The number of New Zealand dairy farms experiencing financial distress is increasing and high debt levels may threaten their ability to meet environmental and regulatory challenges ahead, the Ministry for Primary Industries warned.

"Financial pressures associated with this highly indebted sector may constrain the ability of financially vulnerable farms to invest and adapt to the changes associated with increased environmental and other regulatory requirements on the sector over the longer term," MPI said in its latest situation and outlook report.

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The recent Zero Carbon Bill – passed unanimously by Parliament – targets methane emissions 24-47 per cent lower than 2017 levels by 2050.

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DairyNZ has estimated that, coupled with the cost of implementing the government's freshwater clean-up reforms, this will cost the economy about $7 billion a year by 2050.

MPI also warns the appetite of banks to keep funding sector growth through the provision of credit is decreasing.

Evidence shows the banking sector is taking a more conservative approach to dairy sector debt in its portfolios, reducing credit lines and requiring active repayment of loans.

The latest banking survey report from Federated farmers showed a substantial increase in perceptions of bank pressure, with 23 per cent of farmers saying they felt under undue pressure, up 7 percentage points from May 2019.

Dairy farmers are feeling this particularly with just under 30 per cent feeling under pressure.

According to MPI, the ratio of non-performing loans in the dairy sector has doubled over the past three years.

"Currently at 2.1 per cent of the dairy sector total, this figure is three times higher than that of other comparable primary sector industries," it said.

On-farm bank debt currently stands at $41.4 billion and has increased by $30.1 billion since 2003, MPI said.

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Data from MPI shows that, relative to production, farm debt levels have more than doubled from $9.48 per kilogram of milksolids in 2003 to $21.99 in 2019.

Also, the average level of bank debt held per hectare has more than tripled since 2003, rising from $7,700 to $23,600 in 2018.

While it notes that in the 2017-18 season, dairy farms on average had a debt-to-asset ratio of 50.7 percent, 24 per cent had ratios of more than 70 per cent and 4 per cent had ratios greater than 90 per cent.

"The percentage of farms holding greater than $30 of debt per kilogram of milk solids produced annually has increased from 16 per cent in 2014 to 30 per cent in 2018," it said.

Also, despite falling interest rates in recent years, the burden of servicing this elevated debt has increased, it said.

Since 2014, the average annual cost of servicing this elevated debt has increased by 11 cents to $1.22 per kilogram of milk solids in 2018.

Despite the gloomy outlook on debt, MPI is upbeat about the sector's earnings potential.

The latest report indicates dairy export revenue is forecast to rise 8.4 per cent to $19.6 billion in the year ended June 2020 versus the prior year. In particular, it expects growth in value-added dairy products such as infant milk formula and liquid milk products.

It is forecasting a milk payout of $7.25 per kilogram of milk solids for the current season. Fonterra Cooperative Group is forecasting a range of $7 to $7.60.

"Expectations of another strong production season, combined with robust global dairy prices, and a weak outlook for the New Zealand dollar, are expected to support solid export revenue growth in the year ahead. For New Zealand's dairy farmers, this is expected to translate into higher farmgate milk prices, supporting robust sector profitability for the season ahead," it said.

Overall, MPI said total export agriculture revenue will be $47.9 billion in the year to June 2020, up 3.3 per cent on the prior year. It is also optimistic about 2021, picking revenue to be up another 2.1 per cent.

"A lot of these gains can be attributed to rising global commodity prices and the drivers behind rising prices are likely to be sustained through 2020 and 2021."