ANZ economists say the third food safety issue for the NZ dairy sector in three years sees the country's reputation risk being sullied

ANZ economists say the third food safety issue for the NZ dairy sector in three years sees the country's reputation risk being sullied

There are becoming too many instances of New Zealand "shooting itself in the foot" when it comes to global trading opportunities, ANZ economists say.

Economists are are still trying to get their heads around what the Fonterra scare means, with further weakness in the Kiwi dollar seen as possible, but ramifications for economic growth seen as potentially slight. Assuming the GlobalDairyTrade auction goes ahead this week, short-term pricing weakness is seen as likely

Among credit rating agencies contacted by interest.co.nz, Standard & Poor's said it had no comment as yet, while Moody's, which doesn't cover Fonterra directly, noted that Fonterra was important for the economy. However,  Steven Hess, Senior Vice President, Moody’s Investors Service said the effect on the sovereign rating was "only indirect, and thus has no impact on New Zealand’s Aaa sovereign rating".

However, ANZ chief economist Cameron Bagrie and rural economist Con Williams said New Zealand's reputation risked becoming "sullied".

"This is the third food safety issue for the NZ dairy sector in six years. That’s cannon fodder for NZ’s competitors who are jostling for market position," they said.

"We’re seeing too many instances of NZ shooting itself in the foot in the execution arena.

"The opportunities side of the China story et al, such as the structurally increasing demand for protein, are well documented. Our concerns centre on our ability to embrace the opportunities and implement and execute clear and concise strategies to unlock them.

"The past six months have seen instances of invoicing issues (kiwifruit), meat stuck on wharves (certification issues), and now this in the dairy arena. It’s the across-the-board failure to execute in a number of sectors that’s troubling us," the economists said.

"It’s failure on the execution side as opposed to any lack of opportunities that risks holding NZ.Inc back."

They said that NZ should be wary of having too many eggs in the dairy basket, while instances such as this should harden the Reserve Bank's resolve in regard to financial stability, and implicitly, the amount of leverage within the economy.

"You need a "buffer" within your balance sheet to absorb the adverse."

'Clearly negative'

BNZ economist Doug Steel said the latest safety issue was "clearly negative" for the NZ economy.

"Just how much is very difficult to gauge. The impact will depend on the response from Fonterra, authorities and other interested parties. However, in principal, the real economy impact should be short lived," he said.

"Perhaps, more importantly, the events of the past few days are a stark reminder of New Zealand’s increasing vulnerability to a single product and to a single export destination.

"We are not changing our economic forecasts at this point, although we will stay put on the upgrade to our economic growth forecasts we were considering until the dust settles," Steel said.

He said the BNZ would not be changing its interest rate forecasts either.

Contamination fallout

"The fallout from the contamination issue is a very important one to monitor going forward. Any lingering major concern about the quality of NZ’s food production could have far reaching economic implications, given food’s large share of the nation’s exports. By the same token, it is worth noting that the DCD-residue issue back in January receded relatively quickly. There is a chance that this does the same."

Westpac Senior market strategist Imre Speizer said further reaction in the financial markets from that already seen was possible but would depend on the nature of fresh information that unfolds.

"Indeed, reaction reversals are possible if the scale of the issue is less than media reports initially implied."

But he said that assuming some exports were affected for a significant period, the New Zealand dollar should weaken and NZ long-maturity interest rates should rise, "all else equal".

Risk premium

"The latter is because an additional risk premium would be incorporated into NZ interest rates. The implication for short-maturity interest rates is ambiguous. In the near term, a knee-jerk market reaction lower is to be expected, but beyond that the lower NZD could also have positive [ie upward] implications for inflation and the [Official Cash Rate]." 

Fund managers Harbour Asset Management said in a research paper that falls in the value of the dollar so far could be seen as a "marginal reaction", which highlights that for now the market is "relatively sanguine regarding this issue being resolved".

"To the extent that the contamination issue expands, we could expect the kiwi dollar to take a more significant role in alleviating some of the impact of a probable fall in dairy export revenues," the paper said.

"On the impact on bond and fixed interest markets, it will depend on whether the threat to NZ's export income (taking into account quantity and price impacts through a lower currency) is material enough to effect overall growth.

Shock absorber

"This is very hard to judge so soon, and will depend in part on how much the currency works as a shock absorber. The NZ equity market has also been riding high, supported by strong real GDP growth. A lower kiwi dollar would support companies with foreign exposures, while global investors are unlikely to be that phased provided economic growth continues to be robust."

ASB chief economist Nick Tuffley said that trade bans and product recalls were a "necessary and understandable precautionary move".

"NZ has entered the low part of the dairy production season so output for export will be low. This should mitigate the immediate impact on trade of any ban(s)."

There was likely to be some short-term "reputational damage", however, given the extent to which the issue has been reported globally and in China.

Focus on safety

"There is the potential for greater focus by customers in the short term at least on NZ food safety, and the possibility of more rigorous inspections/quality assurances."

Tuffley estimated that any trade ban by China would have a modest negative impact on third quarter dairy export values of minus-6%, "although the persistence of this effect would depend on how long the ban was to last for".

"However, to the extent there would be little impact on milk production volumes itself the ban would likely lead to a build-up in dairy inventory levels, with the effect on Production GDP likely to be minimal."

There was though the potential for a negative effect to come through if Fonterra were to receive lower prices for its dairy products relative to other first-world producers - and export income would be earned later.

But he noted that given Fonterra has such a substantial market share in global dairy supply, there may be limited ability for manufacturers/ consumers to sustainably substitute to other dairy supply sources.

"If there was any upward pressure on the price of other supply sources that would also likely limit the willingness to substitute to other dairy supply sources."

Unclear longer term

The longer term impacts of the issue were unclear at this stage, Tuffley said.

"Any precautionary trade bans could well be lifted soon if it is clear the incident is an isolated one. Trade impacts would be larger if restrictions on NZ product were in place around the peak of the NZ season late in the year when monthly exports are roughly double what they are over August and September.

"Even so, dairy products can be stockpiled and sold at a later date, a further mitigant to any short-term trade impacts."

But what would be important in the longer term was the extent to which Fonterra and NZ as a whole could provide reassurance over the quality and safety of NZ food exports.

High sensitivity

"In the Chinese market in particular, sensitivities to potential contamination are high given the 2008 Sanlu melamine scandal. It is also important to note that NZ supplies the world with around a third of globally-traded dairy products. It will be very hard for countries with a shortage of their own production to substitute away from NZ-sourced product. Even in China’s case, the extent to which China relies on NZ to make up shortfalls is very high." 

ANZ's Bagrie and Williams said assuming the GlobalDairyTrade auction does proceed this week, the "forward curve" for prices should be watched closely.

"Expect prices for near-term delivery to be soft, but if long-dated delivery contracts hold up, this indicates confidence that this should blow over relatively quickly."

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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7 Comments

Westpac Senior market strategist Imre Speizer said further reaction in the financial markets from that already seen was possible but would depend on the nature of fresh information that unfolds.
 
"Indeed, reaction reversals are possible if the scale of the issue is less than media reports initially implied."
 
But he said that assuming some exports were affected for a significant period, the New Zealand dollar should weaken and NZ long-maturity interest rates should rise, "all else equal".
 
"The latter is because an additional risk premium would be incorporated into NZ interest rates. The implication for short-maturity interest rates is ambiguous. In the near term, a knee-jerk market reaction lower is to be expected, but beyond that the lower NZD could also have positive [ie upward] implications for inflation and the [Official Cash Rate]."
 
Jeepers, the unpaid comment sector got it in fewer words
 
Let's start wheeling out the views of those that can make a difference rather than the not so best guesses of the carnival barking fraternity - there are more than enough of them  chattering away here already - paid or not. Those responsible should not be allowed to remain sullenly silent beyond the full glare of the media.

Ah, the white powder economy!
 
The fact is, New Zealand's milk quality and general all-round goodness remains one of the best in the world. It's certainly better than any milk product made within China or immediate surrounds (anyone tasted MengNiu UHT milk, supposedly from the verdant fields of Mongolia? Blech!).
 
But unfortunately, that's not the point. It's increasingly about image management and smart public relations, and both Fonterra and this country could do well with taking a little less laissez-faire approach to that. If you have a problem, let people now as soon as possible. Yes, shares will take a hit; yes, some people will stop buying, for a while, until they forget; yes, competitors and governments will do their best to take advantage of the situation. But for goodness' sake, don't sit on information for as long as Fonterra has and expect people to be easy with that. Plenty of NZ parents are as angry about this as their overseas counterparts.
 
I'm sure Fonterra will get through this, with loss of sharemarket values and brand reputation that will probably be recuperated later on, if they stay out of trouble. Hopefully it will inspire a cultural and operational shift to lessen the likelihood of a repeat. Part of it has been bad luck: three strikes in a row since 2008 and the SanLu scandal. Having worked on a dairy farm in the late 1990s, I know how easy it is to make a mistake (have seen the head milker put pipe wash into the vat, have seen vat chiller break down, milk from udder quarters with mastitis go in). But you have to learn from these issues, take short-term sacrifices because of them, and try to do better next time.
 
As Matt in Auckland commented last night, this is one of the dangers of a small and specialised economy.

As Matt in Auckland commented last night, this is one of the dangers of a small and specialised economy.
 
He is not the only one:
 
Gareth Morgan Investments is one investment manager that considers the New Zealand sharemarket overvalued, and has no investments in it.
 
About a third of investment managers share the view, according to a Russell Investments survey of investments managers' outlooks released on Friday.
 
While several competing funds had set allocations for New Zealand shares, GMI had not.
 
It could invest in the New Zealand sharemarket if it found a good company it wanted to invest in.
 
"It just so happens that right now we are not because when we look at the NZX stockmarket, in our view it is overvalued, and we are particularly not getting paid for the illiquidity that you've got," O'Grady said.
 
"I'll put a caveat around that - we are talking about illiquidity in a crisis."
 
For GMI, liquidity - the ability to sell readily - is a key issue.
 
"You can't get out of the New Zealand stockmarket full stop in a crisis. That's an overall issue."
 
High Street dairy farmers might regret their investment in the overhyped Fonterra Shareholders' Fund units.

I have some sympathy with the Gareth Morgan Investments view that the NZ sharemarket is overvalued.  But am not so sure that catagory investing and buying into a market or abandoning a market completely, in this case the New Zealand sharemarket,  is the way to go.
There are winners and dogs of companies in every market.
I prefer the Carmel Fisher approach which, as I understand it, is to find good companies and invest there.  There are some in New Zealand just as there are dogs as well.  

I think you can throw in tall poppy syndrome....lots of producers envious of NZs rep for safe, hence higher margins so any opportunity to knee cap will be taken on gleefully.
Looking at this from outside it looks like 1 small instance and came to light from a considerable depth of testing. I have got to wonder if any other manufacturers can throw stones with impunity.
regards
 

Re: this crisis neatly sums up nz's problems. A Small undiversified economy, dominated by monopolies or near monopolies,and a crony culture. Matt in Auckland
 
Can anybody else see another way? What if we diversified our public institutions to attacked the monopolies, unravelled the crony culture and encouraged the diversification of our economy.
 
What if after every crisis, terrrorism, GCSB, earthquakes, housing affordability instead of centralising more power to 'cronies' around the Prime Minister we did the reverse?
 
New Zealand has all the trappings of Western democracies -free and fair elections, independent media, neutral public service, seperation of the executive and judiciary, local government and institutions like a Commerce Commission and an independent Reserve Bank. But the reality is these institutions are being undermined and more power is being centralised to behind doors meetings with the Prime Minister. This is not a specific attack on John Key, Helen Clark was as bad and Muldoon was probably worse. It seems all long serving Prime Ministers in New Zealand succumb to the same temptation of centralising too much power to themselves.
 
I see three key areas where diversifying power would have beneficial effects for New Zealand.
 
1. Enact a law that the Speaker is elected by a majority or near majority in Parliament. Then make the Speaker responsible for appointing key public servants and judges, thereby ensuring a neutral public service and judiciary. Further strengthen laws around regulating monopolies and the balance between public interest and privacy. Thus a neutral and empowered public service can attack monopolies and the crony culture, while the media can oversee this and report safely back to the public.
 
2. For Local government to be responsible for transport and vocational education -the polytechnics. Importantly taxation power is transfered to them so they can achieve this.
 
3. For a new body -MUDs to be created to encourage new affordable, innovative, community controlled and owned residential developments.
 
The last two addresses the recent crisises of the Christchurch earthquake and housing affordability. While hopefully supporting new industries that grow in the more competitive environment , thereby New Zealand can move on from being dependent on the 'white powder'.

Yes.  Some heads need to roll at Fonterra.  Starting with the chairman.  You might then find a better devotion to duty in the rest of the organisation.  Pity for the chairman, but 'it encourages the rest'.