On the back of the wettest spring on record, Australia’s Queensland region is being ravaged by a “once in a hundred year” flood. Europe and parts of north-eastern US have had severe snow storms. A very strong blocking pattern in Greenland is helping to steer a parade of storms towards the British Isles and mainland Europe, while pumping abnormally mild air into the Canadian Arctic. Closer home, unseasonal and plentiful rain south of the Vindhyas has disrupted normal life in many areas. The weird weather would be merely inconvenient were it not for the fact that it is playing havoc with prices of agricultural commodities.
In India, it has created an onion of a problem. Following the unseasonal rain in Maharashtra, the onion basket of India, prices of onions and garlic have more than quadrupled over the last few months. On a larger scale, prices of vegetables, fruits, pulses, grain and other basic food commodities have increased sharply since mid-2009.
What is causing agricultural commodity prices to rise?
Supply: Clearly, an important cause of the rise in prices is inconsistent supply, which is in turn being caused by weird weather. Combine this with a global market for many commodities such as sugar, cotton and rice, and it becomes easy to understand why prices have become very volatile. Occasionally, as in mid-2008, there is a spike in prices that is a few standard deviations above normal. In specific commodities, such as onion, that is happening this year as well. The Food and Agricultural Organization’s (FAO) global food price index for November is a mere 3% below its all time high reached in June 2008, which may well have been breached in December. While weather is the proximal cause of food inflation, structural prices over the long term will depend particularly on agricultural productivity and government policy.
Demand: With robust economic growth in emerging markets, particularly India and China, demand for agricultural commodities is also rising fast. The number of variables impacting structural food demand—population growth, dietary intake and preference, income, policies and so on—make forecasting a mite difficult. With world population set to increase 50% to nine billion by 2050, and with real incomes rising in emerging markets, demand is likely to rise in mid-single digits across a range of basic food products. In addition, greater meat intake will likely drive prices of livestock and fodder.
Bringing to market: The role of storage, transit and middlemen has an important effect on the prices of agricultural commodities. In those countries where food logistics are efficient, the most important factor in the change in prices is rise or fall in fuel costs. In India, we have the additional problems of poor storage, sketchy distribution and hoarding middlemen. Oil prices have risen 25% in the last few months, resulting in fuel price increases. The empowered group of ministers deferred a diesel price increase in late December mostly on account of the potential impact on food inflation.
Financial speculation: There is some controversy over the role of financial speculation—the use of forwards and futures contracts—on agricultural food prices. Financial players provide the natural “other” side to producers of agricultural commodities who seek to hedge their production. In normal times, the futures market serves as a risk management tool for the producer. Occasionally though, the extremes of food prices get accentuated by actions in the futures market.
What can be done?
FAO set up the Initiative on Soaring Food Prices (ISFP) in 2008 to suggest alternatives to combat food inflation. In its “Guide for Policy and Programmatic Action at the Country Level” of December, it advocates “tailoring solutions to the specific conditions of the country”. It begins with a recommendation for “building a broad national consultation” and goes on to discuss trade-related action (favouring reduction in import duties, but not export caps), market management measures and production enhancement techniques.
In India, we tend to go slow on those actions that take time—such as distribution of higher yielding, disease resistant seeds. This ensures that time and again, we have to take emergency action to combat high prices. To fight the latest onion price inflation, the government has reduced import costs and has also characteristically banned exports. When prices of some listed commodities go high, there is knee-jerk reaction to ban futures trading. Better to (temporarily) change margin requirements to cool speculative activity than to ban a legitimate risk management tool altogether.
The problem of high food price volatility is likely to be with us for some years to come. It will serve us well to peel the onion and focus on the deeper, more lasting solutions. Short-term palliatives may not work; worse, they may lead to tit-for-tat moves by other countries.
P.S: Mahatma Gandhi along with his friend Henry Polak once formed a unique club called the “Amalgamated Society of Onion Eaters” in South Africa. Their staple food was an uncooked salad made largely of onions.
Narayan Ramachandran is an investor and entrepreneur based in Bangalore. He writes on the interaction between society, government and markets. Comments are welcome at firstname.lastname@example.org
To read Narayan Ramachandran’s previous columns, go to www.livemint.com/avisiblehand