Those long the Kiwi (NZDUSD) woke up to an unpleasant shock this morning when the pair opened nearly 100 pips lower following news that China and Russia, and likely other countries soon, have halted imports of New Zealand milk powders after Fonterra announced that three batches of whey protein "may have been" contaminated with botulism-causing bacteria: a situation that is a tad more problematic than the diplomatic haggling over genetically modified crops.

Since milk powders accounted for a whopping 15% of total New Zealand exports in 2012, it becomes obvious that unless Fonterra, and the NZ government, engage in some prompt damage control, the Kiwi may have much more room to drop as the country's 2013 GDP forecast may be the next thing to go toxic.

Goldman has more:

Main points:

1. Over the weekend, Fonterra (NZ's largest exporter of dairy products) announced that three batches of whey protein (around 38 tonnes) may have been contaminated with bacteria that can cause botulism. This product is reported to have been sold to eight companies in seven countries (NZ, China, Malaysia, Saudi Arabia, Thailand, Vietnam and Australia) and used in around 500 tonnes of product. Fonterra also stated that there have been no confirmed reports of any illness linked to consumption of the affected whey protein.

2. Various media outlets are reporting (see Bloomberg) that in response to this news China and Russia have suspended imports of NZ milk powders. Fonterra itself stated that to date there has been no official notification of such a reaction and the NZ Government is working with Chinese officials. Some of the companies affected have begun product recall procedures.

3. In the 12 months to December 2012, NZ exported NZ$12.6bn in dairy products (27% of total goods exports). Milk powders totaled around NZ$6.9bn (15%), with China taking around NZ$2.1bn of this. Whey protein itself is only a very small portion of NZ's dairy exports.

4. The market reaction to this news has been sharp, with the NZD initially falling close to 2% on the open this morning.

At this early stage it is hard to be sure of the potential economic impact. In a best case outcome, Fonterra is able to prove that the contaminated product has been identified and reassure over future quality issues. Trade would likely resume reasonably quickly and other than perhaps a small timing impact on NZ's trade accounts, the economic impact would be small. At this stage, that is our base case. A worse case outcome is if the ban lasts for weeks rather than days and the suspension of the importation of NZ dairy products broadens to other countries. Clearly there would be a sharply negative impact on the trade accounts and domestic economic confidence. More difficult to measure, but arguably the biggest concern from this scare, is the effect this has on NZ's food safety reputation.

At this stage our overall economic forecasts are unchanged, although we are watching developments closely.