A sharp fall in dairy prices for NZ farmers has raised the question if the country’s economy is heading for a slowdown much larger than anyone was thinking a week ago when the Reserve Bank of NZ lifted its official cash rate for a fourth time to 3.5%.
At the time the RBNZ said the cut would be the last for a while it sat and watched the impact on sensitive sectors such as housing, and the value of the NZ currency.
Now it might be a bit more nervous given the country’s major exporter earner, dairying, is facing an estimated one third drop in income over the next year (unless the value of the Kiwi dollar plunges).
New Zealand’s terms of trade are also going to take a big hit, much in the same way that falling iron ore prices have undermined Australia’s terms of trade this year.
Yesterday, Fonterra (FSF), the giant dairy co-operative that’s the world’s biggest exporter of dairy products, slashed its price estimate for 2014-15 to $NZ6 a kilo of milksolids, from the first forecast of $NZ7 made in May.
The new price is nearly 30% down on the $NZ8.40 paid out for 2013-14 (which was in turn trimmed from an earlier forecast of $NZ8.65 a kilo).
The dairy co-operative also announced an estimated dividend of 20 to 25 cents a share, amounting to a total payout of $6.20 to $6.25 for fully shared-up farmers.
As a result, the NZ dairy industry, the world’s biggest exporter, is facing a 30% fall in earnings in 2014-15. And some analysts see more price weakness ahead.
That will hit farmers who have enjoyed record returns in the past year or so (especially in the wake of a nasty drought in many parts of NZ in 2013 and record demand and prices in the Chinese market).
FSF 1Y – Fonterra again chops milk price and NZ dairy incomes to plunge
But NZ milk production rose more than 8% in the year to June and prices in Asian markets, especially China, have gone off the boil and are weakening as competitors in the EU and especially the US, ship more products into China and the rest of Asia.
Many NZ dairy farmers have expanded in the past couple of years off the back of the rise in income, expanding herds, buying farms and taking on extra debt.
Earlier this year the RBNZ expressed concern about the potential for falling prices and incomes to hurt dairy farmers who have boosted their debt levels.
The RBNZ said that half the dairy debt of $NZ32 billion is held by just 10% of farmers, making them particularly vulnerable to price falls.
The central bank said in its May Monetary Policy Statement that it had forecast a 27% fall in dairy prices into its economic forecasts, "and the possibility of further decreases”.
Based on a forecast milk supply of 1.62 billion kilograms of milksolids, the NZ dairy industry’s earnings will be crunched – down close to $NZ4 billion – to that would equate to earnings of $NZ9.7 billion (excluding dividends), down from a bumper return of more than $13 billion in 2013-14.
Fonterra’s May forecast of $NZ7 a kilo price for 2014-15 would have been the fourth-highest payout on record, but dairy prices have continued to slide and are now down 34% since February, forcing Fonterra to make a further hack into the estimated price for the coming year.
In fact, looking at NZ and Australia, there’s not much difference between Australian iron ore or New Zealand’s much praised dairy industry – both are now facing increased pressure from falling world prices, which could damage national export performance and industry incomes.
But unlike Australia, which has a far more diversified spread of exports in rural and mineral commodities as well as services and manufacturers, dairying occupies a bigger share of NZ’s exports – around a third of the country’s annual merchandise (non-commodity) exports.
Coming on top of the four quick rate rises this year, such a large cut to national incomes could drag the economy – currently growing around 3.7% a year – into a sharp slowdown later this year.
The only way pressure could be alleviated is if the Kiwi dollar falls out of bed as exporters, the government and the RBNZ want it to do (the resilience of the Kiwi dollar is another similarity with Australia).
Fonterra said yesterday world dairy prices had fallen a further 16% since June.
That was on top of a fall of the fall in prices since February 18 this year when world prices peaked.
All up the fall is 34%, including the near 9% at the July global auction for dairy products conducted by Fonterra.
Fonterra chairman John Wilson said the drop in returns would have an impact on farmers’ cashflows.
"We continue to urge caution with on-farm budgets in light of the continuing volatility in international dairy markets," he said in yesterday’s statement.
“We have seen strong production globally, a build-up of inventory in China, and falling demand in some emerging markets in response to high dairy commodity prices. In addition, the New Zealand dollar has remained strong.
"Our milk collection across New Zealand last season ending 31 May 2014 reached 1,584 million kgMs, 8.3 per cent higher than the previous season," Mr Wilson said.
The dairy industry’s price pressures have been heightened by the stubbornly high New Zealand dollar, which has not fallen in line with commodity prices.
The Kiwi dollar slipped to US85.23c on the news – well under the 87 plus cents level of a week or so ago.
However, it is still higher than it was at the beginning of the year, when dairy prices were a third or more higher.
Last week the RBNZ Governor Graeme Wheeler said the high level of the currency was "unjustified and unsustainable and there is potential for a significant fall”.
A fall in the value of the currency will soften the impact of the 30% price fall for dairy products and other exports (such as wine, timber and horticultural products).
Fonterra’s annual results will be released on September 24.
Shares in the Fonterra Shareholders Fund (FSF) which is the only way for investors to share in the NZ dairy industry’s fortunes, rose half a per cent in Australia yesterday to end at $5.50. They had been up 1.3% earlier before the statement was issued.
