Watch on farming sector after drought adds more stress

The Reserve Bank is "carefully monitoring" an already highly indebted agriculture sector after the recent drought in the North Island is likely to put more strain on stretched balance sheets.

The bank has previously flagged concerns about the high level of indebtedness among farmers and its dairy concentration and warns the recent drought could "expose financial vulnerabilities" across the sector, according to its six-monthly financial stability report.

"Parts of the agriculture sector in particular remain quite leveraged, and progress in reducing debt loads in recent years has been fairly limited," it says. "For these reasons, the Reserve Bank will be carefully monitoring developments in these markets for signs that systemic risks are increasing."

Treasury estimates the drought will trim 0.7 percent from annual growth this year after the dry conditions sapped production and farmers culled livestock. That offset some of the gains dairy farmers were looking at as global milk prices surged during the dwindling supply.

The bank expects the drought will cause lower incomes and higher costs for most farmers and could hinder next season's production due to the culling of livestock.

"There is likely to be some increase in working capital borrowing from banks, in addition to recourse to government support programmes. Non-performing loans could rise amongst farmers who were already stretched before the drought."

Agricultural debt increased 5 percent over the past year after a spell of limited credit expansion, and has led to an increase in the debt-to-exports ratio.

Farmers have also had to contend with an "over-valued" exchange rate which has eaten into their returns.

Governor Graeme Wheeler today said the strength of the kiwi dollar continues to "hinder the rebalancing of activity towards the tradables sector that would assist in reducing external vulnerabilities".

The kiwi's appreciation has been put down to the international environment of near-zero interest rates, meaning New Zealand's returns are relatively more attractive in an economy that is growing.

(BusinessDesk)