Soaring World Food Prices and Volatility: Can Trade break the jinx?

By Linu Mathew Philip, Research Officer, Centad

For the past two years, the global agricultural market has been witnessing structural change wherein the international prices of agricultural commodities have gone through the roof. These changes are primarily driven by a combination of demand and supply factors. Expanding food consumption demand due to rising income and demographic pressure in Asia along with weather aberrations and diseases especially the two drought years, 2005 and 2006 in Australia, is said to be contributing primarily to the present low stocks in cereals at the global level. Even the avian influenza in many Asian countries is being attributed to the current food crisis. ¹ Agricultural commodity prices have risen sharply in 2006 the FAO food price index rose by 9 percent in 2006 compared to the previous year. In September 2007, it stood at 172 points, representing a year-on-year jump in value of roughly 37 percent. The surge in prices has been led primarily by dairy and grains. Even the sugar prices, which peaked in 2006 has been falling since then, has again picked up in the first quarter of 2008. Invariably all commodities have witnessed a structural shift. High prices do help poor farmers, but they also hurt the more numerous category of people (poor city dwellers as well as landless rural folks) who must buy food to survive. Soaring prices for products like rice and wheat cause headaches for aid agencies and especially policymakers find these instances a political risk seriously jeopardizing their electoral results.

Global Food Price Movements

In normal economic theories, price movement follow a cyclical phenomenon with peaks and troughs. Under both these turnarounds leave a trace indelible in the lives of people and most often the poor consumers and producers find it increasingly difficult to adjust to these sudden changes. The current spurt in prices is very often referred to as 'Agflation' created by sharp rise in agricultural commodity including food prices. According to FAO report, 37 countries have been identified requiring external assistance which includes 10 Asian countries and 4 South Asian countries reeling under the food crisis compounded by other political factors. World food price have increased at a very fast pace, in the first quarter 2008 the price indices have scaled up by 23 percentage points and as compared to previous year 2007 it has increased by 78 percentage and from 2005 there has been an increase of over 100 points indicative that prices have almost doubled. At a disaggregated level it can be seen that biggest contributor to this rise in prices are the cereals followed by the oil and fats then dairy, sugar and meat. This increase has been widespread across the globe and the impact on small least developed countries has been the worst (See box 1)

Source: Crop and Food Situation April 2008

Agricultural prices have remained very low for over a decade coinciding with the WTO implementation period and the subsidies had a direct bearing on the depressing nature of prices as the level of subsidies too peaked during the same phase between 1999-2002. The spurt in International food prices is akin to the early 1970s when the prices of international foodgrains doubled and under both these condition there was a serious crisis when the crude oil prices too increased at the same pace. Even now the scenario is similar when the crude oil has shot over USD 100 per barrel and global crisis seem to emerge from the situation of the oil price in simple words the fuel prices is precipitating to a considerable extent the current global food price rise. In another analysis by Jayati and C.P. Chandrashekhar have shown that though food prices have spiked up but many agricultural raw materials, had shown only a modest increase until early 2007.

"In the case of food, there are more than just demand forces at work, although it is certainly true that rising incomes in Asia and other parts of the developing world have led to increased demand for food. Five major aspects affecting supply conditions have been crucial in changing global market conditions for food crops. First, there is the impact of high oil prices, which affect agricultural costs directly because of the significance of energy as an input in the cultivation process itself (through fertiliser and irrigation costs) as well as in transporting food. Across the world, governments have reduced protection and subsidies on agriculture, which means that high costs of energy directly translate into higher costs of cultivation, and therefore higher prices of output. Second, there is the impact of both oil prices and government policies in the US, Europe, Brazil and elsewhere that have promoted bio-fuels as an alternative to petroleum. This has led to significant shifts in acreage as well as use of certain grains. For example, in 2006 the US diverted more than 20 percent of its maize production to the production of ethanol; Brazil used half of its sugarcane production to make bio-fuel, and the European Union used the greater part of its vegetable oil production as well as imported vegetable oils, to make bio-fuel. This has naturally reduced the available land for producing food." ²

Commodity Stock Positions

One of the most critical aspects of food security is the stock option country is having to mitigate the price volatility and offset speculation. And at the global level the utilization and stock position of different food commodities play a major role in the price movements. From the latest report, the turbulent conditions are prevailing in world cereal markets primarily contributed due to tighter supplies in the global markets this becomes critical when the demand for food is rising along with feed and industrial use. The cereal stocks had been very low at the start of the 2007-08 season and due to equally low global cereal production was just sufficient to meet expected world utilization. This would have most likely pushed the International prices of cereal fuelling domestic food price inflation in many parts of the world. Inflation also brings in structural changes in the trade polices of countries on a short term further contracting trade and coupled with soaring freight rates will push the prices further. It is also anticipated that the cereal supply will improve in the coming months as the production will improve in Australia, North America and Europe. (FAO, 2008)

In India, weather conditions for this year's winter wheat crop have been generally favourable and output for 2008 is officially forecast at some 74.8 million tonnes, compared to a near record production of 75.8 million tonnes last year. This year's smaller crop forecast reflects a decline at 500 000 hectares in planted area and unfavourable weather at planting time in some major producing provinces. However, this output is still 6.3 percent above the five year average. Smaller wheat crop is expected in Pakistan this year and production by FAO is forecast at one million tonnes less than last year's record, reflecting a reduced area due to sowing delays, less availability of irrigation water and high fertilizer prices. However, output could still be 5.3 percent higher than the five-year average. The price of wheat in Pakistan remains lower than in neighbouring countries, so that wheat (flour) is being smuggled out of the country; domestic food prices are increasing as a result. In case of rice, the production has been weak in Pakistan and the prices have shot drastically in the first quarter of 2008.

Figure 2 Retail price index in Pakistan (February 2007=100)

Source: Crop and Food Situation April 2008

Cyclone Sidr hit up to 30 districts in Bangladesh on November 15, 2007, and large-scale humanitarian relief operations are still on in the country to assist the most affected 8.9 million people. Food and non-food items are being distributed in 13 cyclone-affected districts. The reduction in 2007 paddy production and rising food price since 2007 are significantly impacting the food security of vulnerable populations in both urban and rural areas.

Figure 3 Wheat and rice retail prices in Bangladesh

In Sri Lanka, the country's food security continues to be affected by the resurgence of civil conflict, natural disasters (recent floods), as well as rising cereal prices (Figure 10). Since the beginning of 2008, more than 2,500 people have reportedly been killed in fighting and the security situation has deteriorated. Rice and wheat flour prices in March 2008 in Colombo city were higher by 77 percent and 72 percent, respectively, compared to the same period in 2007.

Figure 4 Wheat flour and rice retail prices in Sri Lanka

Source: Crop and Food Situation April 2008

Food Prices and International Trade

Most policymakers see the rise in prices as direct reflection of the international price movement as the reverse trend is precipitated if imports surge arises below the domestic prices. The studies by FAO forecast that world trade in cereals is set to slightly increase over the last year as the sharp increase in imports of coarse grains is expected to more than offset decline in wheat and rice trade. Most countries under these circumstance are going to regulate trade options like the export ban which will contract trade which will further push the prices of international prices further up. Another important reason for the low trade is anticipated increase in production this year. In many countries with import tariff schemes in place, most have lowered or suspended their tariffs in order to dampen the impact of high world prices on domestic consumers. However, several countries are expected to increase their imports this season such as Morocco where a severe drought reduced wheat production last year, or in Pakistan where, in spite of higher production, large imports are needed due to significant cross-border exports earlier in the season. For many countries, the costly food imports are going to further erode the trade deficit and adding to miseries to the net food importing countries.

The current food crisis comes at a time when countries like India are in high growth stage of development trying to rope in huge capital in investment for development and looking forward to an agri-business revolution. The prolonged agrarian crisis in many parts of the developing world especially India has shifted in acreage from food crops to cash crops relying on purchased inputs; the excessive use of groundwater and inadequate attention to preserving or regenerating land and soil quality; the lack of attention to relevant agricultural research and extension; the overuse of chemical inputs that have long-run implications for both safety and productivity; the ecological implications of both pollution and climate change, including desertification and loss of cultivable land. The surge in major agricultural commodities comes at a time when there is heightened awareness about risks associated with global warming and climate change. Interestingly, there seems to be a close interlinkage between climate change and the food prices rise. In times to come, it is also anticipated that there is going to be increased variability in temperature and higher incidences of flood and drought which is going to have implication on the production process which can further push the prices up, acute weather vagaries will bring greater fluctuation in crop yield, and uncertain prospects of production, supplies and of course prices. Thus perceiving the trade solution to the current food price may not be sufficient but will need collective effort combining climate change mitigation effort along with trade.

¹ G Chandrashekhar Business Line 2 April 2008 http://www.blonnet.com/2007/05/01/stories/2007050100221400.htm (visited 3 April 2008)

²Jayati Ghosh and C.P. Chandrashekhar (2008) http://www.businessline.in/cgi-bin/print.pl?file=2008040850360900.htm&date=2008/04/08/&prd=bl&

April 21, 2008