Economic Impacts of the Drought
Drought conditions affected much of the country during the late summer, particularly in the North Island. The return of rainfall to much of the country in April appears to have broken the drought, with soil moisture levels much higher now than a few months ago. Nonetheless, the drought will take a toll on the agricultural sector and the wider economy.
Drought will reduce real GDP in 2013...
The resumption of rainfall in April supports the assessment made when the forecasts were finalised that the impact of the drought will be largely contained to the 2013 calendar year. Compared to the situation if there was no drought, it is estimated that annual real GDP growth in 2013 will now be around 0.7 percentage points slower. There may be some follow-on impact on growth next year depending on the speed of the recovery from the drought.This estimate takes into account the expected direct impacts of lower agricultural production, including reduced dairy and meat production and earlier than usual slaughtering and processing. It also incorporates indirect multiplier effects throughout the economy in line with previous studies to capture the impact on all industries associated with dairy and meat production.
The dairy industry made a strong start to the 2012/13 season, with cumulative milk production running around 5% to 7% ahead of the previous year in January. However, pasture conditions deteriorated rapidly from January onwards, particularly in the North Island, and total milk production over the season as a whole is now likely to be around 1% to 2% down from last season. There is likely to be a lingering impact at the start of next season too.
Meanwhile, faced with reduced feed supply, farmers sent sheep and cattle to slaughter earlier than usual and therefore at lower carcass weights. It is expected that total lamb production will be around 3% lower in the 2012/13 year than if there was no drought, with a similar magnitude reduction in beef production. Given the strong negative relationship between lambing percentages and the extent of soil moisture deficit in the previous season, it is assumed that this season's dry conditions will result in a 10% reduction in the number of lambs born at the start of the 2013/14 season (Figure 1.11). However, given that the available feed will be shared amongst fewer animals, this may in turn lead to higher carcass weights next season, so it is uncertain how the drought will affect overall lamb production in the 2013/14 season.
- Figure 1.11 - Soil moisture deficit vs. lambing percentages
- Sources: NIWA, Ministry for Primary Industries, the Treasury
...and have a similar impact on nominal GDP
There are three main channels through which the drought's impact on prices in the economy will be felt. The first channel is the offsetting impact of higher dairy prices following the surge seen at Fonterra's fortnightly GlobalDairyTrade auctions in March and early April. This will provide a welcome offset to the reduction in dairy output and, providing it is reflected in payments to farmers, the incomes of those who have managed to maintain milk supply will be higher than would otherwise be the case.
However, the bulk of annual dairy production appears to have been sold earlier in the season at lower prices, and it is important to note that the recent high auction prices are only being achieved for low volumes at the tail-end of the season (Figure 1.12). Increased production costs for farmers to offset reduced pasture growth will also weigh on many farmers' profits and reduce the value-added contribution to GDP made by the dairy sector.
- Figure 1.12 - Quantity and price of dairy products sold at bi-monthly GlobalDairyTrade auctions
- Sources: GlobalDairyTrade, the Treasury
Moreover, part of the sharp pick up in dairy prices is likely to have been driven by tighter global supply (over and above that caused by drier conditions in New Zealand). The reduced milk production in New Zealand in recent months has limited the extent that the dairy industry can benefit from this spike in global prices, and it is expected dairy prices will fall back later this year as global supply returns to normal.
The second channel through which the drought will impact on prices is through lower meat prices. The drought-induced increase in stock slaughter earlier in the season than usual has seen beef and lamb prices fall by around 10% since the start of the year (although reduced supply may lead to higher prices next season).
Finally, in the face of reduced demand, the impact of the drought will limit price pressures from emerging in related sectors in the rest of the economy, such as the freight and wholesale industries. This would tend to reduce nominal GDP from what it would otherwise be.
On balance, the positive contribution from higher dairy prices is expected to be broadly offset by these other price movements. As a result, compared to a “no drought” situation, it is expected the impact of the drought on nominal GDP in the 2013 calendar year will be broadly similar to the 0.7 percentage point impact on real GDP outlined above (equivalent to around $1.5 billion). However, greater uncertainty is associated with this estimate.
Climatic conditions, including the possibility of successive droughts, pose considerable uncertainty and ongoing risks. Such risks are discussed further in the Risks and Scenarios chapter.
