09 Aug 2018
New South Wales is particularly badly affected, with southern Queensland and Victoria also hit hard.
"Already the impact of the drought is evident in the economic data.”
While persistently dry conditions have been apparent in some areas for a long period, conditions have deteriorated significantly over the past few months.
In New South Wales, 84 per cent of the state has experienced rainfall deficiencies in the bottom 10 per cent this year, the highest since 1965.
Above-average temperatures have made the dry conditions worse.
In many parts of the country, serious rainfall deficiencies alongside above-average temperatures have led to a rapid and intense drying, with sub-soil moisture levels in New South Wales at the third lowest level on record.
The 2002 drought was drier, but not as hot as 2018
The Bureau of Meteorology (BOM) is forecasting warm and dry conditions are likely to continue over the next three months. Signs that an El Niño may develop are also evident, which would bring further warmer- and drier-than-average conditions to eastern Australia.
Commodity prices are already responding.
After a very strong few years, cattle prices are now falling sharply as slaughter rates increase, while wheat prices are sharply higher than historical averages and still climbing.
Western Australia, the largest exporter of wheat, has experienced more normal weather conditions and, as such, will benefit from higher prices and cushion the overall negative impact of drought on the national economy.
Already the impact of the drought is evident in the economic data.
Rural export volumes are down 14 per cent over the past two quarters, and farm gross domestic product is also down 15 per cent over the past year, taking just under 0.4ppts off growth. There is likely to be further subtractions from growth over the rest of the year.
The intensity of the drought has clearly taken the major forecasters of agricultural production by surprise.
As late as June, the Department of Agriculture (ABARE) was expecting a recovery in most sectors of farm output in 2018-19, and winter crop production in line with last year’s. Given the sharp deterioration in conditions over the past few months, new forecasts due in September are likely to show a more pessimistic outlook for the current financial year.
The full extent of the impact of the drought on the economy will depend on when rainfall returns to normal and the drought ends.
With the BOM forecasting ongoing warm and dry conditions, this suggests that farm GDP is likely to continue to subtract from growth through the rest of 2018 and potentially into next year.
Looking for solutions
In each of the five major droughts of the past 30 years, reduced farm output took 0.7–1.1ppt off growth. The impact of this drought is likely to be similar in ANZ Research’s view, although good conditions in Western Australia will take the edge off the national impact.
Overall, ANZ Research expects farm GDP to continue falling into 2019, with a peak-to-trough decline of 25 per cent over two years.
Rural exports will also clearly be hard-hit as well as agricultural sector employment. The risks around these forecasts remain significant, and a larger impact cannot be discounted.
Farmers, as well as the associated regional communities, are likely to feel the effects of the drought on their incomes. Farmers do, however, have some buffers to help smooth the impact.
Between June 2016 and June 2017, the sharp rise in agricultural income (up 70 per cent) enabled farmers to increase their deposits in the Farm Management Deposit scheme (FMD).
The scheme allows farmers to make deposits of pre-tax income in years when income is high, which they can withdraw when earnings are low. The FMD has seen strong growth in deposits over the past few years, in line with the rise in agricultural incomes, which in turn reflects high commodity prices.
Some farmers are also able to access federal and state government relief payments and/or privately donated contributions.
While the RBA has mentioned the drought in its recent publications, its last Statement on Monetary Policy focused more on downside risks to the outlook.
The Bank noted that “rural exports are expected to be a little weaker than anticipated in the May Statement because of drought conditions in parts of the country. If these conditions were to persist or become more widespread, then the impact on rural exports, and the farm sector more generally, would be larger.”
It also referred to the drought at its August meeting, with the minutes noting that “the probability of an El Niño event, which would typically be associated with low rainfall in eastern Australia, had increased over 2018, implying downside risks to the forecasts for farm output and exports.”
While the drought may ultimately be a larger drag on growth than currently forecast, we expect that from a policy perspective the RBA will largely look through it.
While there are clearly deeply felt impacts on the affected regional communities, the drought is unlikely to have much impact on the overall trajectory of the national unemployment rate and underlying inflation.
Felicity Emmett is a Senior Economist at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
09 Aug 2018
26 Jul 2018