Fonterra's Black Friday

A surprise 50c per kg support scheme will go a long way towards building up the confidence of farmers. Photo / Christine Cornege.

Dairy giant yesterday revealed its latest payout forecast, dealing a blow to individual farmers, and the wider economy.

Economic growth looks set slow this year after Fonterra cut its farmgate milk price forecast to $3.85 a kg of milk solids, its lowest point since 2002, but farmer confidence is likely to get a boost from an unexpected 50c per kg support package, economists said.

Economists said GDP growth was set to slow this year in wake of the sharp drop in milk prices, and the slowdown in building in post-earthquake construction activity, but that low interest rates and the sharply lower NZ dollar would help to partially compensate.

As expected, Fonterra took a big knife to its farmgate milk price, which was better than some market expectations of around the $3.50 a kg level, down from a previous forecast of $5.25. It forecast a total payout for 2015/6 at $4.25-$4.35 a kg.

However, the big surprise was the 50c per kg support scheme for fully "shared up" suppliers, which economists would go a long way towards supporting farmer confidence.

Fonterra forecast 40c to 50c would be available for payout, up from an historical dividend average of 32c a share. The co-op slashed its capital expenditure by $500m-$600m, which it said would allow it to fund farmer support measures.

Fonterra said milk production was expected to fall by 2 per cent this year compared with last season, which economists said would help support milk prices. The support package will be interest-free for two years and will be repaid when the milk price recovers above $6/kg.

Rural businesses, not just dairy farmers, will feel a big impact from Fonterra's milk price cut, the farmer funded DairyNZ said.

DairyNZ chief executive Tim Mackle says the drop means a further reduction of $150,000 for the average dairy farm income for this season.

"The effect on the level of payments over a season will keep farmers' cash income constrained for at least the next 18 months and it will take some farmers many years to recover from these low milk prices," Mackle said in a statement. At a national level the $1.40 milk price cut would remove $2.5 billion from the economy.

DairyNZ calculates that nine out of 10 farmers will need to take on extra debt to keep going through some major operating losses.

"For the average farmer you are looking at covering a business loss of $260-280,000 this season but for many it will be a lot more than that," he said. "Low interest rates are helping but our analysis shows the average farmer now needs a milk price of $5.40 to break even, and this latest forecast is well short of that."

The lower farmgate milk price follows sharp falls in whole milk powder prices, which have plummeted 51.4 per cent on Fonterra's GlobalDairyTrade platform since March this year.

Chairman John Wilson said the fall in the milk price forecast was due to the continued "significant imbalance" in the global market between weak demand and surplus supply.

"This imbalance and the challenge of lower prices continuing for longer than anticipated is a global issue which dairy farmers around the world are increasingly grappling with," he said.

ASB Bank rural economist Nathan Penny said earnings per share forecast was "quite bullish". "They are obviously confident that they can turn things around internally," he said.

He said the 50c support payment would help farmer confidence "although it will be very tight".

"This may steady the ship in terms of confidence and that would be a positive," Penny said.

"We still expect GDP to slow this year from 3.3 per cent last year, based on lower dairy prices and a slowdown in the Canterbury rebuild."

ANZ Bank chief economist Cameron Bagrie said the decline in dairy prices the last 12 to 18 months would hit the terms of trade hard, with a flow-on effect on economic growth.

"Fonterra is going to be leaning on its balance sheet, and they are going to be funding that by cutting capital expenditure by $500m to $600m. "That's a short-term fix," he said, that could not be sustained long-term.

He said there was no doubt the dairy industry would be hard hit. "But it's not all one-way traffic," he said, pointing to the beneficial effects of low interest rates and the impact of a weak New Zealand dollar. "But there is going to be some pretty severe pain out there."