New Zealand's dairy sector debt nearly tripled over the past decade to $30.5 billion last year and some farmers will have difficulty servicing their loans in the year ahead, despite the prospect of a higher milk price.
The Ministry for Primary Industries, in its latest Situation and Outlook report, said the debt was spread unevenly among farmers, with about half held by just 10 per cent of dairy farmers.
Given the rapid growth in dairying over the past decade, the ministry said it was not surprising that its level of debt had also increased.
The dairy sector's demand for debt financing over the past decade was due to a number of factors, one of which was the requirement to fund a large number of capital-intensive dairy conversions.
"While there is a strong correlation between the increase in debt and dairying land during the six-year period ending June 2009 - the period of strongest debt growth - the 15.5 per cent annual average growth in debt during this period was only associated with a 2 per cent increase in dairy land per annum," the ministry said.
A significant proportion of the debt accumulated during this period could be attributed to price inflation for dairy land, which averaged 12 per cent a year.
Because demand for such land exceeded available supply, much of the debt was reflected in higher land prices.
"This has left a significant number of dairy farmers vulnerable to a fall in the milk price or a decline in land prices," the ministry said.
This year's drought had increased the vulnerability of most North Island dairy farmers by reducing milk revenues and increasing feed and pasture renewal costs.
Dairy NZ estimates that nearly 40 per cent of North Island dairy farmers will not be able to meet their working expenses and interest costs this season because of the effects of the drought.
An expected higher milk payout this season would assist farmers to service their debt, the ministry said.
"Unfortunately, some of the most heavily indebted dairy farmers may have difficulty in servicing their debt even with the higher payout," it said.
Looking ahead, debt would remain a risk to the financial viability of many dairy farmers, the ministry said.
The main dairy co-operatives have increased the farmgate milk price forecasts for the season ahead.
Fonterra has announced an opening forecast farmgate milk price of $7 per kg of milk solids for the 2013/14 season - up $1.20 on the 2012/13 season.