Lower payout for dairy farmers may crimp New Zealand economic growth

Mon May 26, 2014 10:30pm EDT

* Next season Fonterra payout seen falling to NZ$7.00/kgms

* Sharp payout drop may slow economic growth, weaken kiwi

* Indebted farmers under pressure to manage finances well

By Naomi Tajitsu

WELLINGTON, May 27 (Reuters) - New Zealand's dairy farmers are bracing for a sharp drop in earnings as milk prices fall back from record levels this coming dairy season - a headache for a highly indebted industry that also threatens to slow economic growth and pressure the New Zealand dollar.

Soaring Chinese demand for milk powder has seen farmers supplying the Fonterra dairy co-operative, the world's top dairy exporter, earn more than NZ$8.00 per kilogram of milk solids for the season winding down this month, the highest since the co-op was established in 2001.

But increased milk production, both at home, in the United States and in other countries, now has dairy economists expecting Fonterra's to make a final payout around NZ$7.00/kgms this coming season.

Many believe Fonterra's initial forecast, expected on Wednesday, will start below NZ$7.00 kgms before being revised up in quarterly updates, but some are more pessimistic, worrying that the final payout will come in below NZ$7.00.

While a payout of NZ$7.00/kgms would beat prices paid in the last two years and would sit comfortably above the 10-year average around NZ$5.90, it could shave NZ$2.3 billion ($2 billion) off the economy in a country where dairy exports account for a quarter of all exports.

"That would be getting close to a 1 percent impact on nominal GDP," said ASB rural economist Nathan Penny.

Some economists also expect that lower global dairy prices, which have already tumbled more than 20 percent this year, could put downward pressure on the kiwi in the coming months, knocking it towards $0.80 in the next year or so from current levels around $0.8550.

In addition, reduced payouts would come at time when the Reserve Bank of New Zealand is moving to tighten monetary policy further, giving added urgency to long-standing warnings by the central bank and the nation's lenders to farmers to manage their finances well.

FINGERS CROSSED

David Irvine is a typical dairy farmer who has invested heavily this year to boost production, improve irrigation and replace staff housing at his two farms outside Christchurch. Now he is crossing his fingers that those investments will be enough to preserve profit margins when the payout cut comes.

"It's not going to be nice. It means that our profit will be lower," he said. "But the theory is that when the season is good, when all the stars are aligned, you make hay when the sun shines."

Debt for farmers in New Zealand has tripled in the last decade to total around NZ$30 billion. Borrowing was particularly heavy between 2005 and 2009 as the "white gold rush', spurred on by growing demand from China, encouraged dairy farmers to increase herds and prompted many struggling sheep farmers to switch to dairy.

After three years of record-low rates of 2.5 percent, inflation pressures prompted the central bank to hike its official rates twice this year to 3.0 percent, and it has warned that rates may rise to around 4.5 percent by 2016.

Debt managers say that many are heeding the call to pay down debt and switch to fixed-rate debt from floating rates, which comprise nearly 70 percent of total dairy debt.

"Over the past 12 months when payouts and cash flows have been strong, more people have been directing surplus cash into repaying debt," said Ross Verry, ANZ New Zealand's general manager of agriculture.

"The anticipation of higher interest rates has encouraged people to pay down debt when they are able to," he said.

But there is still the worry that some of the country's more indebted farmers could be caught out if the stars that have recently been so beautifully aligned get skewed.

"If the payout has a NZ$6 in front of it, and we get another bad drought or a winter storm ... there will be a number of farmers who have overextended themselves, who will be caught by a wrong combination of events," said Bruce Wills, president of Federated Farmers, the country's farming lobby. ($1 = 1.1691 New Zealand Dollars) (Editing by Edwina Gibbs)

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