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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. NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -1- 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). NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -2- 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. NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -3- 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. NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -4- 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 NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -5- 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 NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -6- 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. NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -7- 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. NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -8- 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] NFF Speeches – Interest rates and the Australian dollar – the farmers’ story -9-