Dairy sector highly indebted, vulnerable - Reserve Bank

Economists estimate that production is up by 5 to 6 per cent over last year. Photo / Mark Mitchell

New Zealand's dairy sector is still highly indebted and vulnerable to a fall in record high commodity prices and rising interest rates, according to the Reserve Bank.

High levels of agricultural debt, which is heavily concentrated in the dairy sector, poses a risk to the stability of the financial system, deputy governor Grant Spencer said at today's release of the central bank's six-monthly financial stability report.

The report warned farmers may take on more debt on the assumption of consistently high commodity prices, leaving them exposed to a downturn, rather than prudently reducing their borrowing level.

"While the dairy sector is currently enjoying record export prices, its high level of indebtedness makes it vulnerable to a fall in commodity prices or an increase in interest rates," Spencer said in a statement. "A continuation of farmers' cautious approach of recent years will help to mitigate this risk."

In its May financial stability report, the bank said it was "carefully monitoring" the agriculture sector, which was then in the final throes of the North Island drought, which sapped production and caused farmers to cull livestock.

The central bank today said international buyers have been prepared to pay a premium to secure supply of New Zealand milk products, which will stoke production and potentially put downward pressure on prices.

The sector would also be at risk if Chinese growth slows, leading to reduced demand for New Zealand's dairy products, lower prices and putting strain on indebted farmers.

The elevated level of debt in the farming sector partly reflected increased investment in dairy conversions in the last cycle "to take advantage of high milk prices, and the associated strong growth in farm land prices," the report said.