Wednesday, January 26, 2011

An imminent food price increase

An imminent food price increase

IN this space last week I wrote about the likelihood of Pakistan’s already battered economy receiving another shock sometime soon. In 2011 the economy is likely to be hurt by an imminent and significant rise in the prices of commodities.

Last week, I wrote about the recent trends in the movement of two groups of commodities: energy producing items and metals. Today I will turn to the likely impact of a number of global developments on the prices of agricultural commodities several of which are important in Pakistan’s import basket.
There is a mounting anxiety in international circles that we are about to witness an extraordinary increase in the prices of several agricultural commodities that enter the food chain.

While the economy was hammered by a number of domestic developments in the last couple of years – some of them brought on by nature such as the flood last summer of biblical proportions and some by poor public policies – further shocks are likely to be delivered by a series of developments in the international market place over which policymakers have no control.

In these difficult times Pakistan cannot afford to alienate its foreign friends. The policymakers’ poor performance in the area of domestic resource mobilisation means that its relations with the International Monetary Fund and much of the Western world will remain strained. Pakistan’s leaders will have to demonstrate that they can gather the political will needed to introduce long postponed structural reforms in particular of the tax system. They will need to do this before the donors are prepared to loosen their purse strings and come to the country’s help one more time. Help will be needed if the prices of the imported commodities increase and begin to eat into the accumulated reserves.

Much of IMF $11.3 billion standby credit has arrived and is responsible for taking the foreign exchange reserves to a comfortable level. But the Fund has stopped further disbursements since Pakistan has not been able to meet one of the more important conditions: improving the tax system to generate more resources from within the economy. With the Fund stepping aside, Pakistan has very limited options available to meet the pressure on external accounts that will result from a rise in commodity prices.

As is usually the case with commodities, price rises are the result of a number of factors: natural disasters and changes in weather conditions, changes in the structure of demand in large countries, actions by the governments across the globe, and speculation in the forward markets. All these are in play at this time.
Russia, a major producer of wheat had one of the hottest and rainiest summers in 2010. That affected wheat output. Australia has faced serious floods in their summer (our winter) as did Pakistan. Both countries are important producers of several commodities. Argentina had a long dry spell that has affected its grain output.
Financial speculators are adding fuel to the fire that is burning in the commodities markets. Money flows have been large in recent months. Barclays Capital estimates $60 billion was injected into commodities in 2010 contributing to the increase in these prices.

Figures from the Commodity Futures Trading Commission, the US regulator, reveals very bullish bets among many mangers such as hedge funds. Concerns about speculation in the markets has prompted the United States Congress to begin to worry about the impact on the level of prices that may follow heavy trading by speculators not connected with the fundamentals of the market – supply and demand changes. Some US Senators have warned of a “speculative bubble that threatens to drive up gas and food prices even further.” They have threatened to take legislative action if the speculators continue to affect market stability.

Prices of agricultural commodities jumped recently after the United States government surprised the forward markets with the announcement that its stocks of key crops were running very low. The US Department of Agriculture said in a statement that the ratio of stocks-to-demand will fall this year to their lowest level since the mid-1970s. That was the last time the world went through a food scarcity scare. The international community at that time reacted quickly. A World Food Conference was convened in Rome which led to the creation of the International Fund for Agricultural Development, IFAD. This new UN agency was tasked with the responsibility for increasing investment in agriculture in the developing world.

For the moment no international action is contemplated as was the case in 1974. The result is that most governments are taking steps on their own. Some of these are likely to aggravate the situation as happened with the decision by Moscow to ban most agricultural exports. Moscow has said that the restrictions it placed on the export of many food products will remain in place until the end of 2011. South Korea and the Philippines have suspended some of their import duties on food items such as fish and powdered milk.
In December, Sri Lanka released rice stocks and re-imposed a price ceiling that had been removed in October 2010. The Indian government is very nervous about the price of onions that soared 80 per cent in just one week. It has allowed the import of onions from wherever it is available.

According to the Financial Times, “still in its infancy, 2011 is conjuring up memories of the start of 2008. Soaring crop prices have stoked fears of a food crisis and oil markets are bubbling…Prices of corn, soyabeans and wheat in January returned to heights that only two years ago sparked riots in more than 30 countries from Haiti to Bangladesh”.

For obvious reasons the poor are hurt more by a rise in the price of food. For them food constitutes a larger proportion of the budget than for other income groups. According to the World Bank, 65 million were thrown into poverty in 2008 and 2009 as a result of food price increases.

For the moment the prices of the crops that are important items of import by Pakistan have risen while those the country exports have stayed steady. The price of rice, by far the most important agricultural export, is likely to remain steady compared to some other food crops that are imported.
The group that matters the most for Pakistan are the oil bearing crops. The news about the stock situation in the United States resulted in a sharp increase in the price of corn and soya bean. They increased to their highest levels in 30 months. Both crops are important in this group of commodities.

There is a long history of food price increases causing political problems for governments in power which is one reason why policymakers react quickly – sometimes irrationally – to food inflation. Ayub Khan was brought down in the spring of 1969 by public agitation following the rise in the price of sugar, an
important item of consumption for the poor.

Rising food prices may have been an ingredient in the political movement that drove Tunisia’s president, Zine el-Abidine Ben Ali, from office and out of the country. One of the measures Ben Ali used a few days before throwing in his hat was to cut prices for sugar, cooking oil and other commodities. There are lessons in these experiences for Pakistan.

In a weakened and weakening political system a commodity price shock may be hard to absorb since it affects the poor and the lower middle classes more than the classes represented in the political establishment. The government needs to prepare itself and do it soon to deal with this expected shock to the troubled economy.

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