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Opportunities emerging in a finely balanced year

Opportunities emerging in a finely balanced year for NZ farmers – industry report

The outlook for New Zealand agriculture in 2008 is finely balanced, according to Rabobank’s recently released New Zealand Agriculture in Focus Report. Despite a high dollar, increasing input costs, high interest rates and a slowing domestic economy, there is optimism that an emerging soft commodity boom will create opportunities for New Zealand’s farmers.

The annual outlook from the world’s leading food and agribusiness bank says that an unprecedented rise in global staple agricultural commodity prices was witnessed in 2007, creating significant optimism entering 2008 and a growing belief that global demand will exceed supply for some time, keeping prices strong.

Report co-author and Rabobank head of Food and Agribusiness Research and Advisory, Bill Cordingley, says the fortunes of New Zealand’s agriculture sector became more diverse in 2007. “The dairy sector experienced the strongest prices ever, wine exports enjoyed another record year, and the deer industry saw good signs in terms of higher prices on the back of sharply lower production and improving global demand,” Mr Cordingley said.

However, other sectors including sheep, beef and horticulture languished under various pressures, including soft global demand, excess processing capacity and a continually high New Zealand dollar. “These sectors also felt the full brunt of increasing input costs and interest rates, while contending with unseasonably dry conditions in some regions,” Mr Cordingley said.

Both demand and supply conditions produce price boom

The recent boom in global prices is both a demand and supply story, according to Mr Cordingley. “Demand has been growing steadily for a number of years, based on strong population and income growth and new demand from the biofuels sector,” he said

Global GDP is expected to again grow strongly in 2008, despite the increasingly serious problems in the US economy. In its January update the IMF forecasts global GDP growth in 2008 to be 4.1%, well above the long-term average of 3.5%. “Growth in the developed world is slowing, however the developing world is increasingly the engine for global growth and is expected to expand by 7.4% this year,” Mr Cordingley said.

In terms of supply, with attractive prices farmers will undoubtedly respond by increasing output and if successful this would soften prices somewhat, however global stocks of most traded agricultural commodities have been run down to historical lows over a number of years. “The world is unlikely to lift production sufficiently to meet demand and rebuild stocks within the coming year,” Mr Cordingley said.

Inflationary pressure eases

Following four increases in the Official Cash Rate (OCR) over five months from March to July 2007, lifting the OCR from 7.25% to 8.25%, the Reserve Bank of New Zealand has left rates on hold, with signs emerging that the New Zealand economy could be entering a slowing phase.

“The domestic housing sector is now slowing and there is hope this will relieve the inflationary pressures that have been building. Nevertheless, inflationary pressure is likely to remain at least in the short-term,” Mr Cordingley said, citing an increase in annual GDP growth to 3.2% for the calendar year 2007, historically low unemployment, high energy prices, booming dairy exports and the prospect of income tax cuts in a 2008 election year as key inflationary drivers.

Interest rates will in all likelihood remain on hold for the short to medium term, Mr. Cordingley predicted. “Higher interest rates had a severely negative impact for farmers in 2007 – increasing their costs of borrowing whilst also helping to hold the New Zealand dollar higher, thus crimping export returns,” he said.

Food inflation on government agendas

Food price inflation is now an issue for many governments around the world as higher agricultural commodity prices have combined with higher oil and energy prices to push costs up through the whole supply chain, Mr Cordingley said. The International Monetary Fund (IMF) Commodity Food and Beverage Price Index finished 2007 at its highest level since 1980.

“In an effort to reduce inflation and avoid social unrest, various governments have intervened to try to cap food prices - reducing import tariffs for staple food items, increasing subsidies, or utilising export taxes and bans to increase domestic food supply.”

Meanwhile, the price signals these actions send to producers are mixed. “Price controls cap product prices for some farmers and, rather than encouraging them to increase production to meet growing demand, send the opposite signal,” Mr Cordingley said.

In other countries producers have capitalised on rising prices and are looking to expand production and exploit export opportunities, he added.

Climate change a consideration

Climate change is another important consideration for New Zealand’s agriculture in 2008, according to the report.

“An Emission Trading System (ETS) will create new challenges and opportunities for agriculture. It will be important that the new system is structured to ensure agriculture is positioned to gain the benefits, as well as share the costs,” Mr Cordingley said.

Given New Zealand’s exposure to global agricultural commodity markets, any loss of international competitiveness as a result of the new scheme would be damaging, he said.

Volatility a continued theme for 2008

Not only will prices remain higher, but they will also continue to be volatile in 2008, according to the report. “With tight stocks, markets are vulnerable to production or supply news and tend to react with larger than normal price swings,” Mr Cordingley said.

The growing link between agricultural commodities and the highly volatile energy sector, driven by biofuels, and an increase in speculative investor activity, is causing yet more volatility, he added.

Input prices for items such as chemicals and fertiliser will remain high and volatile in 2008. “Oil has reached all-time record prices in real terms, and US dollar weakness is dampening export returns in the local currency,” Mr Cordingley said.

While difficult for New Zealand’s farmers, many global competitors are struggling with the same challenges and also face additional limitations including restricted market access, irrational government intervention in their markets and inefficient infrastructure that make it more difficult for them to compete, Mr Cordingley added.

New Zealand’s farmers should look forward to 2008 with optimism, Mr Cordingley said. “A lift in pricing is emerging for agricultural commodities globally based on fundamentally higher food demand, the emergence of new demand for agricultural products from the energy sector, and a limited ability for production to increase sharply in the short-term.”

However, market volatility will continue to play a key role in sector returns.

“The current variability in returns highlights that some sectors are enjoying a direct and immediate benefit of strengthening global demand and supply shortages – for example dairy and grains- while others like meat, wool and horticulture are likely to benefit more gradually during 2008, through the secondary effects of increasing production costs and tighter global supply conditions eventually translating into higher prices,” Mr Cordingley said.

Rabobank New Zealand is a part of the international Rabobank Group, the world’s

leading specialist in food and agribusiness banking. Rabobank has more than 100

years’ experience providing customised banking and finance solutions to businesses

involved in all aspects of food and agribusiness. Rabobank has a AAA credit rating

and is rated one of the world’s safest bank by Global Finance magazine. Rabobank

operates in 42 countries, servicing the needs of more than nine million clients

worldwide through a network of more than 1500 offices and branches. Rabobank is

one of New Zealand’s leading rural lenders and a significant provider of business and

corporate banking and financial services to the country’s food and agribusiness

sector. The bank has 29 branches throughout New Zealand.

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