Dairy future bright, but challenges remain

Release date
07 May 2014

New Zealand's dairy sector has a bright future, but important challenges need to be managed to ensure it retains its dynamism, the Governor of the Reserve Bank, Graeme Wheeler, said in a speech today.

Mr Wheeler told the DairyNZ conference in Hamilton that the dairy sector makes a vital contribution to the New Zealand economy.

"Dairy exports make up almost a third of New Zealand's annual merchandise exports, animal numbers and prices have increased and on and off farm productivity growth has been impressive."

Commenting on New Zealand's high exchange rate Mr Wheeler said the strength of the terms of trade, which are at a forty year high, are an important driver. New Zealand's long-term reliance on foreign savings to finance its investment needs also places upward pressure on interest rates and the exchange rate. In addition, the high exchange rate also reflects the relative strength of New Zealand's economy compared to other advanced economies.

"The Reserve Bank considers that the exchange rate is overvalued and does not believe its current level is sustainable. Our exchange rate could be expected to weaken if one or more of the following occurs: the US economy continues to improve; global dairy prices continue to come off their recent highs; China's growth slows; financial market volatility begins to rise; or there is a global ‘risk off' event such as a correction in global equity prices."

"If the exchange rate remains strong, it is likely to be reflected in continued low or negative tradables inflation. In such circumstances, the high exchange rate, along with new economic data, will be a factor in our assessment of the extent and speed with which the Official Cash Rate needs to be raised."

"Further, if the currency remains high in the face of worsening fundamentals, such as a continued weakening in export prices, it would become more opportune for the Reserve Bank to intervene in the currency market to sell New Zealand dollars."

Mr Wheeler said that dairy debt almost trebled over the past decade, and currently stands at $32 billion.

"It is concentrated among a small proportion of highly leveraged farms with around half of the dairy debt being held by only 10 percent of dairy farmers".

Despite the prosperous outlook for the dairy sector, Mr Wheeler warned that even the most dynamic enterprises can lose competiveness and suffer losses in market share, so there are important challenges to manage.

"On the external front these include the oscillations in global dairy prices, increasing competition from other international suppliers, the risk of slower growth in China, and the need to continue diversifying our export markets, including positioning for the enormous longer term opportunities in the Indian market. On the domestic front, dairy farmers are conscious that high dairy prices can turn around quickly and will need to continue managing their cash flows and borrowings in a prudent manner."

Read the full speech on the Reserve Bank website: http://rbnz.govt.nz/research-and-publications/speeches/2014/speech2014-05-07

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