International prices of most agricultural commodities are on the rise again. Prices of major food crops have increased disconcertingly, with wheat, rice, maize and soybean registering double-digit increases between June and October. Wheat prices increased alarmingly by more than 71%, while maize recorded a more than 50% spike. The Food Price Index released by the Food and Agriculture Organization (FAO), the most widely accepted barometer for food prices, also painted a dismal picture. The index has risen steeply in the past six months. It averaged 197 points in October, only 16 short of its June 2008 peak, registered when food prices were at unacceptably high levels.
Galloping food prices should be viewed with concern, given that the last such episode put the global project to address chronic hunger back by quite a few years. Following the food price spike in 2007, the number of undernourished went up by 75 million. In 2008, a further 40 million found themselves in this category. FAO estimates that the number of undernourished increased to nearly a billion following the food price inflation in 2007-08.
At the same time, high food prices bring misery to net importers of food. FAO estimates that the global cost of importing foodstuff will jump 15% in 2010, exceeding $1 trillion, and would be marginally below the record levels in 2008. The cost of financing this rapidly increasing food bill poses an additional problem for these countries.
While a demand-supply mismatch has been responsible for the price spikes, commodity speculation has exacerbated the problem in recent years. This was confirmed by a recent FAO report: “Apart from actual changes in supply and demand of some commodities, the upward swing might also have been amplified by speculation in organized futures markets.” In fact, a study conducted by the Bank for International Settlements (BIS) has commented on the “changing nature of commodity markets as a result of financial participation among other factors, indicating the need for transparency of financial participants’ actions in commodity markets”.
Investigations undertaken by the US Congress on the role that speculators have played in influencing prices in the wheat market have provided more definitive indications. In 2009, a US subcommittee pointed to the role of speculators in causing volatility in wheat markets over several years. The investigations examined in detail how commodity index traders had affected the price of wheat contracts traded on the Chicago Mercantile Exchange. The subcommittee concluded that there was “significant and persuasive evidence to conclude that these commodity index traders, in aggregate, were one of the major causes of ‘unwarranted changes’...in the price of wheat futures contracts relative to the price of wheat in the cash market”. The subcommittee observed further that the futures prices for wheat have remained abnormally high compared with cash prices, and the relationship between the two prices for wheat has become unpredictable.
The current episode of commodity price inflation has seen regulators in the Western world responding with alacrity. The European Union (EU) has given out clear signals of initiating measures to check speculation. The EU’s financial services commissioner, Michael Barnier, has indicated that he would seek to limit “risk exposures” derived from “agricultural products”, since in his view, commodity speculation “can only lead to further disasters”. Meanwhile, EU member states are preparing to introduce substantial changes to the structure and regulation of EU commodities markets, which are scheduled to be implemented by end-2012.
In contrast, the US and Japan have already taken legislative action to enhance transparency in financial markets that would help monitor commodity speculation. In June, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, and it came into force a month later. Among the rules it introduces is one on agricultural “swaps” (over- the-counter contracts) that directly affects futures trading in agricultural commodities. Japan has also strengthened its regulatory structure aimed at reining in commodity speculation through amendments to the Financial Instruments and Exchange Act.
Importantly, these initiatives to improve transparency in futures markets have been backed by cooperation and coordination between authorities in the US, Europe and Japan with the same objective in view. While this step towards coordinated action between regulators in the largest markets is welcome, the challenge is to extend such initiatives to cover most (if not all) countries so that the undesirable fallout of such price hikes can be rooted out.
In this context, the Group of Twenty (G-20) countries have taken the right initiative by supporting the work on regulation and supervision of commodity derivative markets being carried out by the Task Force on Commodity Futures Markets set up by the International Organization of Securities Commissions (IOSCO). The recently concluded Seoul summit directed the task force to report on the next steps necessary. Needless to say, greater transparency in the operation of the financial sector, a critical element of the G-20’s proposed regulatory reform package, would substantially help in addressing the concerns of commodity price speculation.
Biswajit Dhar is director general at Research and Information System for Developing Countries, New Delhi.
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