'White gold' turns New Zealand into the 'Saudi Arabia of milk'

It was once derided as a country with 20 sheep for every person. But it is now cows that rule resplendent as an agricultural revolution driven by consumers in China has transformed New Zealand into the world's biggest milk supplier and transformed its US$175bn economy.

Thanks in part to the explosion in trade that saw exports to China - New Zealand's biggest trading partner - rise 45 per cent year-on-year in 2013 to NZ$9.9bn, bullish investors too have been descending on the country best known globally as the backdrop for The Lord of the Rings film trilogy. Trade figures published on Monday show export volumes hit a record in the three months to the end of December, due mainly to surging dairy exports.

"The rural sector has hit a sweet spot," says Paul Bloxham, chief economist at HSBC. "New Zealand is set for a strong 2014, with the economy already firing on all cylinders."

HSBC sees Wellington leapfrogging its peers in the developed world this year with a 3.4 per cent annual rise in economic output, up from 2.8 per cent in 2013, on the back of surging dairy exports, a housing boom and reconstruction after the 2011 earthquake in Christchurch.

Manifestation of this bounty is likely to come in the form of higher interest rates - New Zealand is expected to nudge its rates higher on March 13 - and the Kiwi dollar may surpass parity against the Australian dollar for the first time in 40 years, according to a report by HSBC.

White gold, as milk is becoming known in New Zealand, is changing the face of the country. Since 1980, the dairy herd has more than doubled to 6.5m cows while the number of sheep has halved. At least 300,000 hectares of land has been transferred to dairy use from other types of farming and forestry over the past decade, causing a jump in agricultural land prices.

The dairy industry is driving the boom in capital investment with NZ$1bn dairy plants under construction along with other spin-off infrastructure projects.

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Three times as many upper level agriculture qualifications were awarded in 2012, compared with 2006, although this is still not enough to meet surging demand for skills.

But not everyone is buying into New Zealand's newfound status as the "Saudi Arabia of milk" with some investors questioning its vulnerability to external shocks, particularly in China, and a drop in dairy prices.

"New Zealand has severe structural weaknesses that are very similar to those of crisis-hit southern European and southern emerging market economies," says Stephen Jen, a partner at hedge fund SLJ Macro Partners.

In a recent note he compared New Zealand with Ireland in 2007 before its financial crash with an economy based on debt and credit, low savings rates and current account deficits. The Kiwi dollar may be 20 per cent overvalued, he said.

New Zealand's growing reliance on a single sector - exports of milk, butter and cheese hit a record NZ$13.4bn, almost a third of total exports in 2013 - was graphically illustrated in August when Fonterra, the dairy co-operative that controls 90 per cent of the country's milk production, became embroiled in a contamination scare.

<>Fonterra recalled products across Asia following the discovery of what it thought were potentially fatal bacteria in some milk powders. Its reputation took a hit when China temporarily halted imports of some products and Danone cancelled its supply contract and filed a NZ$490m lawsuit against the company.

"We have started rebuilding," says Theo Spierings, Fonterra chief executive. "Before the end of 2014 we will be stronger than before we entered the crisis."

News of the contamination scare initially caused a sharp sell-off in the Kiwi dollar and prompted Wellington to label the incident as an "embarrassment" to New Zealand.

But Mr Spierings downplays the risks posed to the economy from Fonterra's dominance of milk production in New Zealand and the growing reliance on dairy.

"I prefer a situation where you are depending on protein, which people need for health and growth, than I would be depending on minerals [like Australia is] which are being used for excessive infrastructure building at the moment in China," says Mr Spierings. "Infrastructure that isn't really required in China and underutilised."

<>He says that Chinese demand for dairy products will continue to be driven by urbanisation, a growing middle class and an ageing population while other developing Asian nations are also discovering a thirst for milk. Fonterra's annual revenues should grow by NZ$10bn to NZ$35bn by 2025 and help to deliver Wellington's goal of doubling total agricultural exports by then, says Mr Spierings.

Whether New Zealand's dairy industry can expand at this rate is debatable though, given the impact that dairy farming, a particularly intensive type of agriculture, is having on the environment.

A report by Jan Wright, New Zealand's parliamentary commissioner for the environment, warned the booming dairy industry is causing excessive growth of weeds, slime and algae in waterways.

"Even with best practice mitigation, the large-scale conversion of more land to dairy farming will generally result in more degraded fresh water," said Ms Wright. "In this case, New Zealand does face a classic economy versus environment dilemma."

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