Government Facing a Farm Credit Drought

government-facing-a-farm-credit-drought

This Eastern States drought is turning out to be one of the biggest on record, bigger and drier than the centenary, second world war and millennial droughts. Running into its second year this one has now become a serious political and economic headache for the Morrison government compounded by the recent intervention of Barnaby Joyce and Alan Jones.

The existing policy approach by the government which focuses on farm household support to put food on the table is not what Joyce and Jones want to see. They are demanding funds to help farmers pay for fodder, water and plug the gap in credit when the banks turn their backs on them. However, the economic dry’s in treasury will be dead against providing any form of direct farm business support and wearing the risk of opening the door to ongoing farm subsidies. Easy to start but hard to end. On the other hand, the more pragmatic economists in Treasury will be equally worried about the impact of declining farm gate production on the national growth figures. With growth already low, another year of drought is the last thing the economy or the government needs.

A comparison of growth rates for GDP and non-farm GDP reveals that agriculture has shaved around one percentage point off growth during the last three droughts and so far, this one has pruned at least 0.5% off what is already a weak economy. So, while farm production might make up just 3% of the total economy, when the rains stop coming, the impact from lost agricultural production can hit the Australian economy hard.

At the other end of the scale when things are growing strongly on the farms such as the 2016-17 season, Australian agriculture ends up being the largest contributor to economic growth. In that year, farm production drove over a quarter of the national economic growth, accounting for 0.5% out of 1.9% total growth. In fact, agriculture had a faster growth rate than any of the 19 other key sectors in the economy.

This is in part why treasury and the government still hang off the back of farmers, just as in by-gone days when Australia was built on the sheep’s back. Farm production can make or break the budget growth figures, and with it, governments electoral prospects. Linked to all of this is the strong interest that the media and community have for what’s happening on Australia’s farms. It is a brave politician that ignores the plight of farmers and the mood in the bush, just ask Bill Shorten.

Which is why this drought is a problem for this government, particularly when added to the international pressure’s farmers are facing from global trade wars, China’s economic slowdown, and increasing global grain competition. Overall, the current signs for agriculture and the Australian economy does not look good. Even if the rains come again soon, it might not be enough for the government to see an economic bounce, particularly if farmers can’t get enough credit out of their banks and finance providers to restock and replant.

Worse, if this drought runs into a third year, the government will be facing the nightmare scenario of heading into the next election with their most important regional seats suffering from dry and dying communities. Already you can see the politics starting to move as Barnaby muscles up from the back bench threatening to trade his vote for another $1.3 billion in drought support. What the government desperately needs is for one sector of the economy to crank up and bring in some big export dollars, but the drought has taken agriculture out of the game for this year and farmers access to credit for next year is drying up as fast as the drought is drying out their land.

With the size of the seasonal capital requirements running to the tens of billions of dollars only the banks can carry farmers through a drought, not governments. If this government really wants to ensure that the tractors roar into life next year and full cropping programs are rolled out, then they need to find ways to keep the credit flowing. As the banks tighten up, the ability of farmers to borrow and maximise returns is limited. If the opening rains come next autumn the government needs the whole farm sector running full roar, cropping fence to fence, to pump up those growth numbers. If the rains do not come, they need to keep the liquidators at bay and the credit flowing so that the farmers can go hard again in 2021.

Listening to the media one would think that there are already large amounts of support flowing to drought affected farmers. However, a quick review of the programs on offer shows that the half dozen Commonwealth drought and rural support programs are mainly focused on some form of farm social security or wellbeing. In terms of business funding, there is some State government fodder, transport, water and infrastructure rebates plus the option to borrow up to $2m from the newly established Commonwealth Regional Investment Corporation which offers concessional drought and farm investment loans of up to $2m at 3.11%, but only to viable farm businesses.

Credit must go to Barnaby Joyce who promoted this new rural bank (Barnaby’s Bank) which was promised as an alternative to the existing financial institutions when they fail to back farmers through tough times. But we know that Treasury has no appetite to become the lender of last resort. In fact, due to tight criteria the bank has only lent around $250m to less than 300 farmers in the past 8 months and with a capital base of just $4 billion it will never fill the looming gap in farm credit finance. A credit gap that in part has been created by the Banking Royal Commission which has made banks wary of any negative media such as that which comes from forcefully evicting farmers.

If Barnaby’s bank is to make a difference, Treasury needs to take the hobbles off and encourage it to advance seasonal funds to farm businesses supported by second mortgages and registered securities. If the bank does not have the capacity to act quickly it should appoint other lenders as agents to get the money flowing. However, it will only ever be a marginal player helping to keep downward pressure on interest rates. The real solution to tight farm credit lies with ensuring greater access to the private lender market, which can only be done by reducing the risk existing lenders face when it comes to supporting farmers through tough times.

From experience, we know that the only thing that will keep farms viable and country towns working through drought years is extended credit beyond normal debt to equity levels. What the Federal Government fears the most is what happened in the millennial drought when the banks slowly shut off farmers access to credit which exacerbated the impact of that drought. The end result was the loss of around 70,000 agriculture jobs, 1 in 7 of the total Australian farm workforce. This decline reverberated through rural communities leaving in its wake empty shops, school desks and houses and a change of federal government in 2007 which coincided with the tail end of that long drought.

So how does the government respond to the current drought in a way that will minimise the impact on rural employment and maximise the rebound when the rains come again? They could for instance increase the instant tax write off for farm infrastructure from $30,000 to $100,000. This would keep some fencing contractors and dam builders in work, but only on those farms that still have cash in the bank or credit to spend. Or they could reduce the tax rate on farmers withdrawing Farm Management Deposits (FMDs) to a flat 25% in line with where company tax rates are heading in 2021-22, with a one off reduction to 20% for 2019-20 in recognition of the drought. But these measures will only help those with a tax problem or cash in the bank.

The reality is, the vast majority of farmers impacted by this drought are not in a position to claim a tax deduction from building a new dam, nor do they have reserve funds in FMD’s, nor would they be eligible for the Barnaby bank concessional loans. This is where the government should think carefully on what other options are available before rushing to splash another billion dollars on make work projects such as giving shire councils $10m each to spend on dog cemeteries. This is a guaranteed way of ending up with bad press from mad cap council projects. The two Commission of Inquiries into the Rudd’s $14.7 billion Education Revolution and Western Australia’s $7 billion Royalties for Regions program should be compulsory reading for the Treasurer.

The government would be far better off looking at how they can encourage the banks to keep lending to farmers at competitive interest rates even if it sees farm equity levels drop to just 20 or 30% but backed by crop insurance. Just as the banks and state governments work together to leverage new home buyers into home ownership with the aid of mortgage insurance and loan guarantees, the commonwealth can look to risk insurance models to support farmers to plant next year’s crop.

We know banks do not like elevated risk and they like selling up farmers even less, so the easy thing for them to do is to minimise their own financial and social license risk by not offering any more credit to high risk farm businesses during a drought, then wait for them to walk. So how could the Commonwealth offset some of the bank’s risk when it comes to lending to farmers, without becoming the lender of last resort? There are options around, but they mostly require the government to go part guarantor or to subsidise premiums for risk insurance.

As explored in a 2012 paper by ABARE Options for Insuring Australian Agriculture there are problems with most of the various farm risk mitigation schemes that have been proposed or trialled in Australia; multi-peril crop insurance, weather derivatives, area yield insurance, crop income insurance and mutual funds. Of the schemes that have been trialled almost all have failed either due to poor take up by farmers who prefer to self-insure, or they were not financially sustainable without government support.

One of the few viable options put forward that could gain some traction in Treasury is some form of farmers mutual (like private health insurance mutual) set up for the express purpose of underwriting seasonal cropping and livestock replacement and management programs. Being farmer owned it would act as a crop or income insurance scheme that pooled risk across Australia using low decile rainfall impacts on income as the trigger for payouts. Such a scheme would need government support to be kicked off in the middle of a drought, but a half billion dollars put up as part guarantor to mutual fund would I suspect be a better bet in helping to underwrite next year’s crop than taxpayer funds being spent upgrading country rodeo grounds or hunting feral pigs.

Crop and revenue insurance underwrite the banks risk which gives them the confidence to back a stretched farmer into next year’s crop. The economic upswing to the rural and national economy of a farm sector planting 22 million hectares and chasing our record 56 million tonnes in 2016-17 vs last year’s 30 million tonnes is at least half a percentage difference in national GDP. It takes a lot of dog cemeteries to generate the sort of multiplier that a big national crop can produce.

How to fund any support so it does not become a long term burden on the taxpayer would be a dilemma for government, linking it to the drought as part of drought policy is the obvious way forward. In turn government could wind back some of its other family farm support programs. The risk capital could be sourced by tapping the tax generated from encouraging farmers to withdraw some of the $5.7 billion in FMDs which remain locked up due to the high exit tax rates. Every billion could be worth $200m in tax revenue along with the multiplier of the regional business activity it would generate.

Another option is redirecting some of $1.3 billion in funds currently being touted to be spent on regional community projects as part of drought support round two. Or they could trade farm family access to a government backed mutual for withdrawing from the Farm Household Allowance Scheme which allows families to have up to $5m in assets and still receive $1008 a fortnight for a maximum of 4 years.

The final option is hypothecating some of the governments new bank levy funds. In this year’s budget the government extracted $6.2 billion from the banks as an additional levy to balance the commonwealth’s budget. It was an out and out cash grab when the banks had no friends during the height of the Royal Commission. One could argue that at least 5% of the levy funds has come from agriculture so why not offer those funds back to the banks on the condition they redeploy this cash towards underwriting farm risk insurance.

It would be a win, win, win, win, banks get part of their levy funds back, farmers get access to more credit, the government actually does something useful in terms of drought programs, and the treasurer will get the funds back through the multiplier effect.

It’s time for the government to have a whole new look at drought policy and get away from handouts to focus on crank ups. While some won’t make the cut and will exit the industry the government needs to focus its attention on the risk takers who want to go around the paddock again for another season. The current drought policy is a slow welfare death and is not working. Give farmers the credit they need to go hard or tell them to sell up and extract their capital.

If the government is going to avoid being hung out to dry by Alan Jones and Barnaby Joyce, they need to do something different sooner rather than later around drought policy. The government cannot afford a rerun of the millennial drought and see another 70,000 farmers and farm workers leave the land and head for the big regional towns and the cities. The impact of such an exodus would see a rerun of the 2007 election.

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