Present era of 2008 is stormed by rising food prices world wide. The aggregation of rising energy prices , use of food crops for biofuels and torpid food aid have threaten food security of many developing countries.
Globally agricultural commodity prices were significant during 2004-06: corn prices rose 54 %, wheat 34%, soybean oil 71% and sugar 75%.But this trend hastened in 2007, due to continued demand for biofuels and drought in major producing countries. Wheat prices have risen more than 35 percent since the 2006 harvest, while corn prices have increased nearly 28 percent. The price of soybean oil has been particularly volatile, due to high demand growth in China, the U.S., and the European Union (EU), as well as lower global stocks.
Estimated results of food and agriculture organization of United Nations shows that the high food prices of 2006 increased the food import bill of developing countries by 10 percent over 2005 levels. For 2007, the food import bill for these countries increased at a much higher rate, an estimated 25 percent.
Let’s find out in detail what the causes of such a scenario……are……….
As in case for every product demand and supply theories apply, food prices are no exceptions. However no one particular factor can be blamed for rise in prices. Contributions of some unfortunate conjunction of activities over past years have led to mounting prices.
· Meat mania
With the increasing wealth of emerging economies like china and India, there is escalating demand for meat in these countries , which in turn intensifying the demand for cereals to feed the animals. The demand for grains and chapattis is always associated with population growth, which has been remaining flat during the past years, meaning slow growth in population. However demand for meat linked to economic growth. Generation of higher incomes in countries like china and India have made people enough rich to afford meat and other food products. For instance if we look at the history, during 1985 average Chinese consumer ate 20 kg of meat a year ; now he eat more than 50 kg.
It takes 7 to 8.5 pounds of grain to produce a pound of beef and 5 to 7 pounds of grain to produce a pound of pork.
· Ethanol for American cars
Another and one of the most dominant reasons behind mounting of food prices is surging demand for ethanol as fuel for American cars. If we look at the figures it can be figured out that in 2000 around 15m tones of American maize crop was into ethanol ; in the current year it is likely to be around 85 m tones. America is one of the largest maize exporters and now it tends to use more of its maize crop for ethanol rather to fetch trade surplus in its balance of payments by selling it abroad. Ethanol has not only contributed to the rise in prices of maize crops but also accounts for rise in prices of other food crops. Partly this is because maize is fed to animals, which have now become more expensive to rear. Partly it can be due American farmers, who are anxious to take advantage of biofuel boom, went out all to produce maize this year, planting it on lands which have been used previously for wheat and soybean.
In the current year overall downfall in stockpiles of all cereals will be about 53m tones The increase in the amount of American maize going just to ethanol is about 30m tonnes. In other words, the demands of America's ethanol programme alone account for over half the world's unmet need for cereals. Without that programme, food prices would not be rising anything like as quickly as they have been. According to the World Bank, the grain needed to fill up an SUV would feed a person for a year.
· Unfavouable weather conditions
Global climate change brought about by the rising temperature of the Earth is the fourth major cause. Altered weather patterns have been accompanied by floods, tropical storms and droughts all over the globe. Australia, normally a big exporter of wheat and rice, is in the grip of a multiyear drought and has seen its grain production plunge.
· Export restrictions
Some major countries have introduced or have increased export taxes or bans and other restrictions on domestic products to keep down domestic prices. This in turn will lead to adding surmounting pressure on prices. Many countries have imposed food –price controls of some sort. Argentina, morocco, Egypt, Mexico and China have put restrains of domestic prices. A dozen countries include India, Vietnam, Serbia and Ukraine has imposed export taxes or limited exports. Governments of all these countries are trying to safeguard their people from rising prices of food. From such policies some will benefit while others have to bear the repercussions of it.
Obviously, farmers benefit—if governments allow them to keep the gains. In America, the world's biggest agricultural exporter, net farm income this year will be $87 billion, 50% more than the average of the past ten years.
Other recipeient of such policy benefits are in poor countries. Food exporters like india , south africa will gain from increased exprot earnings. Countries such as Malawi and Zimbabwe, which used to export food but no longer do so, also stand to gain if they can boost their harvests. Given that commodity prices have been falling for so long in real terms, this would be an enormous relief to places that have suffered from a relentless decline in their terms of trade.
In emerging economies lot of income inequality prevails between cities and countryside over the past few years. As now many countries have gone through transition phase of shifting from agraian based economy to more industrial and services oriented , urban wages have score off the rural ones. The Asian Development Bank reckons that China's Gini coefficient(measure of inequality) rose from 0.41 in 1993 to 0.47 in 2004. If farm incomes in poor countries are pushed up by higher food prices that would extenuate the gap between incomes of cities and countryside. But will this happen?
Lets look at the answer to it…………………….
According to the World Bank report, 3 billion people live in rural areas in developing countries, of whom 2.5 billion are involved in farming. That 3 billion includes three-quarters of the world's poorest people. So on the fundamental basis the poor overall should benefit from higher farm incomes. In practice many will not. There are large numbers of people who lose more from higher food bills than they gain from higher farm incomes. Exactly how many varies widely from place to place.
From the above context the major losers from high food prices are big importers.this will include Japan , Mexico and Saudi Arabia. A more deeper look shows that these countries might can afford but worry is about countries like Bangladesh and Nepal and Africa who will face higher import bills. Developing countries as a whole will spend over $50 billion importing cereals this year, 10% more than last.
The travail of agflation
Food prices are tipped to rise 50% in another 5 years. The delinquent behind this is agflation.
The up surging prices of bushels and barrels are interrelated. Like the price of agricultural commodities the prices of oil and metals have increased substantially in the past few years. Food prices world over are rising so quickly that a new term has been invented to describe the inflating prices of breakfast staples and dinner favourities i.e. agflation.
As we have already witnessed the causes of this global agflation above, apart from this agflation is also causing headaches for central banks. In most countries when central bank takes appropriate steps of monetary policy to control inflation they exclude food and energy prices. Both are sensitive and erratic to supply shocks. As central banks try to control demand they tend not to react to price fluctuations caused by see-sawing supply.
The major sufferers of agflation are the developing countries as residents of these countries devote large percentage of their personnel expenditures on food. This is reflected in the heavy weighting given to food in the commodity baskets used to measure inflation in developing countries. For instance in America food carries just 14% weight in consumer price index ( measure of inflation) ,china accounts for 33% , south africa 25% , phillipines 50% and india it is 46%. Insuch countries rising prices of food which gives more weight to food in their CPI will lead to high inflation levels all over. In addition, if food prices stay high, and if consumers spend less on other goods, other parts of the economy might suffer. Good reason, therefore, for central bankers and others to hope that the pain of agflation is not shared too widely.
The world food crisis and financial markets
The primary concern underlying current food crisis is not physical lack of food but rather its unaffordability for growing number of people due to rapidly mounting prices.
Among the immediate factors causing the rapid worsening of the food crisis, a major role is played by the explosion of speculative investment in basic commodities such as oil and grain, itself bound up with the difficulties facing US and world financial markets and the decline in the US dollar. Thriving speculation by hedge funds and other big market players has increased costs, encouraging private firms to further bid up prices in a competitive drive to amass as much profit as possible.
The basic reason behind upsurge in prices of agricultural commodities is that big investors have pulled out of tradional investments and credit markets due to bursting of US housing and credit crisis. Speculative capital has shifted investments in more profitable avenues.
The one such aveneue of profitable investments is commodity futures. This involves finacial bets that prices of basic goods such as oil , grains and metals will continue to rise. Since these futures are used as benchmarks for actual trading in the physical commodities, their heady rise has helped sharply pull up market prices for the commodities themselves.
Is this speculation or investment..?
In technical terms speculation is referred to as purchase of something in the hope of gaining profits from change in its price. In this context2 forms of speculation are visible.
1. The purchase / hoarding of commodities in expectation that their price will continue to rise.
2. Purchase of agricultural commodities future and options – essentially, bets that prices will either rise or fall – purely as investment strategy (rather than as a way to manage risk related to the sale and purchase of commodities.
At the end of March 2008, according to Citigroup, investors worldwide held an estimated $400 billion in commodity futures contracts—about $70 billion more than at the beginning of the year, and twice as much as in late 2005. These investors include commodity index funds, commodity trading advisors, hedge funds, and exchange-traded funds. Many of them are trying to assemble commodity portfolios that replicate the performance of major commodity-price indexes, such as the Standard & Poor's/Goldman Sachs Commodity Index and the Dow Jones/AIG Index. They are doing so for two reasons. One is that commodity investments generally increase in value when other classes of assets decline. The second is that many investors believe that the commodity markets are in the midst of a "super cycle"—a long-term trend that will drive prices higher for years to come.
While we have seen number of reasons for rising food prices, there is growing concern that supply and demand do not explain the accurately the speed and severity of price increases. Blame of rising food prices is being put on flood of speculative capital into the U.S commodity future markets , which attract lot of capital from worldwide and set global benchmark for prices.
According to Bloomberg, quoting the Forward Markets Commission, volumes on the National Commodity Exchange, which trades futures contracts in 48 commodities, reached $226 billion in the year ended March 31, 2006. That was more than the $184 billion of shares traded on the Bombay Stock Exchange in the same period. Forward and futures trading had been promoted on the ground that it helped traders deal with market uncertainty by hedging their transactions, and stabilised prices for the final producers. However, the surge in futures trading could not be explained by pure hedging requirements, and obviously reflects an increase in speculative activity.
Indian scenario
Rising inflation… reaching to a level of 12.8 % is a burning issue.
The issue has cause serious worry for policy makers political circles as well as consumers who are facing shrinking purchasing power. The whole sale price index have reached to a 13 year high of 11% on june 7, 2008. The WPI index was close to 4% at the end of 2007 and it has taken just 6 months to reach current level. The volatility in the economy has put the political position of the government into risk , forcing it to take measures like complete elimination or sharp reduction in import duties and ban or increase in export duties of few commodities like rice, steel and cement. However, despite these measures, inflation is well above the comfort zone of both the RBI and the finance ministry. The high inflation rate has seen the government coming under pressure, with both its supporters and the opposition encircling it over the price rise issue. Meanwhile, there is an increasing hubbub from some to impose a ban on futures trading in essential commodities. The case for a ban is mainly on the ground that speculation in futures trading is largely responsible for the price rise.
The most obvious question that comes before us is whether futures trade is actually contributing to a rise in prices or not?
The futures market performs twin functions of efficient price discovery and provides with management to various constituents. The exchange markets have evolved over the years to provide efficient platform for the producers and consumers to extenuate their underlying price risk associated with particular commodity. Price discovery which is a key for any market would become more efficient if number of participants are large and comprises both of hedgers and non-commercial users. As typically the hedgers (producers & consumers) would prefer to take a risk neutral stance while trading on the exchange and would always want to hedge their price risk using the futures markets. However, if both parties remain risk averse, in any economic activity, it becomes very important for somebody to take the economic risk required so that a particular activity is carried. The activity so carried out may not be tangible in the traditional sense of how Keynes would like to define the GDP, but this is more service oriented and the agent willing to undertake this activity is defined as "speculator. Looking at the overall economic situation in India, these economic agents are bashed for carrying out their work. Unfortunately their role in future markets is not well judged. The current rise in prices should be analysed from a both national and international perspective. Internationally, the world has seen a sharp rise in the prices of all commodities, including food items, particularly cereals. Almost each and every economy is facing the problem of price rise and inflation, and India is no exception to this trend. At the national level, prices have also increased more because of supply side problems. These basically relate to years of neglect of the agricultural sector, resulting in general stagnation of agricultural production, productivity and the non-creation of buffer stocks to meet exigencies.
Indian agriculture is characterized by problems of low level public investment particularly in irrigation facilities , low yeild per unit area exhaustion of the yield potential of new high yielding varieties of wheat and rice, unbalanced fertiliser use, low seeds replacement rate, unavailability of extension services and an inadequate incentive system. It’s a fact that reforms need to be carried to address supply side constraints and improve food security. Making futures trading the scapegoat and imposing a ban on it is not realistic on part of the government and will give negative signals to investors. Such a ban will hamper the growth of the market system in India, which already lags other developed economies in this regard. The market is in a nascent stage and must be nurtured for it to yield its full potential benefits. A ban will do just the opposite, Developing a well-regulated market is the only way forward to integrate better with global market, as each economy depends on international market for trade. Even a country like China, with its controlled economy, has a rampant futures market.
Evidence shows that: prices of rice, wheat and tur have increased despite of ban .In fact, rice prices had increased by over 20 per cent since the ban. Against this, the prices of sugar and potato have remained constantly stable since last year even as they continue to be traded on the futures market. A UNCTAD study conducted in five leading exchanges of the developing world, including India and China, suggests that the impact of these exchanges have remained positive and they can contribute in the development of physical infrastructure, imparting transparency and empowering farmers while maintaining quality standards. In an another study by NCDEX, a leading Indian commodity exchange, it has been shown that prices of essential commodities traded in the futures market have increased at a slower pace than of those that remained outside the ambit of futures trading.
Thus its seems to conclude that india is facing a trend of imported inflation i.e inflation due to global rise in food prices.
While it is difficult to ascertain the effect that the Indian economy may face in the future as result of a closer linkage with the global economy, the challenge is to be better prepared to tackle our fundamental weakness, which is the ailing agricultural sector. The banning of futures trade is not a solution for rising prices; instead we must approach issues objectively.
While the commodity markets in the West and in China have achieved the status of price-setters, the Indian commodity markets struggle to stand on their own
Future of global food crisis
Having a look at how global supply and demand changed between 2005 & 2007, it may appear to ones mind that nothing much spectacular has happened that could spark off these price increases than actually observed. Yet, there has effectively been a gap between growth rates of demand and supply wide enough to cause prices to rise significantly on markets where neither supply nor demand (can) respond flexibly and swiftly to price changes – at least not in the short term.
According to the experts sharply rising costs for food staples and fuel are leading to deadly clashes in impoverished countries and likely will continue for some time. According to a world bank report Food crop prices are expected to remain high in 2008 and 2009 and then begin to decline, but they are likely to remain well above the 2004 levels through 2015 for most food crops.
Prices of foods will continue to rise until there is a new balance between food production, bio fuel production and a new price balance.
World agriculture is facing new challenges that, along with existing forces, pose risks for poor people’s livelihoods and food security. This new situation calls for policy actions in three areas:
1. comprehensive social protection and food and nutrition initiatives to meet the short- and medium-term needs of the poor;
2. investment in agriculture, particularly in agricultural science and technology and in market access, at a national and global scale to address the long-term problem of boosting supply; and
3. trade policy reforms, in which developed countries would revise their biofuel and agricultural trade policies and developing countries would stop the new trade-distorting policies with which they are hurting each other.
In the face of rising food prices, both developing and developed countries have a role to play in creating a world where all people have enough food for a healthy and productive life.
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