Both Australia and New Zealand face the worrying prospect of the impact of lower commodity prices. For Australia it is iron ore whilst across the Tasman it is the dairy industry. So how will each economy be affected by this?
The whole milk price has fallen from:
US$4999/tonne on 18th February 2014 to US$2270/tonne on the 16th December – a 54.6% decrease.
This downturn in prices will have a significant impact on the rural economy of NZ. The lower prices will not only reduce dairy farmers’ incomes, but there will be a knock on effect in other parts of the local economies as farmers and contractors will be less inclined to spend or invest in anything but necessities.
Short-term credit facilities will be able to help farmers with their costs but permanent lower returns would cause a rethink regarding production capacity and economies of scale.
Aussie Iron Ore
For Australian the iron ore prices have fallen from US$136 a tonne December 2013 to US$68 a tonne December 2014. This will have a major effect on their economy for the following reasons:
Iron ore represents 25.5% of exports from Australia
Iron ore producers are significant tax payers to the Australian Government. The drop in prices = AUS$18 billion loss of revenue
Lower prices mean less investment in capital – this sector has been a major part of the Aussie economy over the last few years
Who will take the biggest hit?
It is expected that Aussie will take the biggest hit mainly because of the tax revenue lost through lower iron ore prices. In NZ dairy farmers are not big tax payers and the NZ government are not expecting a big fall in tax revenue. Furthermore overall economic activity is largely unaffected as milk production is likely to continue in the short-term. However the falling unemployment rate in NZ and a rising level in its Trans Tasman neighbours suggests NZ is in a much better state to weather the storm. Other indicators below favour NZ. These include GDP growth and consumer confidence as well as having the ammunition of being able to cut interest rates further, a situation that Australia might find difficult.
Source: NZ Herald December 20, 2014
With the dairy industry accounting for approximately 25% of NZ’s export market, a reduction of dairy prices by 46% from last year will definitely slow growth over the next year. Lower prices will also mean a deterioration in the terms of trade and a bigger current account deficit.
The BNZ have identified 3 factors that have influenced the global dairy market:
1. Ongoing very strong growth in global milk supply – lagged response to previous high prices, favourable weather, and low grain prices. Low grain prices mean that feed for farmers is cheaper and relative to milk prices makes it worthwhile to produce even more milk;
2. Disruption caused by the Russian trade ban on dairy products from the EU, US among others;
3. Question marks around Chinese demand amid reports of high inventory levels.
The graph below suggests that there will be $5.5bn less revenue coming into the economy – 2.3% GDP.
New Zealand Dairy farmers are bracing themselves for some tough times ahead with 3 pieces of bad news. There are as follows:
1. Last week saw a 8.9% drop in the Global Dairy Trade (see graph below) which has meant that prices have dropped 35% since February – their lowest level since December 2012. Farmers can expect revised payout forecasts of less than $6 a kilogram of milksolids to follow the 35% fall.To give you an idea of how the lower payout will influence the rural economy – a forecast of a $6.25/kilogram of milksolids would take $3 billion out of dairy incomes – Con Williams ANZ Bank.
2. The high NZ$ is still hindering farmers revenue. With the latest drop in the GDT you would expect some sort of relief to farmers with a fall in the value of the NZ$. However the NZ$ only fell from US$0.88 to US$0.87
3. On Thursday RBNZ Governor is making an announcement on the OCR (Official Cash Rate) and famers are hoping that Graeme Wheeler will not hike interest rates as originally indicated in the June Monetary Policy Statement. Inflation has been somewhat benign but interest rates seem to be influenced more by Auckland house prices and the Christchurch rebuild.
Why have prices dropped?
There has been a world supply shock especially in Europe. It is estimated that if Europe’s 27 milk-producing countries maintained their current volume increase this could knock New Zealand off the perch of top dairy exporter. Below are some supply figures which show that approximately 16bn litres will be added to the market:
New Zealand – 2013 production up 2bn litres
Europe – with the removal of milk quotas, European milk production is forecast to be 7.5bn litres more
China – Milk production is said to have recovered and could be up 15% this year which adds 4.5bn litres to the market
USA – higher milk prices and lower feeds costs are said to add another 2bn litres this year.
Therefore big surpluses accompanied by weaker demand would hit NZ dairy export earning considerably.
Source: The NZ Farmers Weekly July 21, 2014
On 7th April 2008 New Zealand became the first OECD country to sign a free trade deal with China. However this is not the only first with regard to the relationship between the two countries. New Zealand was the first to negotiate a WTO accession agreement with China as well as the first to recognise China as a “market economy”. But has there been any benefit to the New Zealand’s dairy industry?
Since 2012 New Zealand dairy farmers have benefitted little from the reduced tariffs negotiated in the New Zealand – China free-trade agreement. Special protection, allowed under the 2008 deal, has meant that China can now increase tariffs to pre-agreement levels for the rest of 2014. This is designed to protect Chinese farmers from being exposed to cheaper NZ dairy products and the higher tariff is implemented when diary products from NZ exceed levels agreed in the negotiations. However the higher tariff has been introduced every year since the deal was signed in 2008. This year the higher tariff was activated when 127,309 tonnes of NZ milk powder was exported into China. As with any free trade agreement there is no sudden removal of tariffs and quotas from the participant countries as there is usually a weaning off process so that industry can adjust to an environment with no trade restrictions. Under the agreement between China and NZ the tariff on milk powder was scheduled to fall from 5% of export value to 4.2% this year. However by exceeding the allowed volume of milk powder in January the tariff will rise to 10% for the rest of the year.
Cost to NZ Dairy Farmers
It is difficult to estimate the cost to NZ farmers as either some of the Chinese importers will pass on the cost to the Chinese consumers or NZ exporters will pay for it themselves absorbing the tariff as part of their business costs. An approximate value of the lost revenue for NZ dairy farmers is in the ‘tens of millions’ of dollars every year since 2008. The issue for NZ farmers is the agreed volume of milk powder before and after the 2008 agreement. Since 2008 the demand for NZ exports has increased dramatically as increased food safety regulations has seen some of the smaller Chinese producers unable to compete and this has left an opening in the market. Also the local Chinese consumer has lost faith in the Chinese producer with the contamination of milk and milk products which caused the deaths of some infants. Its importance is shown by the fact that in 2013 milk powder accounted for $4 billion of the $10 billion of total exports to China from NZ.
How things change for New Zealand lamb farmers. In 1961 86% of lamb produce went to the UK but by 2013 that figure was only 18%. The market has developed since that day and with cheaper distribution costs and more demand from South East Asia lamb farmers have looked to closer markets. Some interesting facts:
* NZ exports sheep to 120 markets
* The regulatory issues from China was not quality but paperwork
* 140,000 tonnes of sheep meat sent from NZ this year – only 3.5% of the total sheep market
* China took all the mutton from NZ farmers this season
Source: The NZ Farmers Weekly
I’ve written a lot on this blog about the resource curse and how it is an economic paradox. It refers to the fact that once countries start to export a natural resource like oil their exchange rate appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the natural resource industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports.
For New Zealand there is a similar scenario with a reliance on the dairy industry and the Chinese market for trade.
The BNZ Economy Watch reported that dairy contributed the most (63 percent) to the total exports to China, valued at $774 million, in November 2013. This is the highest value of dairy exports to China for any month. Total dairy exports were valued at $1.7 billion – also the highest for any month.
China is now our top export destination on an annual basis, just under two years after it became our top annual imports partner in December 2011, industry and labour statistics manager Louise Holmes-Oliver said. In November 2013, goods exports were valued at $4.5 billion, up $647 million (17 percent) from November 2012. Exports to China hit record levels in October 2013 and November 2013. Exports to China were valued at $1.2 billion. In 2013 China accounted for 22% of NZ’s goods exports, 17% of NZ’s goods imports and 20% of total two-way goods trade.
The last thing New Zealand wants to become is nothing more than a milk powder exporter to China. Economic diversification is as important as investment diversification from a risk profile perspective. The answer is not to kill off existing trading relationships or reduce dairy production but to look to other sectors to play a bigger part. Furthermore if the purchaser gets too dominant they can exploit monopsony power.
Share of NZ Primary Produce going to China
Got this graph from the BNZ which shows the potential revenue of the Dairy industry this year. Like last year there have been concerns over the lack rainfall especially in the North Island and how it is impacting on milk volumes. However the sector is benefiting from the high export prices – in January there were annual increases of 56% in the value of milk powder, butter, and cheese exports and 37% for casein. Combined with an expected 9% increase in milk production this could lead to a $5.6bn increase in revenue from last year which equates to 2.6% of GDP.
Furthermore with a significant amount of milk products going to China this increase in prices has seen China become New Zealand’s number one trading partner with regard to revenue. This has traditionally been NZ’s neighbours Australia. Notice the increase in importance of China since the signing of the free trade deal.
Over the last decade the policies implemented by the Chinese authorities have had an unrivaled short-term impact on the global economy. These effects include: very high mineral and oil prices; significant amounts of foreign reserves; deals with countries in Africa to secure resources; pollution levels that are unparalleled by any time in history.
Historically China’s economic model was based on export-led growth, massive government injections into the economy and access to cheap money. For instance the Chinese authorities have artificially created growth – as well as building ghost cities –
in that a seven year old bridge (built to last for 40 years) was blown up and rebuilt. This generates jobs for construction industry, including contractors for different aspects of the bridge.
Impact on the Global Economy
As an economy of 1.35bn people (approximately 20% of world population) rapidly industrialises and urbanises it requires a vast amounts of food and non-food commodities. The global market for bulk commodities shows the enormous consumption levels of China and ultimately this led to global commodity prices to treble. (See table above). Another impact is the size of China’s foreign reserve assets and their relationship with the value of China’s currency – the renminbi. China has abandoned its pre-2005 practice of fixing the renminbi against the US dollar, but now uses a flexible peg against where its value is allowed to change. Although there has been some appreciation of the renminbi it is still seen as undervalued against the major currencies – Euro, Yen and US dollar.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.
No doubt you have come across the movie documentary “Black Gold” which looks at the global coffee industry focusing on the plight of coffee farmers in Southern Ethiopia. The Indian onion market has similar characteristics and it is the farmers that lose out the most. Here are some of the issues that they have encountered:
* Higher rural wages have pushed up farmer’s costs
* Farms are small and therefore lack potential economies of scale
* The supply chain involves 5 middlemen who take their cut on the way through
* The onion is loaded, sorted or repacked at least 4 times
* Retail prices are double what farmers get
* Poor quality onions get dumped as there is no modern food-processing industry in India where they could be put to use.
* Little stock of onions is held in reserve so prices can vary greatly
Foreign food companies, including Walmart, Carrefour and Tesco, have been keen to make inroads into the Indian market. This would undoubtedly reduce the number of middlemen who take their cut on the way through and the development of modern storage facilites would assist in stabilising onion prices.
The graph from National Australia Bank below shows the components of Australian GDP from 2007-2013 with forecasts for 2014 and 2015. GDP consists of C+I+G+(X-M) so from the graph you can see that:
C = Private Consumption
I = Business Investment
G = Government Demand
(X-M) = Net Exports
* There is anticipated an increase in non-mining investment with investment in the mining sector slowing down as completion nears.
* An increase in private consumption as well as net exports holding its own.
* The relationship between business investment and the increase in net exports
* Pace of growth is below the trend over 2014-2015 which means that that population growth will be greater than the number of new jobs created.