The Reserve Bank of New Zealand (RBNZ) says some dairy farmers will begin to default on their loans if commodity prices remain low for a long period of time.
Fonterra has set its milk price forecast at a midpoint of $7.25 per kilogram for the coming dairy season, down from $8.22 last year. This is higher than the lowest trough in 2015, adjusted for inflation, but farmers now face higher costs — including interest rates.
The central bank thinks low commodity prices and high operating costs in the primary sector could pose a threat to financial stability, if sustained across multiple seasons.
Kerry Watt, the RBNZ’s director of financial stability, said the agricultural sector made up 11% of all bank lending with the majority of those loans made out to dairy farmers.
“Whilst defaults in banks’ agricultural lending portfolios are currently low, they are expected to increase and could accelerate if there is a prolonged period of high costs and low prices,” he said.
This risk was outlined in a chapter of the Reserve Bank’s upcoming November financial stability report which was pre-released on Thursday.
China confidence crisis
The RBNZ noted agriculture demand from China—which typically buys a third of dairy, 40% of meat, and 60% of forestry exports—had been declining with consumer confidence as the economy has emerged from Covid restrictions.
This has put pressure on dairy farmers, who have been showing some early signs of rising financial stress, and could threaten the wider economy.
New Zealand is more reliant on the agriculture sector than most other advanced economies.
Few farmers have defaulted so far, but demand for working capital had “surged” as farmers reached for credit facilities to support cashflow.
“Defaults, payments overdue by more than 90 days, could increase materially if there is a prolonged downturn in export prices and demand,” Watt said.
“Banks tell us they are monitoring the situation and working closely with their rural customers.”
Farm input costs have increased significantly over the past couple of years, with animal feed and fuel prices rising after the invasion of Ukraine. Meanwhile, local inflation has boosted the prices of labour, electricity and insurance.
The rapid increase of interest rates has also boosted debt servicing costs for farmers, who now faced an estimated cost per kilogram of $1.43 in August — up from just 59 cents two years ago.
The RBNZ said dairy farmers had “generally deleveraged” over the past five years but those who are still carrying significant amounts of debt would be seriously impacted.
Profitability pressured
Fonterra’s reduced farmgate milk forecast could leave many farmers struggling to cover their costs this season. The average breakeven price is estimated to be around $8 per kilogram, or 75 cents more than current expected.
Analysis provided to the central bank by Figured estimated that half of all dairy farms would make a loss if the final milk price were to settle at $6.75 and over 60% if it dropped to $6.25.
“How long farmers can operate under these conditions depends on factors such as indebtedness, access to working capital, cost structures and scale,” the RBNZ said.
Retail banks told the RBNZ they expect defaults among dairy borrowers to rise over the coming year, because there tends to be a time lag between cashflow stress and default.
“A prolonged period of low dairy prices or a further reduction in prices are more likely to exhaust the cash buffer of farmers with weaker balance sheets, leading to materially higher default rates”.
An added challenge for dairy farms is the prospect of being charged for carbon and methane emissions sometime after 2025, under the incoming National Government.
The Reserve Bank asked retail banks to estimate the impacts of a range of emission prices and has focused on a starting price of $15 per tonne. At that level, 8% of dairy borrowers would be unprofitable compared to 6% without emissions pricing.
This estimate assumed international milk prices were kept at a fixed level and did not rise as agricultural emissions prices were also put in place overseas.
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