Rural Report

September 2008

Above Average

But above–average farmers do better don’t they?

The above–average or benchmark groups do show higher gross margins but they also have similar trends in business returns perhaps lagging the average by up to two years.

Putting It Together

The growth in asset values has outstripped growth in income.

This is demonstrated by looking at the ratio of value of the farm business as a going concern to gross income. The capital turnover ratio is very high implying a sub-optimal return on capital.

Several reasons can be given for these observations. One is the low cash return from farming pushing farm businesses to strive for economies of scale by purchasing more land. Result: Competition to buy additional land pushing land prices higher than might be justified on a pure economics approach.

Sure there are about a dozen other reasons for widening asset to income ratios. New Zealand is a great place to live and farm relative to most other countries. The political system is open and well based on democratic principles. Commercial and social law and property rights are robust and enforceable. Farm businesses are (relatively) free to choose what farming system to use, where to use it and decisions are unencumbered by subsidies. Finance is readily available and income tax laws are favourable. Climate is temperate, soils not too unkind and water is readily available. Industry infrastructure is well established and dominated by farmer-owned organisations. The availability of roads, ports, electricity and communications enhance production opportunities. Finally, land is a tangible asset and controlled by the owner.

Intangible factors also apply to farming and they appear to be highly valued from an economic perspective. The apparent low opportunity cost attached by owners to their equity is an indication of the value they place on the intangible factors.

The bottom line remains however. Many farm businesses are providing a less than satisfactory and unbalanced economic return.

So how has the industry survived and in some instances prospered? Off-farm income has long been a part of the cash flow on the ‘average’ farm. It helps in the accumulation of capital to get started in farming in the first place. It subsequently remains a contributor to cash flow. Secondly: the increase in the dollar amount of equity has been substantial and provided security to capitalise any losses. Finally, debt servicing was relatively low at the start of the period analysed, allowing scope to service capitalised losses.

But that opportunity has been closing. Recall the previously noted upward trend in the level of debt servicing as a percentage of income.

Agricultural Debt

The annual rate of growth in rural credit has also been 14 percent or higher for much of the past 15 years.

The ready availability of credit and its ‘low’ cost is one of the reasons given for the rapid escalation in the value of property and equities globally over the past decade. The growth in rural debt in New Zealand mirrors those trends.

The total agricultural debt held by M3 institutions now exceeds $37 billion (b). The Reserve Bank M3 data does not capture non–bank institutional finance (hire purchase, etc), vendor mortgages and family debt – perhaps another 10 percent of the total?

Net M3 debt (loans minus deposits) has grown at a similar rate. The rapid increase in the value of rural land might suggest that agricultural debt is well secured, but what is the distribution of that debt against assets and can the borrowers pay?

Cost of Debt

The average rural interest rate over the past 18 years is higher than one might expect.

Interest rates have trended down from the frightening levels of the late 1980s as inflation also fell from 15 plus percent to less than 5 percent and stayed at the low level for the next 16 years.

But history does repeat itself as do economic cycles. Interest rates are again ‘high’ for new or rolled over debt as a consequence of inflation pressure and the credit crisis. Interest rates may stay higher and for longer than most will want. Diligent use of fixed interest rate loans has provided farmers with a cushion against the higher cost of debt over the past three years.

Aggregate Debt Servicing

The proportion of agricultural exports required to service agricultural debt has doubled from 6 to nearly 13 percent between 2000 and 2007.

Debt servicing at nearly 13 percent of gross income might look low, but the New Zealand Inc farm (and orchard) working expenses also include processing costs. Averages hide more than they reveal.

Of course, what really matters is the distribution of debt servicing between the entities holding the debt. Aggregate data on this point is not available.

Some now very dated research by the author in 1990 showed that debt was held in a skewed distribution. Less than 20 percent of borrowers held more than 80 percent of the debt. A shift in the mean of a skewed distribution suggests that there has also been an increase in the proportion with high debt servicing. Just how vulnerable is New Zealand agriculture to its level of debt?

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