Post-white gold rush, what next for New Zealand?

Herd of cows in New Zealand, North Island, Auckland.
Scott E Barbour | Getty Images

As New Zealand's dairy industry - a key pillar of the economy - crumbles under the pressure of a supply glut and slowing demand out of China, tourism in the land of hobbits is picking up some of the slack.

But, this won't be sufficient to reverse the slowdown in growth in the once "rock star" economy, say analysts, flagging the likelihood of further monetary easing as soon as this week.

"With very low dairy prices and confidence falling sharply, New Zealand's economy is slowing from the rapid pace of growth recorded in 2014," said Paul Bloxham and Daniel Smith, economists at HSBC.

Dairy products are the country's biggest export earner, totaling 12 billion New Zealand dollars ($7.5 billion) in the year to June 30. However, this was down almost a quarter compared to the same period a year earlier, reflecting the slump in global diary prices.

Dairy prices sank to a 12-1/2-year low in August as the slowdown in China, the Middle East and other emerging markets damped on demand for protein and other producers stepped up production.

However, prices have started to perk up in recent weeks as New Zealand's Fonterra, the world's largest dairy exporter, reduces the amount of dairy products it offers at auctions, according to Reuters.

Despite this, analysts are not expecting a strong recovery anytime soon.

Craig Ebert, senior economist at National Australia Bank expects prices will remain subdued for another 1-2 years.

"The recovery is built on the excess supply righting itself. There is a rebound story as the glut gets dealt with, but it will only be a gradual process," he said.

Weakness in the dairy sector not only hurts farm incomes, it has implications for the broader economy, say economists.

"Low prices will reduce farm incomes, with many farmers facing negative cash-flow for the second season in a row. More worryingly, the malaise in the dairy sector appears to be spreading to other sectors," said Bloxham and Smith. "Confidence has fallen sharply in the agricultural sector, but has also declined to varying degrees across all other business sectors."

Tourism to the rescue?

Lucky for New Zealand, as demand for its milk product cools, it is enjoying an uptick in inbound tourists, many of them inspired by the highly successful The Lord of Rings films trilogy shot in the country.

Arrivals have also flocked from China – the country's second largest visitor market after Australia. Over 315,000 mainland tourists traveled to the country between August 2014 and July 2015, up 30 percent on year, according to Tourism New Zealand.

As such, tourism is set to overtake dairy as New Zealand's biggest export earner as visitor arrivals continue to set new records, according to analysts.

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"The biggest increases we've seen are coming from China – which is interesting given the perception China is slowing," said Ebert.

Aside from tourism, construction activity is another support for the economy, driven by rebuilding efforts in Christchurch following the 2011 earthquake and a surge in housing construction in Auckland.

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However, upward momentum to growth from the Christchurch rebuild is fading. "The rebuilding program is getting close to peaking in terms of home building and repairs," said Ebert.

Taking all factors into account, Ebert predicts gross domestic product (GDP) growth will slow to 2.4 percent this year and 1.9 percent next year, down from 3.3 percent in 2014 – the fastest pace since 2007.

Enter the RBNZ

With a softening growth outlook and low inflation, economists say further monetary easing is needed.

The Reserve Bank of New Zealand is widely expected to slash borrowing costs by 25 basis points to 2.75 percent when it meets on Thursday. This would be the third interest rate cut this year, bringing cumulative easing to 75 basis points in 2015.

"Even though the lower New Zealand dollar is helping ease monetary conditions, further interest rate cuts are likely in 2015 if domestic demand continues to disappoint," said Katrina Ell, economist at Moody's Analytics.