And the central bank warns that forced sales of farms could rise if dairy payouts remain low, though farmers would go to great lengths to keep paying their loans.
Many highly indebted farmers were facing «negative cash flow» Reserve Bank governor Graeme Wheeler said in the Financial Stability Report out on Wednesday.
Around 11 per cent of all farm debt was held by farmers with negative cash flow and high debt levels.
«The risks will become more pronounced if low milk prices persist beyond the current season,» Wheeler said, with current milk prices near five year lows.
It was likely that dairy farmers would face «difficult conditions» for two seasons in a row.
«It is likely that the number of foreclosures among (highly) indebted farms will eventually increase if weak cash flows persist for multiple seasons,» the Financial Stability report says. And bank losses because of mortgagee sales could be made worse if land values fell alongside weaker farm incomes.
Speaking at Parliament’s Finance and Expenditure Select Committee hearing, Wheeler said 37 per cent of dairy farmers had negative cash flow, given the forecast payout at $4.50 a kg.
Dairy debt had trebled since 2003 to about $34 billion and about a third of that debt is held by the 10 per cent of most indebted farms.
«So that is a major concern,» he said.
If the dairy payout price remained at low levels for a long time, the negative cash flow problems would get worse. As well, dairy farm prices would start to fall, compounding the problem.
The dairy sector made up about a third of New Zealand’s merchandise exports, so was a big part of the economy.
The spot price for whole milk powder was now about US$2400 a tonne, and was expected to rise to about US$2700 a tonne by the end of the year.
The equilibrium price that it could settle at was between US$3200 and US$3800 a tonne he said.
New Zealand was the most efficient dairy producer in the world and a lot of international producers were not making money at current prices. They had only been supported by falling cereal prices making feed cheaper.
«The whole situation is not sustainable. It depends on what happens to inventory levels and domestic production in China,» Wheeler said, among other factors.
«But if we saw another year of low prices, that would be a worry for the economy, no question, and a worry for farmers and their debt capacity» Wheeler said.
Lending to farmers was reasonably steady in recent years, though shorter term funding had increased in the face of negative cash flows.
If the payout remained low that could lead to some hard conversations with bankers.
«But there is some degree of optimism that farmers hate to walk away from the land,» assistant governor Grant Spencer said.
«They won’t do it lightly and will go to extraordinary lengths to service the mortgage,» Spencer said.
But Wheeler added that farm incomes also depended in part on the exchange rate which had fallen about 5 per cent on a trade weighted basket measure in recent weeks.
«We still think the exchange rate is unjustified and unsustainable so we’d like to see that come down, so that will also affect the returns dairy farmers can get,» he said.
Source: Stuff