The frenzy in the global food markets

As food prices continue to soar two years after a similar crisis, the same tired old reasons are being trotted out again, even though they are far off the mark now as they were then.

Jayati Ghosh

CLEARLY, we are back in another phase of sharply rising global food prices, which is wreaking further devastation on populations in developing countries that have already been ravaged for several years of rising prices and falling employment chances. The food price index of the United Nations Food and Agriculture Organisation (FAO) in December 2010 surpassed its previous peak of June 2008, the month that is still thought of as the extreme peak of the world food crisis.

Some of the biggest increases have come in the prices of sugar and edible oils. But even staple prices have shown sharp increases, with the biggest increase in wheat prices, which doubled in the second half of 2010 and have been increasing since then. Rice prices have been relatively stable in global trade over the past year in comparison, but are still much higher (by around 48%) than they were at the start of 2008 (see Charts 1 and 2).

No one can claim that we could not see this coming. In fact, ever since the severe price crunch of mid-2008, there have been those who argued that unless major changes were made in national policies towards agriculture and the way in which we manage the global trade in both agricultural commodities and their futures markets, such a repeat would be almost inevitable.

But the world is a curious place nowadays, with public memory so short as to be almost non-existent and media analysis (as well as public policy) still dominated by those who have comprehensively messed it up but have no sense of either shame or rectitude. So the same tired old reasons for the current food price increase are being trotted out once again, even though they were completely wrong two years ago and are wrong again today.

Wrong reason number 1: Global food prices are increasing because of increased demand from developing countries, especially the rapidly growing large populations of China and India. In fact, FAO data tell the real story, which is quite the opposite. The total consumption of major food grains increased only slightly in the world as a whole (less than 2%) and for several crops it even fell. The total amount of food grain traded in global markets has actually fallen.

Consider the case of wheat, which has seen such a dramatic increase in price over the past year. Total global 'utilisation', or consumption, is estimated to have increased by only 1.2% over the previous year. But global wheat production fell, quite sharply, by 4.3%, so it is the supply shortfall that affected prices. Of course, even this real imbalance is not enough to explain the significant price shift - but more on that later.

In annual terms, the really big increase has come in maize (or corn) prices. The US f.o.b. corn export price increased by around 53% in the year to December 2010. But global utilisation of all coarse grains (in which corn dominates) increased by only 1.8%. The problem for corn was that production fell by 1.1%, and the effects of La Nina and other weather-related phenomena suggest that there may be further adverse effects on supply. In early January the US government cut its forecast for corn stocks by as much as 30%, creating a new and even more intense spiral in corn prices.

And of course corn use is significantly affected by the obscene subsidies that are still provided for biofuels. Last year these subsidies - which ironically are not even really 'green' - meant record ethanol production that accounted for nearly 40% of US corn production.

Clearly, therefore, the recent problem relates much more to supply than to demand - and that too, supply from the major large exporters among developed countries. Production in most developing regions was actually significantly higher in 2010 than it was in the previous year, and indeed has generally kept pace with utilisation in some developing countries. But various weather and other shocks have meant that large exporters have seen their production and exports drop, thereby affecting global markets.

So does that mean that supply shocks have caused the recent problem? Certainly to a significant extent - and that brings back the crucial issues of reviving agriculture and making it more viable, especially for small cultivators in the developing world.  But it cannot explain the entire increase. And that raises the second common - and wrong - reason that is presented for the current price hike.

Wrong reason number 2: The price hike is entirely because of real demand and supply imbalances. This is simply not possible given the volatility and sharp movements of prices that can be seen from the charts. Once again, it is likely that a combination of panic buying and speculative financial activity is playing a role in driving world food prices up well beyond anything that is warranted by real quantity movements.

The most recent data on financial activity in commodity futures markets from the US Commodity Futures Trading Commission suggest that until the end of November the net long positions of index investors had increased dramatically in commodities like wheat and corn. This is likely to have increased even more in the past few weeks, given the announcements about lower levels of public stocks.

Similar trends are evident in the petroleum market, which has driven oil prices up to around $100 a barrel. Higher oil prices also feed into higher food prices, creating another source of price spiral.

Once again we are also seeing contango in these commodity markets, with futures prices higher than spot prices. This is all a repeat of 2007 and the first half of 2008, when prices of these commodities nearly tripled. And it is not surprising, because the regulations that could prevent or at least limit such speculative financial activity are not yet in place, and there are even concerns about whether they will be effective or toothless in the implementation.

Of course the effects of speculation need not (and should not) translate directly into prices faced by consumers in poor developing countries. Certainly, given the much lower per capita incomes in such countries and therefore lower purchasing power of the people, it should be expected that there would be some public mediation of the relationship between global prices and domestic food prices. This is all the more desirable, if not essential, in periods of high price volatility in global trade, such as has been marked in the past four years. Otherwise, poor consumers in the developing world would be sharply affected by such price movements in countries where basic food grains still account for around 40-50% of the consumption basket of the poor.

As it happens, the period of dramatic increases in price volatility in global markets has also been one in which there has been very high transmission of international price changes to domestic prices in many developing countries. This is evident from a quick perusal of retail price changes in wheat and rice markets in some developing countries.

Consider India, a country which currently has the largest number of hungry people in the world and very poor nutrition indicators in general, despite nearly two decades of rapid income growth. Chart 3 shows the behaviour of retail wheat prices in two major cities - Delhi and Mumbai - in relation to the global trade price of wheat (relating to US wheat in the Chicago Board of Trade).

Two important features are immediately evident from this chart. First, the substantial variation in retail prices across the two Indian cities (which would be reinforced by other data showing the variation in retail prices across other towns and cities), which suggests that there is still absence of a national market for essential food items, even those that can be transported and stored easily. Second, the degree to which price changes have tracked international prices.

Many analysts have argued that the Indian food grain market is insulated from the international market because of the system of domestic public food procurement and distribution. Indeed, until the early part of the last decade, this has been generally true. However, the opening of agricultural items to international trade without quantitative restrictions has clearly allowed for greater impact of global prices on domestic prices.

Further, the public distribution system itself has been increasingly run down in the past two decades. Recently it has been further complicated by the insistence of the central government on raising procurement prices and procuring more, but not distributing the increased procurement to states to allow them to provide wheat to the defined 'non-poor' population in a manner that would restrain prices. Instead, the focus has been on building central stocks, which has even turned out to be somewhat counterproductive because of the lack of adequate storage facilities. As a result, Indian retail wheat prices have been higher than global prices in both these urban centres. They rose by about 30% in the year to October 2010 as global prices also increased.

Bangladeshi retail prices have closely tracked global trade prices, always remaining higher (Chart 4). This in itself is significant given the low purchasing power of most Bangladeshi consumers. It indicates that there is little to no mediation between import prices and prices faced by consumers in Bangladesh, and that the latter are subject to the fierce fluctuations and rising tendencies that have characterised the global market.  

What is surprising is that the same is broadly true of Pakistan (the retail price here relates to Lahore city). What is of interest in this case is that while periods of rising prices appear to be marked by rapid transmission to Lahore retail prices, the period of global price reduction shows no such tendency. In fact, Lahore retail prices kept rising even as global prices came down, such that even after the latest global price surge, global prices are still at around the same level as the Pakistan retail price.   

The food grain commodity that is most important for most Asian consumers is rice, which remains the grain that is dominantly consumed by large parts of the population in most of the region. Chart 5 indicates the behaviour of rice prices in Sri Lanka and the Philippines, in relation to the global price.

Note that the two are rather diffferent countries: while Sri Lanka exports cash crops, it is close to self-sufficient in rice in recent times, thanks to major efforts to promote domestic rice cultivation. Rice is of course by far the dominant food crop, accounting for around 60% of dietary requirements. The Philippines, on the other hand, is a rice producer but also depends on imports for between 15 and 20% of domestic consumption, so it is likely to be far more affected by international prices. Rice accounts for around 46% of dietary requirements.

Retail rice prices in Sri Lanka (referring to Colombo in Chart 5) very closely track international prices. Other than the extreme peak of June 2008, retail prices have been close to identical to global trade prices, despite the lack of reliance on imports. So the global price volatility has been reflected even in a country that is largely self-sufficient in rice. In the Philippines the story is even more worrying. Rice prices (referring here to retail prices in Metro Manila) rose dramatically in response to global price movements, almost to the same level as the peak in June 2008, came down as global prices fell in the second half of 2008, but since then have actually been higher in the Philippines than in international trade. Further, they have continued to rise even as rice prices have stabilised in the global market.

Chart 6 describes retail price movements of rice in India (Delhi) and Bangladesh (national average). It is worth remembering the retail prices vary quite significantly across towns and cities in India; even so, this provides an important indication of recent patterns.     

According to FAO data, India is completely self-sufficient in rice whereas Bangladesh currently is only 97% sufficient, importing around 3% of its requirement (possibly more if cross-border smuggling is taken into account). While retail rice prices did not peak in June 2008, they have risen steadily in India and increased by around 26% in the second half of 2010 alone. In Bangladesh there has been much greater volatility, with prices rising sharply following the global surge in 2007-08, then falling and then rising again. In the past two years retail rice prices in Bangladesh have increased by more than 35%.

These trends in different Asian countries point to a broader trend whereby prices in domestic food markets are more and more strongly affected by and related to international price changes. This is a matter of some concern, especially in the context of the ongoing extreme volatility in global prices.

We now have direct recent experience of how financial speculation in commodity markets can not only create unprecedented volatility, but also affect prices in developing countries, with extreme effects on hunger and nutrition for at least half of humanity. The case for moving swiftly to ensure effective regulation in this area - and for dealing with supply issues in a serious and sustainable way - has never been more compelling.                 

Jayati Ghosh is a Professor at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.

*Third World Resurgence No. 247, March 2011, pp 12-15