Tuesday, May 19, 2009

Managing food inflation, critical for developing countries.

The price of food in the world market has been an unstable. Better yet, the agricultural commodities market has been destabilized, to the extent where no one knows what to expect at any time amidst this global economic crisis. The impact on developing countries is concerning.

The problem some countries are facing currently is that as a result of the drop in food prices from the developed countries and large developing countries that produce food for mass export (Ecuador and Brazil with bananas and sugar cane and Vietnam and Indonesia with rice), food inflation remains high and in some cases, rising inflation. On the other side- especially in large farm to export countries- farmers in developed countries have been losing value on their produce.

To put the matter in some context, the issue can be good for, or, “should” be good for developing countries that import food. However, if prices are rising while there is food price drops from the producer countries as well as massive deflationary pressures in global commodity company stocks, then; where is the benefit?

To understand the answer to that question, we have to take into account the issues that impact global food prices.

For starters, consumers were paying too much for food to begin with. There are three main factors as to why that was. For one, the commodities markets- which include agriculture and oil- were victims of artificial price inflation in the developed markets.

The US is by far the largest agricultural exporter out of the world’s top ten, with eight of the remaining countries in the top ten Euro-zone countries. The Euro-zone, as an aggregate, accounts for a much larger share than the US. All of these major developed markets have futures markets, which spotted the price of commodities as a result of the futures contracts to which they involved themselves into with farmers.

The second issue and which has played a major role in the additional spikes, was the fact that commodities rose on the back of oil prices. While the relationship between oil prices and food is understood and while this is true that farmers do factor in fuel costs to their production as well as traders in the financial market do too as well, the fact should also be as one commodity decreases the other should decrease as well?

This is not always the relationship. In fact, the derivatives market is slightly segregated from the real market where prices, should be denominated by aggregate demand. For the mere fact that in 2007 and 2008 as production and supply rose, oil prices rose as well as demand declined, should have us re-think the framework within today’s price and value driven market.

While the cost of facilitating additional output from OPEC should be a consideration, output gaps far outstripped supply gaps in 2008.

The third major reason is that world trade in agricultural commodities have been severely strained. Post WTO Uruguay Round, 1996, the dispute settlement mechanism has been vigorously used with agricultural complaints, second behind GATT 1994 compliance, out of the 300 plus cases brought forward since 1996.

The true realization is that protectionism, with regard to agriculture, is a major issue and currently has the current WTO Doha round, deadlocked. In fact, the concessions originally on the table at the start of the round 2001, have been watered down to the extent that makes the round meaningless.

What should developing countries be mindful of during this food crises? Everything!

Protectionism: Protectionism is on the rise in developed markets, in particular regard to the agri-commodity market, particularly in North American and the EU and now, the BRIC and other food producing countries in Asia and South East Asia. They all have been turning their supplies in agricultural and consumer goods inward, to supply their own domestic demand as well as hiking tariffs to spur their domestic consumers towards purchasing as many goods as they can at home.

This decreases global supply and in effect, raises the price for everyone that depends on their produce.

The Derivatives Market in developed countries: The US is now seriously contemplating, regulating the derivatives market more carefully. I think that now even average consumers, with no background in economics or finance, understand that the demand sets the value of the good, not the price setting the value of the good, solely.

With the exposition of the price and demand irregularities in the oil market, consumers demand to not go back to the status quo. And, as goes the USA, so goes the EU.

However, if the regulations are “weak” and are not cognizant of diminishing the factorization power of the quantitative models that evaluate prices on historical data- especially now on the artificially inflated data between the late 90’s to the beginning of the crisis- we can see price further pricing irregularities in the commodities market, which would make the impending regulations rather useless in the short term.

Production cuts: This has to be the foremost issue with regard to the food crises. While stockpiles have risen in the 00’s, as accounted by the UN and the World Bank for developing and least developed countries, the stock pile is being depleted due to the lack of food from developed countries penetrating through the current and frayed market mechanisms.

Currently, the US farm report stated that acreage in the US has decreased and is set to decrease again, as farmers cut back on production because they are not making what they used to make, pre-crises, due to the fact that demand is soft and the market pricing mechanisms- the derivatives market- is even softer. With impending legislation and soft power on its usage, the historic price levels they enjoyed during the boom years, is no more.

These factors in respect to the pricing mechanisms on commodities, have come back to bite farmers as much as it has helped them to produce in the past.

Lack of progress in the WTO Doha Round: The Doha Round is DOA. In order for it to be impactful for all, there needs to be a full completion, with the debate on tariff cuts logged back to the pre-2005 deadlock, where the cuts were meaningful and the harmonizing of modalities with non agricultural market access (NAMA), made an additional sweetener to achieving this objective.

If not, increased demand from developing countries- post crises- will envelope, with little or no global obligations put in place on the G-20 to meet the global geography and population realities and demand.

Internal inflation: This has to be the more crucial and yet paradoxical realities some countries face; while world commodity prices have sharply declined in the developed markets as well as deflationary pressure in production looming, prices in some countries rose.

The fact that there is increased protectionism, a decline in demand and as a consequence, ongoing inventory drops with respect to wastage due to over supply and more importantly as a response, intentional production cut’s, makes for a lugubrious food price reality for countries that do not have internal agricultural production to suppress food prices internally.

Coupled with aggregate supply disparities due to job losses, food retailers that have not gone out of business due to the external shocks and price deviations and irregularities, have had no choice but to raise prices as they have no control over domestic job losses in addition to the irregular- and more universally- imported inflated food prices, with the latter, being more systemic with increases in food prices to increase as the economic crises nears an end as the re-regulation of the real economy as a result of recovery, leads with demand rising with supply lagging short term.
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