Download Interest rates and the Australian dollar – the farmers` story

Interest rates and the Australian dollar – the
farmers’ story
Address to the
WA Farmers 2010 Annual Conference
Perth
26 March 2010
By
Charlie McElhone
Manager – Economics and Trade
National Farmers’ Federation
Interest rates and the Australian dollar are two issues that have a significant impact on
Australian farm incomes and overnight can turn a profitable farm business into one that is
leaking cash and wondering whether it will be able to make it through the next season.
In a high turnover, low margin enterprise like farming, the difference between profit and loss
can be finely tuned and can hinge on very small changes to factors such as these.
This has been highlighted for farmers in recent months when the Reserve Bank of Australia
entered a contractionary phase, attempting to restrict economic growth and inflation to within
its target range by raising interest rates.
This drive was reinforced this month when the RBA Board raised the official cash rate by 25
basis points to 4.0%, the fourth consecutive increase since October last year.
The impact of these monetary policy decisions by the RBA have a two-fold impact on
Australian farmers:
1. Impact on debt repayments
Firstly, they usually affect farmers’ debt financing liabilities as the banks pass on changes to
the official cash rate through their commercial loans.
As outlined by this ABARE chart, Australian broadacre and dairy farm debt has increased
significantly in recent years (by 62% between 2003-04 and 2008-09) as farmers continue to
invest in capital items such as modern tractors, machinery and other more efficient farming
technologies despite lower incomes due to drought. These debt levels have increased at the
same time that receipts have reached a plateau as poor seasons have restricted production.
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While these investments in capital works should hold those farmers in good stead into the
future, recent interest rate rises have hit hard for those looking to recover from the drought.
To put these debt levels into perspective in relation to interest rates I will look at the impact
on an average farm debt level of around $450,000.
For a loan of this size a 0.25% lift in interest rates equates to additional debt repayments of
around $92 per month – (i.e. assuming the banks only pass on an equivalent increase to their
farming customers).
Since October last year the average additional debt repayment level therefore equates to
almost $400 per month. These are difficult increases for any small business to absorb, let
alone those in an industry that is coming off the back of a number of poor seasons.
2. Impact on the AUD
Secondly, let us not forget the upward pressure that rising interest rates also have on the AUD
as it draws foreign investors towards our higher yielding currency.
Australian agriculture’s exposure to international markets is renowned, exporting around two
thirds of all domestic production.
An appreciating exchange rate makes these exports more expensive on world markets while at
the same time making imported food and fibre cheaper. However, on the positive side, we
must remember that an appreciating dollar reduces the cost of imported farm inputs like fuel,
fertilizer, tractors and machinery.
Yet the net balance of the appreciating AUD is very much in the negative for most Australian
farmers.
Even taking into account the cheaper imported farm inputs, NFF estimates the net impact on
farm incomes of a one percent appreciation in the AUD to be in the range of $190 million
annually.
The NFF acknowledges that there are a number of factors in addition to higher interest rates
that have driven the Australian dollar to its current level above the 90 US cent mark (a 30%
appreciation since the start of 2009).
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The major driver is the strong global demand for Australian commodities, particularly those
from our mining sector. The resilience of the Australian economy in global terms following
the Global Financial Crisis is also a factor.
However, despite this, the additional impetus provided by lifting interest rates is an additional
constraint on the ability for exporting sectors like agriculture to continue to lift the Australian
economy back into positive territory.
The NFF supports monetary policy as an economic lever
So you would think hearing what I have just said that the NFF is completely against the use of
monetary policy as an economic lever if that equates to higher interest rates and a higher
valued AUD. This is not the case.
The NFF recognises that monetary policy, while a blunt instrument, can be an effective means
in keeping inflation stable and low, and in doing so ensure that the Australian economy grows
at a sustainable rate without eroding the living standards of its people.
In these efforts we must remember that inflation is no friend of the farmer, particularly
considering the sectors’ level of trade exposure means that farmers are rarely able to pass on
additional costs to their customers.
I do not need to remind everyone here today about the enormous stress that increasing costs of
inputs are having on Australian farmers. ABARE estimates that the total cost of farm inputs
has increased by over 48% since 1997-98 with the cost of vital inputs such as fuel and
fertilizer more than doubling during this time period.
The goal of combating these inflationary impacts is a good one for the RBA to retain, even
though it can be seen from the above figures that they have not done a particularly effective
job in doing this when you look at farm inputs in isolation.
In fairness though, despite the cost of farm inputs, if you look at the economy wide consumer
price index (CPI), you can see that since the 2-3% target inflation range was introduced in
1993, the RBA has on the most part been quite successful in accomplishing this aim.
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However, the NFF’s concerns in relation to the way the RBA manages interest rates stems
from two areas:
1. Fiscal and monetary policies may not align
Firstly, the NFF becomes concerned when there is a clear disconnect between monetary and
fiscal policy.
We are seeing this right now as the RBA tries to contract economic growth while the
Government continues to provide additional fiscal stimulus emanating from the $42 billion
stimulus package announced in February 2009.
The NFF is thankful that the RBA is now independent of Government (in theory anyway –
e.g. the government appoints the governor), therefore removing some of the pressure to
manipulate interest rates for political ends, and instead keep monetary policy focused on its
long-term goals.
The same cannot always be said about fiscal policy, thus leading to the conflict and mixed
messages for the Australian economy.
2. The state of the general economy may not reflect the circumstances felt by Australian farmers and
indeed the rural economy in total
Secondly, the reality is that monetary policy is an economy wide instrument, and RBA
decisions on interest rates are based on the Australian economy in total. However, the state of
the general economy may not reflect the circumstances felt by Australian farmers and indeed
the rural economy as a whole. As a result, the blunt monetary policy instrument can be
challenging for a sector such as agriculture and the regional communities it supports, whose
fortunes are to a large degree dictated by the seasons.
Contractionary policies can often be seen being enforced by the RBA during the height of
drought, exacerbating the pressure on regional communities through increased costs of debt
financing and reduced competitiveness for the output they produce.
The NFF accepts that this is the reality of how the RBA works but that does not mean that it
isn’t a challenge for Australian farmers.
Can the NFF do anything to help?
Unfortunately, there are real limitations on the capacity for the NFF to change the way
monetary policy is managed, so as to have it more targeted to the needs of Australian farmers.
The RBA is understandably fiercely protective of their independence and has bolstered efforts
in recent years to demonstrate transparency in its policy decisions (e.g. publishing the minutes
of RBA Board meetings).
However, the NFF does see itself playing a vital role to provide linkages between the farming
communities and the Reserve Bank, to ensure that they understand the dynamics faced by our
sector and the communities in which we operate.
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With this aim, the NFF has an ongoing process of engagement with the RBA, particularly
through the RBA’s Economic Analysis team, to maintain this dialogue and provide feedback
to the RBA on current issues relating to agriculture that affect the sector. This process will
continue.
Farmer access to finance
Yet when we talk about interest rates we also need to talk about the issue of farm financing
more generally.
It has often been suggested that money acts as a lubricant to the economy in the same way
that oil lubricates a car's engine.
In recent times, particularly in the wake of the Global Financial Crisis, this money in the form
of credit, is becoming more difficult for farmers to access. This is clogging up the arteries of
regional and rural Australia by restricting the plans of existing farmers to expand and improve
efficiencies while inhibiting potential new entrants and young farmers from gaining a
foothold in our industry.
The banking sector is often put forward as the culprit in this whole equation.
It is very easy to be suspicious about the banking sector when you hear about the profits they
have acquired while receiving Australian Government support in the form of deposit
guarantees.
While the NFF notes that a banking sector making losses would be a far worse scenario than
the current industry in a position of strength, one has to raise their eyebrow when they hear
that in the 2009 financial year the big four banks earned underlying profits before tax of $35
billion or just under 3% of GDP.
Why then with this being the case is credit access tightening?
In starting to try and answer this question it should be said that by and large, Australian banks
have been very supportive of Australian farmers in the last 10 years while drought has
ravaged large stretches of the continent.
Bank practices are now a lot more balanced and considered and foreclosures are now the
exception rather than the norm. The same could not be said 20-30 years ago when it seemed
to be commonplace for banks to liquidate problematic loans at the drop of a hat.
While banks’ understanding of the importance of reputational risk and the benefits of having a
clear Corporate Social Responsibility have made enormous advances since those times, there
is no doubting a key reason behind this change in mentality relates to increasing land values
since 2003.
These have provided banks with some comfort that debt to equity ratios are being maintained
regardless of seasonal conditions.
There is no doubt that Australian banks remain acutely aware of this exposure to land values
and understand that adopting a foreclosure mentality risks setting off a domino effect that
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could seriously damage their existing equity while at the same time doing significant damage
to a sector with strong growth prospects.
Yet while this could explain the treatment of existing loans by the banking sector, there is no
doubt that farmers looking to access new loans are experiencing more difficulty in accessing
the same amounts that they were two years ago.
It should be said that this trend is not isolated to agriculture, but the same applies to
businesses across the whole of the economy.
With the Australian consumer spending more than they save, Australian banks have been
forced to off-shore their finance purchases in order to meet the credit needs of their
customers.
This has meant that Australian banks are increasingly exposed to economic movements and
variables on international markets and the cost of credit emanating from the entities from
which they source finance.
As a result, the tightening of credit access on international markets is undeniably having an
increasing influence on the amounts and rates at which Australian banks are offering for
finance.
It is also leading to an increasing disconnect between the official RBA interest rate and those
offered by the banks which in many instances have failed to pass official interest rate
decreases to their customers – at times arguably due to internal financing pressures being
experienced by the banks themselves.
Interest Rate Changes in the Second Half of 2008
RBA Cash rate
ANZ
CBA
Westpac
NAB
Sept 08
Oct 08
Nov 08
Dec 08
–0.25
No change
–0.25
No change
–0.25
–1.00
–0.60
–0.65
–0.80
–0.20
–0.75
–0.40
No change
No change*
–0.40
–1.00
–0.40
–1.00
–0.80
–1.00
Total from
Sept to Dec 08
–3.00
–1.40
–1.90
–1.60
–1.85
*Note: Westpac announced a 0.8 % reduction in business credit card rates in November 2008.
Source: RBA Bulletin, ANZ, CBA, Westpac, NAB
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But this does not suggest that it is therefore OK for Australian farmers to be experiencing
greater difficulty in getting the finance they need to build and grow while Australian bank
profits increase. Far from it.
Concerning for the NFF is that it now appears that Australian banks are wearing very little of
the risk they face in sourcing finance.
Increases in bank financing costs, whether they be a result of official cash rate movements, or
as a result of other finance sourcing issues, are too easily passed on to the end consumer whether they be farmers or others within the general community.
Competition within the finance sector must come into question, particularly since non-bank
lenders have increasingly struggled since the big banks received the Government’s deposit
underwriting guarantee.
As a result of this policy decision, the non-banks have seen significant amounts of liquidity
leave their institutions as customers seek the security provided by Government backed,
banking institution deposits.
The result has been a lower capacity by the non-bank lenders to offer credit to customers,
including farmers, and greater power to the big four.
The big four are now deemed to be “too big to fail” as demonstrated by the government bank
deposit guarantee. Yet enjoying this safety net in a commercial environment understandably
puts the big banks on a platform that the non-bank lenders can only dream of.
The question of whether this asymmetry will be to the advantage of end customers such as
farmers remains to be answered.
The NFF is open about the fact that we are far from having the answers to correcting the
finance access and business uncertainty issues experienced by farmers. Yet we do believe
this challenge will continue to escalate unless workable options are developed to build
transparency and enhance competition within the finance sector.

The need for interest rate transparency
To this end we believe that it is too difficult for consumers of credit to keep financial
institutions to account for their decisions regarding interest rates.
It is all too difficult, particularly for farm businesses, to monitor how much of the official cash
rate cut is being passed on by their own financial institution, or indeed to monitor the actions
by competing financial institutions. Changes to mortgage lending rates understandably hog
the headlines.
The NFF therefore believes that, in the interests of enhancing competition within the banking
sector, a mechanism should be created whereby rate change decisions by financial institutions
are lodged and publically reported.
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Transparency in this area (particularly for small business loan rates) is sadly lacking, and
therefore cloud competitive interaction in the marketplace and detract from the urgency for
financial institutions to pass on rate cuts.
In turn, this is subduing the intended market response to monetary policy changes through the
RBA.
The NFF is encouraging Government, and particularly the ACCC to look closely at this issue
of competition and transparency in the banking sector.

Reviewing the mechanisms to attract metro money into agriculture
The NFF also questions whether alternative means of financing farming operations might also
be developed that ease farmers’ reliance on the banks. In other words - is there a way of
attracting metro money into farming through other means?
In this regard, much has been said on the issue of Managed Investment Schemes and the
issues that they have created in distorting resource allocation in regional Australia. It is
widely accepted that in most cases, this mechanism will not be appropriate to finance
agricultural enterprise.
But that is not to say that we should not look at alternative investment mechanisms that draw
in investment through the taxation system or by other means that retain some link to the
output generated by the operation – a factor sorely lacking by MIS.
Work continues in this area by the NFF in the lead up to the 2010 Federal election.

Risk management – How can farmers manage their risks more effectively?
Finally, the NFF notes that responsibility also rests with farmers themselves to ensure that
they manage their risks effectively and in doing so, give confidence to lenders in providing
them with credit.
Effective risk management strategies can help to provide some insulation to the interest rate
and currency fluctuations discussed earlier.
A range of tools are available from both the public and private sectors to help with risk
management that many of you would be using every day.
Policy based tools such as Farm Management Deposits have emerged as being a successful
tax-linked mechanism to assist primary producers deal with the inevitable ebbs and flows in
their cash position resulting from climate variations and fluctuating market prices. There are
now over 36,000 FMD holders (4,123 in WA) with total holdings of almost $2.5 billion ($362
million in WA).
Despite uninformed pockets of the community criticizing FMD’s, the NFF remains adamant
that the scheme provides invaluable commercial options for better and more timely resourcing
decisions by farmers – decisions that result in farmers being able to produce food and fibre in
the most trying of circumstances and keep the economy ticking over in the process.
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In addition to public policy based tools, the private sector is now also providing increasingly
sophisticated risk management options for farmers to use. While including their own set of
pitfalls, these tools, including currency and price hedging, and interest rate fixing options, are
playing an important role.
In addition, the push towards longer term contracts with suppliers and customers and
techniques such as on or off-farm storage are ensuring that farmers gain more certainty in
their business operations and in doing so become a better bet for investors.
Conclusion

In summary, interest rate and currency fluctuations are significant challenges for
Australian farmers.

It is important that farmers are aware of the factors driving these issues and take every
step to manage the risks they have on their businesses. Failing to do so will lead to
additional pressures on accessing finance for future growth.

On the NFF’s part, we will continue to play a role where we can in educating the RBA
about the issues surrounding agriculture to ensure that they are given appropriate
consideration in monetary policy settings.

We will also look to build a competitive financing environment for Australian farmers
while pursing alternative options to draw investment into agriculture.

This will be vital to allow our sector to capitalize of the vast opportunities ahead.
[ENDS]
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