Tag Archives: Canada

Is the Canadian agriculture falling into a debt trap?

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With agricultural commodities prices falling and the prospect of rising interest rates getting closer, I thought it could be interesting to see where the Canadian agriculture stands debt-wise. In this post, I will look at the indebtedness in two ways.

Firstly, farm indebtedness will be assessed relative to the output of the Canadian agriculture. We start by deflating the farm debt value by the CPI. The output is derived from the value of the production (farm sales and change in inventories) by deflating it by the farm products price index. By building an index, we are able to obtain the change in our ratio [Farm debt / Output].

We do the same with the Gross value added (GVA) of the Canadian agriculture and the total value of farm assets (real estate and quota).

The first graph below presents the evolution of our three ratios. What really stands out is:

  • the significant decrease of the economic efficiency (GVA/Output) of the Canadian agriculture over the period considered here (1981-2014) though it has bounced back a bit over the last 10 years thanks to high prices.
  • from 1995, the divergence of dynamics between, on one hand indebtedness and farm assets value, and on the other economic efficiency.

debt trap CDN_AG

That could be explained mainly by two factors :

  • lower interest rates which are now close to the lowest level they could reasonably be at;
  • the increasing share of off-farm income in the farm households which is not captured by the GVA account, and that provides liquidity to repay debt obligations

Secondly, we will look at the indebtedness in the Canadian agriculture through the ratio (Farm debt outstanding)/(Maximum farm debt).

Maximum farm debt is defined as the long-term debt allowed by the aggregate debt servicing capacity, assuming terms and conditions complying with current best agricultural lending practices:

  • Debt service coverage ratio of 1.1, calculated as Earnings before Interest, taxes, Depreciation and Amortization (EBITDA) divided by Principal plus Interest payment. Using Statistics Canada data, EBITDA is approximated by Net cash income plus interest. Because of the intrinsic volatility of farm income, we will use a 3-year average of net cash income before interest in place of the current value to calculate our debt repayment capacity.
  • Repayment period based on useful life of assets. Usually, it is based on the weighted average of the useful life of the different asset classes. However, in order to assess the maximum level of debt, we could use a 20-year repayment period providing the ratio Maximum debt to total Land value remains below 75%. If that ratio was to be above 75%, we would have to revert to the weighted average, with 15 years a good benchmark.
  • Prudent interest rate: the 5-year conventional mortgage rate which is commonly used to stress-test credit risk of agricultural loans. Comparing it to the apparent average interest rate paid by farms, we could note that from the mid-90’s, the spread between the two interest rates is relatively stable.

The graph below shows that indebtedness capacity became more and more saturated until 2005-2007. Then, lower interest rates, increasing farm products and farmland prices, all contributed to raising the maximum farm debt.

max debt + scen

We note that two provinces stand out : Saskatchewan and British Columbia (BC). The former has experienced a remarkable drop in indebtedness saturation because all the recent trends mentioned previously were amplified here. The latter, a contrario, has experienced a very significant jump with a current indebtedness saturation of more than 100%. How is that possible? Short answer: off-farm income, low interest rate, non-standard lending term and conditions, farmland prices driven by non-agricultural factors.

Now, we will assume that the interest rate gradually reverses to its 20-year mean over 10 years while debt repayment capacity, farm debt and land value remain constant. That sole change would lead to increasing saturation of the indebtedness capacity. However, we could construct realistic scenarios which would lead to a much faster saturation.

As far as I am concerned, the debt problem of the Canadian agriculture is not a problem of solvency. The Canadian agriculture is solvent. I do not foresee any collapse of crisis-scale within the next decade. It is a problem of restricting the ability of the Canadian agriculture to sustain, over the long term, a level of investment consistent with the competitive pressure, the pace of innovation and of demographic change.

Then, questions come to mind: Why debt? Are there other sources of capital available? 

This is a first-level analysis at a very aggregated level. To assess the risk identified here adequately, we need to dig deeper and go to disaggregated levels. Preliminary results show differences along industry and farm-size lines.

Supply management : nobody is getting the facts right. Here are some examples.

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Apparently, neither proponents nor opponents of supply management are able to present their figures in an unbiased rigorous fashion.

Consolidation of dairy farms has been faster in Australia than in Canada. Well, it depends on the period you want to consider. For instance, between 1970 and 2014, consolidation has been faster in Canada. Over this period, the number of Canadian dairy farms decreased by 78%, 71% in Australia. For the period 2008-2014, the rate slowed significantly in Australia to 16% (8% in Canada). Production wise, between 1970 and 2013, Australia experienced a 23% increase while production in Canada barely grew (+1%). Between 2008 and 2013, production grew by 3% in both countries. However, there is one common dynamic: the five to ten-year period following a significant policy change (introduction of supply management in 1970 in Canada, deregulation in 2000 in Australia) saw a rapid consolidation and a drop in production in both countries, which is to be expected as farms have to adapt to a new environment and delayed changes are accelerated. Besides, it is interesting to see that nobody talks about the extreme drought experienced by many Australia regions between 1995 and 2009 (especially between 1995 and 2003) and how it has affected dairy farms, most likely magnifying the effects of deregulation. Similarly, since the introduction of a price cap on quota in 2007, quota markets in Canada are feeble and the recent consolidation rate in Canada has been slowed somehow artificially.

I also find a bit misleading the comparison of milk retail price used by Dairy Farmers of Canada, especially in the case of France, a country I know very well. Unlike Canada, most of the consumption of fluid milk in France is made of UHT ½-skimmed milk (about 70% of fluid milk retail market). The average price per liter of UHT ½ skimmed milk in France was 1.15 CAD according to official statistics, not 1.81 (the price of fresh whole milk). I have not checked yet any such discrepancies for the other countries used in the comparison. Any relevant comparison of milk price must account for the differences between milk consumption patterns.

Talking about price, I took a look at egg prices in Canada, at the farm gate and on the retail shelf. It was very instructive. First, farm gate prices in Canada are in line with wholesale price in the US. This means that Canadian egg producers could be competitive on the North-American market, especially considering the strength of biosafety protocols in Canada. However, the most interesting thing is the differential between farm gate and retail prices which has been growing for a decade or so (see figure below).

egg data

Regarding economic contribution of the dairy industry, the proponents of supply management tend to forget to outline that about a third of contributed jobs and GDP, half of fiscal revenues come from the induced effect, which is the most tenuous one and is widely debated in economists’ circles as to its relevance. Besides, they do not highlight how Saputo and Agropur are the cornerstones of the industry nor do they show what would be lost in phasing out supply management (perhaps they want us to believe that all would be lost).

We could fight over these figures forever and forget what the real issues are.

The real issues for the dairy industry are that strengthening forces are weakening the three pillars of supply management: import control, production discipline and price fixing. I have discussed them in a previous post. Like any public policy, supply management has an expiry date, and my guess is that it is before 2030. By then, supply management could well be about 6,000 dairy farms, a handful of dairy processors, and a few retailers fighting over a dormant market, triggering at some point a major crisis originating in a spat between Ontario and Quebec. The dairy industry itself will ask for dismantling supply management, but it may well have lost any political goodwill – the fourth pillar of supply management – to fund the transition by that time.

Some people should really think honestly about the two following questions: how long can we expect to make supply management work in the interest of most of its stakeholders? Are we sure we can get enough political support for massive assistance funding when time comes?  Right now, there is an apparent consensus on the fact that phasing out supply management requires financial assistance for dairy farmers and processors. The industry should take advantage of that to develop a vision and a strategy, and start investing in its future.

Phasing out supply management in Canada is not that simple

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In a previous post, I have highlighted that supply management will likely be phased out within the next 15 years, either because of trade agreements or because of internal tensions which could morph into fault lines. I have been quite critical of some of the arguments used by the proponents of supply management because they don’t pass the test of facts. I will be equally critical of some of the arguments of the adversaries of supply management.

Martha Hall Findlay and Jack Mintz recently published an opinion piece in the Globe and Mail in which they outline a possible scheme to phase out supply management in Canada. Their proposal is to transpose to Canada what was implemented in Australia following the deregulation of the dairy market in 2000, namely a temporary levy on fluid milk sale to finance a quota buyout to help dairy farmers transitioning to an open market. However, one key element seems to be missing there : geography matters to trade patterns.

The Australian domestic market for fluid milk is, well, quite insulated from any competition. Therefore, substitution by cheaper imports was not a threat to Australian dairy farmers on that specific market.

In the case of Canada, the situation will be very different. If a levy was imposed on any fluid milk sale in Canada while the market is totally open, the retailers would have many incentives to substitute Canadian milk by cheaper US milk. One fact to remember here: the US states neighbouring our border produced in 2014 about 5 times more milk than Canada in its entirety (Wisconsin alone produced more than Canada). The threat of substitution will be very real in the aftermath of a brutal end of supply management. Moreover, such substitution by retailers would happen very quickly, much faster than any adaptation at the farm level.

While operating costs are fairly similar on average between dairy farms in these US states and Canada, capital and labour costs are quite higher in Canada, partly due to unrealized economies of scale. Consequently, to have a chance to compete against US dairy farms, Canadian dairy farms must be given time to transition and realize their economies of scale.

In these conditions, I think that an Australian-style levy on fluid milk would have dire consequences on the Canadian dairy industry.

The current debate has been painting supply management as the last Canadian obstacle standing in the way of the TPP agreement. Obviously, this is not true as many other issues are contentious but too often perceptions are stronger than reality. In the meantime, the dairy industry contributes significantly to the Canadian economy. So, we could say that the stakes are high.

Unfortunately, the public debate is rather poorly informed and too many arguments – for or against supply management – are weak, resorting to wishful thinking, twisting facts. What is particularly missing is foresight. Fortunately, the federal government has a group dedicated to such exercise, Policy Horizons Canada. Perhaps, it could be mandated to lead a foresight study of Canadian supply-managed industries, allowing scenarios with and without supply management in different forms.