Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: Agriculture debt an economic winner

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Borrowing has been used wisely in farming and has made a positive contribution

Agriculture, including wool, horticulture, grain and seeds, accounts for more than 55 per cent of the country's total exports. Photo / APN
Agriculture, including wool, horticulture, grain and seeds, accounts for more than 55 per cent of the country's total exports. Photo / APN

New Zealand has a strange attitude towards debt. We criticise the agriculture sector for having too much debt even though it generates the bulk of the country's export earnings.

Meanwhile individuals are encouraged to take on more and more debt albeit this generates little economic activity and makes residential property less and less affordable for new home buyers.

This weird situation is highlighted in a recent report by the Ministry of Primary Industries, an amalgam of the old agriculture, forestry, fishing and food safety ministries. It also comes through in a major report by ANZ Bank, "Greener Pastures: The Global Soft Commodity Opportunity for Australia and New Zealand".

The Primary Industries Ministry's Farm Monitoring 2012 Reports look at the outlook for the dairy, beef and sheep sectors.

It believes "the main concern going into 2012/13 is the drop in the expected [dairy] payout".

The ministry concludes: "While many farmers have paid off debt over the past two years, aggregate debt remains high, and there are a small number [20 per cent] of dairy farms with high debt that are vulnerable to a drop in payout".

These are strange comments as debt can be used for sound investment purposes, as it has been by most agriculture sector participants.

Total agriculture debt has risen from $16.6 billion in June 2002 to $48.3 billion in mid-2012. This has coincided with a huge increase in dairy and meat exports from $7.3 billion in 2001/02 to $16.7 billion in the latest 12-month period.

Dairy and meat now represent 37.5 per cent of total exports compared with 34.5 per cent a decade ago.

Total agriculture exports, which also include wool, horticulture, grain and seeds, represent over 55 per cent of the country's exports.

It is clear from the agriculture export and production figures that farming debt, which is modest compared with business and individual debt, has been used wisely and has made a positive contribution to the economy.

Business debt has risen from $41.3 billion to $76.9 billion since mid-2002. This is a lower percentage increase than either agriculture or individual borrowings.

Most of our major companies have survived the global financial crisis and have fairly strong balance sheets. But smaller companies, which often need bank funding, find it difficult to access borrowings.

Banks are often reluctant to lend to small companies and, if they do, they usually require personal guarantees.

Most additional bank and non-bank lending since mid-2002 has gone to individuals, mainly for residential property mortgages.

Total individual borrowings have soared by $106.2 billion, from $82.7 billion to $188.9 billion since mid-2002. The housing component of this has rocketed from $74 billion to $176.7 billion.

What are the economic benefits of the additional $102.7 billion of residential mortgage debt over the past 10 years?

During this period 224,400 new houses and apartments were built with a consent value of $50.7 billion.

Based on the assumption that buyers borrowed 75 per cent of the cost of these new properties then $38 billion of the $102.7 billion of extra mortgage debt went into new properties with the remaining $64.7 billion used to buy existing homes.

These are rough estimates but they give a clear indication that most of the additional individual debt has created limited economic benefits.

This is because the additional borrowings have been mainly used to push up prices of existing houses, rather than building new homes.

Meanwhile, Australia built 1,563,000 new residential units over the same 10-year period.

This is seven times more than New Zealand even though Australia's population is only five times greater than ours.

Thus the scorecard for agriculture and individual debt is as follows:

$31.7 billion of additional agriculture debt generated $21.3 billion of extra dairy and meat export receipts over the 10-year period.

$102.7 billion of new residential borrowings helped to create $50.7 billion of new housing and apartment consents over the same period.

The clear message from these figures is that we have to build more new houses and apartments because this will generate more economic activity, will help keep a lid on house prices and make them more affordable for first-home buyers.

ANZ's "Green Pastures" study argues that New Zealand stands to capture an additional $500 billion to $1300 billion of agriculture exports between now and 2050.

However, we will have to overcome a number of barriers, including capital constraints, land-use conflicts, inefficient water markets, poor R&D, rising supply chain costs and market access limitations, to achieve the upper end of this goal.

The ANZ believes that New Zealand - and Australia - could become the food basket for the emerging Asia Pacific region but will lose out to Brazil, Malaysia, Indonesia and other ambitious countries unless we grab our opportunities.

The report had this to say about farm finance: "Farmers face significant challenges in raising sufficient capital to fund growth and support farm turnover.

"Farm debt levels are already high and few external sources of equity capital are available to farmers, particularly in Australia," it said.

"New structures for owning and operating farms need to be encouraged to attract investment from domestic and foreign investors and capital markets.

"These structures might include rapidly evolving partnerships, modern variants of share farming and use of off-take agreements, as in the mining sector."

Between now and 2050 New Zealand agriculture will require $210 billion of additional capital to generate growth and a further $130 billion will be needed to support the purchase of existing farms from ageing farmers.

New Zealand agriculture needs to find innovative ways to attract domestic and foreign capital and Fonterra's Trading Among Farmers scheme is a step in that direction.

The obvious outcome is that more and more of our agriculture assets will be purchased by foreign interests, particularly Asian, because they have the financial resources and recognise the huge opportunities available in the Asia Pacific region.

Domestic ownership is preferable for a number of reasons including:

* Foreign investors may control and monopolise the supply chain to customers which will reduce the price paid to New Zealand farmers.

* Overseas shareholders may move value-added operations out of New Zealand as they have with the forestry sector.

* New Zealand's tax base can be compromised when domestic companies and assets are owned by offshore interests.

Thus, New Zealand is facing the following challenges:

* Additional debt has to be shifted away from existing housing and into the productive sector, particularly agriculture and the construction of new houses and apartments.

* The Government has to develop consistent and widely acceptable policies regarding the purchase of rural land by overseas parties. The Crafar farm debacle shows we are a long, long way from achieving this.

The ANZ report concludes: "Over the past few decades, agriculture has sometimes been viewed as a 'sunset sector' with declining interest from younger generations.

"Today, market developments suggest that agriculture is entering a new era with significant commercial opportunities on offer," it said.

"Both Australia and New Zealand have the potential to boost agriculture exports and returns, and enormous rewards await both countries if they can succeed in harnessing their agriculture industries to the growth of the Asia Pacific region."

In other words New Zealand's future prosperity is highly dependent on a huge increase in investments and lending to agriculture and the other productive sectors.

Over-investing our scarce financial resources in existing residential property, which only pushes up the price of existing homes, is not the way for New Zealand to keep up with the rest of the world.

Brian Gaynor is an executive director of Milford Asset Management.

bgaynor@milfordasset.com

- NZ Herald

Brian Gaynor

Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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