned enterprises must go through FIRB, regardless of the size of the deal.
Even U.S. investors can expect heavy scrutiny of major deals. In December, the federal government's blocked a A$2.8 billion ($2.6 billion) takeover of GrainCorp by U.S. agribusiness giant Archer Daniels Midland (ADM) on the grounds of national interest.
During the feverish bidding war for Warrnambool, much was made of the local credentials of bidders Bega Cheese Ltd and Murray Goulburn Cooperative Co Ltd over their Canadian rival.
In the end, Lord said, only one thing mattered.
"Saputo made it clear they had the financial capacity to invest for innovation," he said. "That's clearly very attractive for the business." (Editing by Alex Richardson)