EconomyView. Impact of Global Food Inflation. March I. Introduction

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1 EconomyView Impact of Global Food Inflation Analytical Contact: Poonam Munjal I. Introduction The prices of various food items have been at abnormally high levels in the international market for the past few years. In fact the recent surge in world food inflation has been exceptionally high. The current state of the global food market is a rare situation when the whole world shares a widespread and common concern about food price inflation. This is fuelling debates about the future direction of agricultural commodity prices in importing as well as exporting countries. The impact, which fortunately is still not in sight in domestic market, can have very serious implications for India. 21

2 II. Global Food Prices The unfavourable global climate results in record low wheat stock pattern of trade, as many countries are sourcing their imports from suppliers closer to home to save on transport costs. Food to feed starving people or to run automobiles? Since the prices are largely based on demand and supply conditions, a poor harvest coupled with rising demand to feed an increasing population leads to a hike in food prices. The unfavourable climate change across the globe has resulted in unprecedented poor harvest in most of the countries. Australia, the second largest wheat exporter in the world, experienced the worst drought in recorded history starting from The impact has been severe on crops, wheat, in particular, with its global production at the lowest in the last over 12 years. Similar climate conditions hit parts of Europe, like Spain, Portugal and Ukraine and certain North African countries. Given these circumstances, the world wheat stock has been at record low levels, having a severe impact on food prices. According to Food and Agriculture Organisation (FAO) of the United Nations, world wheat stocks by the close of the crop seasons in 2008 are forecast to be 142 million tonnes, 10 per cent below the already low opening levels and the smallest since The soaring fertliser prices together with high international freight rates exert further pressure on world food inflation To add to the problem of low stocks, rising prices of fertilizers have made the agricultural production costs dearer. High demand from developing countries, together with high energy prices, particularly natural gas, which is the main input in the production of nitrogen, have led to the surge in fertilizer prices. Consequently, the production per acre has decreased, thus leading to further food shortages, and pushing up the already spiraling food prices. The situation worsened further with the record high international freight rates, making imports of bulk food commodities extremely expensive. Increased fuel costs, port congestion and high demand for food and feed products from importing countries are the underlying factors that led to a gush in freight costs. According to FAO, record freight prices not only increased the cost of transportation, they have also changed the geographical Further, the surging oil prices and the global warming threat have prompted an increased demand for food-based fuels, diverting a major portion of crop production from food for consumption to food for fuel production. The United States has increasingly been using the produce of maize/corn crop for the production of fuel ethanol. In fact, the production of ethanol has created a very large growth market for corn in the last few years. In , more than 2.1 billion bushels or 20 per cent of the corn crop was used for ethanol production, which was nearly twice the amount used for ethanol in And according to an industry estimate, the ethanol industry s consumption of corn is expected to double again in the next two years. In response to the escalating ethanol demand, both corn futures and corn cash prices have increased rapidly in the international markets. The firming prices of corn, the primary animal feed, have resulted in the increased prices of livestock and dairy products. Apart from US, food-based fuel production is also concentrated in Brazil, Europe and Asia. Brazil, the world s largest sugar producer and exporter, is now converting half of its sugar harvest into fuel ethanol, eventually leading to a surge in international sugar prices. In Europe, the emphasis is on producing bio-diesel using edible vegetable oils. The refined rapeseed oil is used for direct injection into trucks as fuel. Starting from mid 2007, the prices of rapeseed oil are increasing persistently. In Asia, both India and China are producing food-based ethanol. In China, apart from corn, grains like wheat and rice are also used for the production of bio-ethanol. Thailand is concentrating on ethanol from cassava, while Malaysia and Indonesia are investing heavily in additional palm oil plantations and new bio-diesel refineries. After soybean oil, palm oil is the most widely produced vegetable oil in the world. In India, ethanol is produced largely from sugarcane. Other than the fact that a number of food crops are being used for producing bio-fuels, there is an increased shift of acreage of essential 22

3 crops to fuel producing crops, the inflationary consequence of which is a matter of serious concern. Figure 2 : International Inflation of major bio-fuel crops (Y-o-Y) The figure (Figure 1) below gives the year-on-year variation of international food prices (Note that the international commodity food price index includes Cereal, Vegetable Oils, Meat, Seafood, Sugar, Bananas, and Oranges). The year 2002 ended with the food inflation jumping to over 14 per cent largely because of the record low world wheat stocks resulting in steep rise in wheat prices. This period corresponds to the severe drought in Australia and North Africa. However, the situation improved with higher than expected wheat harvest in Russia and in most of the Asian countries. Later, the year 2004 experienced the acceleration in food inflation even higher than wheat. This was the period of increased use of food crops in the production of bio-fuels. This period is marked with unparalleled price rises of corn, soybean oil, palm oil and sugar, apart from wheat and other cereals (depicted in Figure 2). The recent escalating trend of food inflation is a combination of global dry conditions, ever-increasing use of food crops for fuel production and rising disposable incomes of countries like China and India, who spend more than half of their growing income on food, hence increasing the demand and supply gap Figure 1 : International Food and wheat Inflation (Y-o-Y) Source: Primary Commodity Prices, International Monetary Fund. Source: Primary Commodity Prices, International Monetary Fund. III. Food Inflation across countries Contribution of food in headline inflation rose across most of the countries According to the latest World Economic Outlook, September 2007, average domestic food price inflation (defined as the purchasingpower-parity weighted aggregate of an individual country s domestic food price inflation) rose to about 4.5 per cent in the first four months of 2007 from about 3 per cent over the same period in This figure is more than 9 per cent for developing countries. The weight of food in the consumption basket of a country is negatively correlated with its income levels. For example, the weight of food averages more than 60 per cent in sub-saharan Africa, whereas it is about 46 per cent in India, 30 per cent in China and only 10 per cent in the United States. The contribution of food inflation in the total consumer headline inflation has risen quite drastic in developing countries. In China, the contribution during the period January to April 2007, was recorded at 75 per cent, which is among the highest in developing Asian countries. The following table shows the average contribution of food in headline inflation in different regions of the world confirming the role of spiraling food prices in a country s headline inflation. 23

4 Table 1 : Contribution of Food Inflation in Headline Inflation in different regions Contribution (per cent) (January to April) World Advanced economies Africa CIS Developing Asia Central and Eastern Europe Middle East Western Hemisphere India* Sources: World Economic Outlook, September * Calculated using Wholesale Price Index for India. In India, Inflation is commonly calculated using WPI rather than CPI, which has been used to get food contribution in rest of the table. IV. Scenario in India Back home, with good monsoon and several policy measures taken by the government, India has not been affected too much by the high global food prices and has managed to contain food inflation within the range of tolerance, till now. The policy measures include allowing private import of wheat and pulses at zero duty, reduction of import duty and removal of additional customs duty of 4 per cent on edible oils. Besides, to augment domestic availability, wheat is released under open market sale scheme, and the exports of pulses, non-basmati rice, wheat and wheat flour are completely prohibited. But such temporary measures are not sufficient to face the challenge of soaring food prices in the international market. Although India is quite self-sufficient as far as the availability of main staple cereal like wheat and rice is concerned, but the dependence on imports of certain other foodgrains like pulses is quite high. India, world s largest producer, consumer and importer of pulses, witnessed a massive growth in its imports, escalating from 40 per cent in FY to 47 per cent in FY The data for the first half of current fiscal reveals the growth of 89 per cent over same period last year. Thanks to rupee appreciation, the imports were cheaper and did not effect the prices too much but in future, India might not be able to escape the spiraling overall world food, particularly foodgrain, prices. Use of food crops for bio-fuel production in other countries impacts India as well Our dependence on world market for fertliers also poses another threat to domestic food inflation. Rising demand for foodgrains calls for higher production, and hence higher use of fertilizers. Domestic availability, not sufficient to meet such demand, is supplemented with increasing imports of fertilizers, the international prices of which are shooting drastically. Another matter of concern for India is the rising use of vegetable oils for the production of bio-fuel in various countries as India is a large importer of vegetable oils. The domestic supply of vegetable oils, which is more or less stagnant, is insufficient to meet the rising demand, resulting in high price inflation. With respect to previous year, prices of soybean oil rose by 8 per cent in , rapeseed oil rose by over 10 per cent, and imported edible oil by more than 11 per cent. Besides this, the restriction imposed on the import of palm oil products at all the ports of Kerala has further curtailed the availability of palm oil leading to a hike in the prices of palm oil and products. India s low spending on agriculture-related infrastructure services is a prime reason of our increased dependence on world market. Public investment in agriculture has only recently picked up to 0.5 per cent of GDP in FY07 after averaging 0.4 per cent of GDP in the preceding three years. Spending on irrigation has also been low with only about 42 per cent of farm area under irrigation. The historic data on rate of growth of productivity of major food crops in India, confirm such observations. These data for most of the crops show either stagnancy or worse, a declining trend. In Figure 3, the year-on-year growth rate of wheat yield per hectare starting from is plotted along with 24

5 the trend line. The picture shows a clear declining trend. Other staple crops like rice are no better placed. Figure 3 : Growth rate of Wheat Productivity (y-o-y) Data Source: Ministry of Agriculture, Government of India. Advance estimate for as on V. Conclusion The foodgrains supply condition in India is expected to be quite comfortable, thanks to the favourable monsoon and hence a good kharif harvest. According to the latest report released by FAO, among the Asian countries, both India and China have harvested record cereal crops this year. In India, the output of most of the foodgrains is expected to be higher than those of the previous year. The favourable weather conditions for the winter crops are projected to produce an output of 75 million tonnes of wheat this year, up by 7 per cent from last year s output. In response to the surging world prices, India had already prepared to achieve this target by increasing the acreage devoted to wheat in Punjab and Haryana. Further, for the year , the minimum support price for both wheat and paddy was increased by 17 per cent and 11 per cent respectively over last year s MSP. Nevertheless, the overall food situation is subject to the prospective rabi harvest. In the event of not-so-good crop, and a failed next monsoon, if the supply fails to meet the demand level, and the dependence on imports becomes indispensable, then the impact of spiraling world food prices would be unimaginable on domestic food inflation. With international oil prices already exerting pressure on current rate of inflation, the inflationary effect of food prices would continue to be a matter of concern for India. 25