By Rod Nickel and Kelsey Johnson
WINNIPEG, Manitoba/OTTAWA, June 19 (Reuters) - For years, the financial stability of Canadian farmers was the envy of their American counterparts, but rising costs, drought and a dispute with China have weakened their bottom lines.
Net incomes plunged last year, and that setback was followed in March by China's halting purchases of canola, Canada's biggest crop. Now farmers are turning to government aid to avert disaster, lenders are extending the term on loans and machinery dealers are seeing declining sales.
Prime Minister Justin Trudeau's Liberals hold only a handful of rural western seats to potentially lose in the October election, but they have also angered eastern dairy farmers for surrendering greater market access in recent trade deals.
Agriculture is not as directly important to Canada's economy as the service sector, for example, said Brett House, Scotiabank's deputy chief economist. But farm spending indirectly underpins other sectors, said Alberta Agriculture Minister Devin Dreeshen.
"Farmers reinvest every dollar they get. (The pullback) reverberates throughout the entire economy," he said.
Shaun Dyrland, who farms near Kyle, Saskatchewan farm, said conditions are the toughest in about 20 years, forcing the farm to make its first claim from AgriStability, a federal government program that helps farmers weather losses due to poor crops, rising costs or market disruptions.
"Things were running along pretty good and now we've had to make some changes just to make ends meet and make the numbers continue to work," he said.
Dyrland, 40, has eliminated two hired positions on his fourth-generation farm and cut chemical and fertilizer purchases.
"It's definitely reminding me of the late '90s, early 2000s, where we had to really squeeze every penny and make sure every decision was the right one."
Canadian farmers' net income plummeted 21% last year to C$11.6 billion ($8.6 billion) due to soaring debt and labor costs, marking the lowest income level in seven years. Farmers owed a record-high C$106 billion.
Payments from AgriStability have jumped 37% year over year, a spokesman for the federal agriculture department said.
"(Farmers') stress level is extremely high," said Wendy McDonald, an agronomist at Manitoba farm consultancy 360 AG. "They need this crop to do well and it's not off to a great start."
Canadian farmers have fared relatively better under low commodity prices than U.S. growers in recent years due to a low dollar that helped exports and greater crop diversity, said Ryan Riese, national director of agriculture at Royal Bank of Canada RY.TO . Now amid harder times, interest in buying farmland is tapering off, he said.
In Ottawa, there is still hope that farmers can withstand a short-term decline.
"They had a good number of years with significant increases (before the downturn). I'm still optimistic," said Canadian Agriculture Minister Marie-Claude Bibeau, whose government has increased limits on interest-free farm loans.
But farmers are already making adjustments.
"They're not buying new equipment. They're fixing what they have," said Steve McCabe, executive director of Agricultural Manufacturers of Canada, whose members include Ag Growth International AFN.TO and Buhler Industries BUI.TO .
"Buying is really down from last year.
Farm supplier Nutrien Ltd NTR.TO is "particularly concerned for the financial health of Canadian farmers" who are shut out of China, their best export market, said spokesman Will Tigley.
BANKERS 'HOPING FOR SOFT LANDING'
Lenders are anxiously penciling out farmers' growing risk.
"There is a significant amount of nervousness in both the cattle and cash crop sector at the moment," said Glen Snyder, agri business manager for Bank of Montreal BMO.TO in Saskatchewan, Canada's main canola-growing province.
"I'm hoping for a soft landing, and not a hard one that we experienced in the late 1980s early 90s."
The prospect of soft crop prices and potential for lower yields raises concerns about farmers' debt service coverage ratio (DSCR) – a metric closely watched by lenders that indicates a farm's profitability and ability to manage debt, Snyder said.
Even a well-managed farm could see its DSCR slip into a worrisome range this year if crop receipts decline by 10%, a realistic scenario given Saskatchewan's drought, Snyder said.
The drop in net income "is a big deal for sure," said Jean-Philippe Gervais, chief agriculture economist at government lender Farm Credit Canada. "Producers are going to have to be a little bit more careful."
Gervais said some farmers are spreading their debt over longer periods of time.
"I always felt the good times couldn't roll forever," said Dyrland, the Saskatchewan farmer. "Nobody likes to see it come. But I think in agriculture, it's bound to happen."