Reserve Bank concerns about dairy farming debt appear to have eased as milk prices remain robust and farmers pay down debt, but an industry stress test paints a grim picture if prices slide for an extended time.
The Reserve Bank's latest financial stability report said while dairying's share of agriculturesector lending by banks remains "considerable", it had declined from 69 per cent to 63 per cent in recent years.
With banks encouraging farmers to use current strong milk prices and low interest rates to pay down existing debt, and a falling number of farmers identified by banks as financially stressed, the dairy sector was building resilience, said the report.
However draft results of a stress test by the bank, usually applied to financial institutions, suggested that if the milk price reduced to $5.50 per kg milksolids for five years, almost one third of dairy farms would have negative cashflows. More than half of these would need some form of debt restructuring.
With the cash price paid to farmers by national milk price setter Fonterra above $6/kgMS since the 2016-2017 season and in $7kg-plus territory for two years now, this scenario may sound most unlikely.
The Reserve Bank report noted dairy farm debt to banks had fallen this year to just above $35 billion, down from a little over $40b in 2019.
The sector's lower exposure to risk was a result of banks having continued to diversify their lending away from dairy in favour of sheep and beef farming and horticulture.
China's rapid recovery from the pandemic had supported continued demand for New Zealand's key agricultural commodities.
"While demand for dairy has been the driving factor, stronger prices have recently also been recorded for meat and forestry products," the report said.
It shows total bank lending to sheep and beef farmers at just under $15b this year, while horticulture players have borrowed around $5b in total.
The report warned the agriculture sector faced several headwinds longer-term, including increased variation in climate conditions as climate change intensified.
"The expected full entry of the sector the Emissions Trading Scheme from 2025 will likely raise compliance costs, and weigh on profitability.
"Further potential risks such as surplus overseas milk production, the growth of milk alternatives, bovine and crop disease outbreaks, heavily concentrated export markets and geopolitical trade tensions have the potential to undermine commodity prices and sector prosperity."
Independent economist Cameron Bagrie told a recent DairyNZ forum dairy farmers were "very aggressively" paying down debt, a trend he expected to become more noticeable over the next six to eight months.
Economist Cameron Bagrie sees dairy debt continuing to fall in next eight months. Photo / Supplied
"The dairy sector is one of the few sectors in which I am seeing less points of vulnerability. Balance sheet imbalances are starting to be addressed and it's happening in an orderly fashion.
"But there's still a pocket of what banks call non-performing dairy loans - it's about 3 per cent.
"That trend hasn't changed in the last five years. That tells me there's a consistent group of underperformers or there are models that just do not work. Another eight per cent are defined as potentially stressed - that is they have a credit rating of B or below.
"So there's still a fair bit of work to be done."
Bagrie said one of the biggest economic lessons of 2020 and the pandemic was "thank God New Zealand was one big farm".
"We can't lose track of that. It was there when it was needed and it's going to be a pretty big part of New Zealand's economic future in a world that's changing rapidly."
Bagrie said he hoped sentiment in the farming sector over the coming 10 to 20 years would be more of a "half glass full" view than farmers were expressing at the moment.
