There is ''significant risk'' dairy prices will remain low for an extended period, and concern is mounting over the heightening risk of overly indebted dairy farmers defaulting on loans, the Reserve Bank has reported.
While the falling milk price has prompted widespread coverage, the Reserve Bank also notes if dairy farm prices falter, that could become the tipping point for highly indebted dairy farmers to default on loans.
Yesterday's loan-to-value ratio (LVR) changes announced by the Reserve Bank specifically addressed the housing sector, but the bank also expressed concern in its report that continued weakness in dairy prices could markedly increase financial stress in the dairy sector.
''Many highly leveraged farms are facing negative cash flows, and the risks will become more pronounced if low milk prices persist beyond the current season,'' the report said.
The existing financial stress of the current lower payout would be exacerbated if the low milk prices led to falling rural land prices, the report said.
''The ensuing reduction in equity buffers could prevent indebted farmers from drawing on credit lines and result in a rise in loan defaults in the sector,'' the report said.
''If the lower dairy payout were to be sustained, there is a risk that farm values could fall sharply and exacerbate the increase in financial stress associated with lower farm incomes.''
As at March 2015, aggregate rural land prices were ''flat'' on an annual basis, with dairy farm prices having risen by about 10%, which suggested that low interest rates and a reasonable longer-term outlook were supporting farmland demand, despite the current season's difficulties.
Fonterra's forecast milk payout for the 2014-15 season is $4.50 per kilogram of milk solids, down sharply from the $8.40 payout in 2013-14.
The 46% milk-price plunge removes about $7 billion from New Zealand's economy.
The sector's vulnerability to reduced incomes had been increased by elevated indebtedness, despite moderate borrowing growth since 2009, the report said.
However, about 30% of total dairy debt was concentrated in the most indebted 10% of farms.
Global dairy supply was increasing because of rising United States production and the removal of European milk quotas and Russian sanctions on milk imports were also adding to global supply. After China's large build-up of inventories in 2013, the recovery of Chinese demand was critical to supporting demand.
''Assessing the balance of these global forces is difficult, but there is a significant risk that milk prices remain low for an extended period.
''Despite many farms being in a position to manage down working expenses, around one-quarter of dairy farms have negative cash flow for the 2014-15 season.''
While deferred payments from last season of $1.50 per kg of milk solids would boost cash flows this season, the deferments from this season would be ''significantly lower''
