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SpirE-Journal 2008 Q2

Food for Thought

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Food for Thought

The surge in food prices over the past year has been as historically unprecedented as it has been sudden. Millions of poor people around the world are struggling to cope, prompting urgent appeals from charities and multi-lateral bodies like the United Nations and World Bank. As governments in Asia attempt to find solutions, all companies, not only those in the agri-food sector, will have to grapple with the threats and opportunities posed – from reduced discretionary spending in the mass market to a boom in rural investment.

Food prices take a hike

The rising economic power of emerging markets on the world stage is well-known. Since 2001, emerging economies, predominantly China, India, Russia and Brazil, have accounted for roughly half of global GDP growth. What has been less well understood has been the way in which the growth of emerging economies has fuelled spikes in demand for energy, agri-food and other commodities– until the recent sharp rises in the prices of these commodities drew the world’s attention to this phenomenon. The astounding rate of growth in the demand for food has resulted in a disconcerting rise in food prices. The World Food Price Index published by the UN Food and Agricultural Organization (FAO) has shown an increase of over 50 percent between April 2007 and April 2008 (see Figure 1).

Food price hikes have been driven by a number of factors: rising oil prices, as the agri-food industry is transportation-intensive; the expanding biofuel industry, which tends to compete with the agri-food industry for arable land; adverse climate phenomena, which have affected agricultural outputs in countries as far apart as China and Australia; a slow rate of innovation and productivity gains in the agricultural sector in the past two decades; and rising demand coming from emerging economies.

To make matters worse, a great deal of speculative investment has flowed into agri-food futures contracts as a result of investors fleeing other troubled asset classes such as equities. A recent compounding factor has been the food export controls that have been imposed by the governments of food exporting nations, which tend to shrink global supply and drive prices up further.

The impact of all of this on the world’s poor is well documented. Senior figures in the United Nations, World Bank and NGOs world-wide have publicly called for concerted government intervention, pointing out that food at current price levels threatens to plunge millions of people around the world into destitution, malnutrition or worse. The fact that more and more governments are imposing food export controls underlines the political dimension to the problem. The public pronouncements of charities like Oxfam and Care about the impact of expensive food on the world’s poor highlights the moral dimension to this problem.

What is less widely discussed is the impact of expensive food on the private sector. Businesses will have to deal with a host of negative effects – including inflationary pressures on input prices and wages, deflationary government monetary policies affecting price competitiveness and changes in consumer spending patterns to reduce discretionary expenditures.

However, the current food price signals have fostered a renewed interest in food production that is likely to lead to a reversal in the trend of government underinvestment in agriculture – a promising development. New government expenditure and private initiatives in agriculture and food processing may translate into a growth in income share for the rural population, which accounts for between 40% and 60% of the population in most of Asia’s big emerging economies.

Food as a national security issue

The proportion of food expenses in the Consumer Price Index (CPI) for most Asian countries, especially the less mature economies, is significantly higher than the OECD average. Curiously, despite the fact that countries such as Indonesia, Malaysia and the Philippines are agricultural economies, they remain net food importers. The FAO reports that the global food import bill is expected to reach USD1 trillion this year, 26 percent higher than last year’s peak (see Table 1).

The largest net exporter of rice in the world (Thailand) and the largest net importer of rice in the world (Philippines) are both in Asia. In 2006, the Philippines imported over USD540 million worth of rice while its rice exports only amounted to about USD130,000. Thailand, on the other hand, exported rice with a trade value of over USD2.5 billion in the same year (see Table 2).

The US Department of Agriculture has forecasted the global rice stock for 2007/2008 to be 65 million tonnes, the lowest level since 1983.

Food producing companies have already started to transfer the cost of rising commodity prices to customers but companies such as Hershey’s and Nestle have reported that, at the rate of increase in prices of food production inputs such as milk, this practice will soon become unsustainable.

To governments in Asia, the imbalance of supply and demand is an indicator that food production and imports have to increase to ensure food security concerns are addressed.

The Fall-out from the Food Price Crisis

Falling consumer demand: as food prices hike, the poor fall off a cliff

Rising food prices will inevitably affect the spending patterns of consumers. Asia, where most people live in economies with low income per capita, will be disproportionately affected. In Asia, the poorest quintile (20% of the population) spends over 60 percent of their income on food (see Table 3). Businesses which target lower income households will face declining sales as high food prices inevitably crowd out other expenditures.

The effects are already being felt in major economies in Asia such as China. According to a regular survey by the People’s Bank of China, a new high of 49 percent of respondents complained that prices were too high in the first quarter of 2008. These sentiments were echoed in a recent study which showed that consumers were cutting back on discretionary spending.

India’s retail companies such as Food Bazaar and Subhiksha are already starting to import and stock up goods of lower value as consumers opt for cheaper alternatives. The shift of consumer spending from premium to affordable in India is likely to continue as inflationary pressures remain high.

In Australia, one of the richest countries in the Asia Pacific, some analysts believe that income tax cuts planned by the government in July will more likely be saved rather than be spent. The Chief Executive of one of Australia’s largest supermarket chains, the Woolworths Group, said that the rising food costs, fuel prices and high mortgage interest repayments will force a strong pullback in discretionary spending.

Even in Singapore, another mature economy, consumers have not been insulated from rising food prices. In February, the government called upon its citizens to purchase more frozen food and in-house brands, which can be up to 50 percent cheaper, to mitigate the effects of inflation. The republic’s major supermarket chain, NTUC Fairprice, reported an increase of 10 percent in sales of frozen meats and seafood last year.

Food price hikes will most impact discretionary spending in the Asian countries with the largest low income-per-capita populations – China, India and Indonesia, which make up three of the four most populous countries in the world. These changes will result in the growth of low-cost products and brands as well as budget retail channels, as high food prices lead to increasing consumer price sensitivity in the mass market. As the retail sector sees a reduction in the discretionary spending of consumers as a whole, budget retail channels will take an increasing share of this shrinking pie.

Government policies – stronger currencies

Stronger currencies due to tightening monetary policies in Asia would impact the price competitiveness of exports, creating another challenge for businesses.

Governments in Asia have resisted interest rate rises as a solution to curb imported inflation because of fears of dampening domestic demand in a situation where Asian economies are facing a slow-down in exports. In this context, allowing national currencies to appreciate is an attractive option. The delicate balance of allowing the appreciation of currencies to ease the pressures of imported inflation without incurring politically unpopular disruptions in domestic demand is something that many Asian governments are grappling with.

Singapore and China have already allowed their currencies to appreciate against a trade-weighted basket of currencies in order to curb the rising costs of imports. However, some analysts argue that countries such as Indonesia may face the problem of asset price inflation should real interest rates turn negative, as inflation continues to spread despite interest rates hikes.

Whilst the practice of fighting food price inflation with the tightening of monetary policies can fuel unemployment and political instability, the recent appreciation of Asian currencies against the US dollar has helped to curb imported inflation to some degree.

Government policies –pricing controls, subsidies and trade regimes

As surging food prices become a politically charged issue, Asian governments have begun to tinker with food import/export, food pricing and agricultural subsidy regimes:

China has frozen the retail prices of main food items such as rice and cooking oil and lifted the minimum wage rates and increased the budget for social welfare payments.
In Philippines, President Arroyo has ordered frequent checks on price manipulation and illegal profiteering of subsidized rice.
India plans to make speculative future trading more costly at the commodity exchange.
Vietnam, the world’s second largest rice producer, placed temporary bans on rice export contracts earlier this year amidst food security concerns.
The Indonesian government has responded to the food price crisis by distributing subsidized cooking oil and pledging to give out rice to poorer citizens of the Republic

India has recently implemented fiscal measures such as the removal of import duties to ease the impact of the current inflation, and there have been calls for other governments to do the same. However, such solutions run the risk of cutting government revenues and reducing the government’s ability to invest in infrastructure for long-term growth.

Some countries, such as Malaysia, have raised government spending on agricultural subsidies. However this solution threatens to worsen the problem of inflation.

“Food subsidies have been the most important distorting aspect there is,” Peter Brabeck-Letmathe, chairman of Nestle, said at the World Economic Forum on East Asia in June this year. “It distorts the free market and therefore it has a negative impact on the availability of food.”

Political and social unrest

Leaders in Asia are preparing to cope with social unrest resulting from soaring world prices of food and other essentials.

“It is clear which countries are going to be at risk,” commented Graham Hutchings of Oxford Analytical. “Those who are net importers of food and those with weak governments will fall, in all likelihood. The overthrow of the leader in Haiti in April over food prices is the shape of things to come.”

In Vietnam, for instance, industrial strikes have become more regular as the consumer price index rose to 16 percent in the first quarter of this year. A union official in Vietnam reported that 15,000 workers held a two-day strike in a Vietnamese shoe factory in April in protest at low wages that are not keeping pace with inflation. Some workers have even quit and moved back to the villages where the cost of living is lower.

There are also fears in China that rising food prices may exacerbate the widening gap between the newly rich and low wage workers and farmers, leading to potential social unrest. In an address earlier this year, Premier Wen restated the government’s commitment to tackle inflation and rising food prices in order to maintain social harmony and stability.

NGOs and multi-lateral agencies are increasingly calling for a strengthening of social safety nets through targeted income support for the poor rather than generalized food subsidies or trade measures.

Opportunities in an era of expensive food

High food prices are creating knock-on effects that will transform economies, creating dangers but also opportunities for consumers and businesses alike. On the consumer front for example, appreciating currencies may lead to lower prices for some imported products as well as the availability of cheaper,locally-made products that might not have been marketable previously. Higher food prices also have the potential to lift the incomes of rural populations, though the extent to which this is realized depends on economic structures in each country, which can either permit this value to diffuse to farming communities or siphon it off to large, organized firms in the agri-food value chain.

Expanding the agricultural sector
Many Asian governments have responded to the food price crisis by seeking to expand agricultural output through fiscal stimulus, as well as issuing developmental plans targeting rural populations. The growth in output will not only create opportunities for companies in the agri-food value chain, but also other businesses providing non-farm goods and services to the rural sector – such as ICT vendors and infrastructure providers.

For example, Malaysian Prime Minister, Abdullah Ahmad Badawi, has said that the government will optimize the use of its “smart card” (Malaysian Identification Card) technology to better manage and facilitate the dissemination of subsidies to the local agricultural workforce13. The government will also be focusing on ICT based solutions to help solve problems and bottlenecks in the Malaysian agricultural sector.

China’s central government budget allocation this year to the agricultural sector, rural areas and farmers will total over USD80 billion – a year on year increase of close to USD20 billion dollars. The renewed focus on the industrialization and development of the agricultural sector is an indication of the Chinese government’s move to address the polarizing urban-rural wealth gaps after years of focusing almost exclusively on pursuing urban-led economic growth.

The Vietnamese government is keen to increase foreign direct investments (FDI) in agriculture. It aims to attract sufficient FDI to account for 11 percent of the targeted USD9.4 billion investment into the Vietnamese agricultural sector for 2006-2011. This will create opportunities for foreign companies with the requisite capital and expertise, for example in rural infrastructure developers.

A recent United Nations study has shown strong linkages between the development of rural infrastructure and the growth of agricultural productivity.

According to the study, Thailand showed marked achievements in reducing rural poverty as a result of strong rural development policies since the 1970s. The reduction of poverty over the 25 year period of 1975 to 2000 in rural Thailand was shown to be strongly correlated with the provision of roads, electricity, phone lines and education systems in rural areas.

As governments seek to raise agricultural output, more public sector investment in rural infrastructural development can be expected.

Marketing to the rural sector

More than half of Asia’s population still lives in the countryside. The world’s most populous country, China, currently has 60 percent of its population living in rural areas, while the comparable figure for India is 71 percent.

In a recent World Bank report, the percentage of the rural population in East and South Asia is forecasted to be as high as 43 percent in the year 2030 despite rapid urbanization.

As the agricultural sector grows, the demand for inputs supplied by non-farm firms will increase. Technological improvements will strengthen the linkage between the two because of increases in the demand for more sophisticated technological solutions to agricultural practices.

Studies of rural areas in Asia have shown that the region has an estimated income multiplier range of 1.5 to 2.0 of change in the value of non-farm products and services for every dollar of value added to the agricultural sector. What this means is that as rural incomes grow as a result of government programs or rises in food prices, opportunities will abound to supply products and services to rural consumers – from consumer electronics and ICT through motorcycles and cars to financial and retail services.

As the recent hikes in food prices lead to more investment into the agricultural sector by both public and private sectors, this multiplier effect will disproportionately lift demand for broad-based products and services on the part of rural communities. The fundamental question is whether these rural economies will see a growth in real incomes per capita or whether the value gained from the growth of the agricultural sector will be siphoned off by large, organized firms.

Growing new food

The bulk of scientific opinion holds that Genetically Modified (GM) foods will be a necessity in ensuring food security in future. New land for rice paddy fields is becoming harder to find and the traditional practices of rice production may no longer suffice to meet the current growth in demand. The problems of food price inflation and the falling gains in crop yields in recent years are likely to push the role of biotechnology to the forefront. Related companies can expect to see a boost as governments in Asia scramble to find longer term solutions to the supply side issues in food.

The Malaysian government has recently taken a strong interest in the biotechnology sector and has announced the allocation of close to USD100 million in government funds to develop the sector.
In Thailand, the National Biotechnology Policy Framework for 2004-2009 has set targets to bring in over USD125 million worth of investments into the sector and see to the establishment of over 100 biotechnology and affiliated firms. The country has established itself as a regional hub for biotechnology research in rice and shrimp production.

The necessity of countries in Asia to increase agricultural production and productivity will lead to a growth in local research businesses aimed at tapping funds allocated by governments for these purposes.

The way ahead

The food price crisis is fundamentally a profound moral challenge not only to governments but all members of society.

Seen in this light, it not so much a question of whether government intervention is necessary in response, but what intervention is called for and how it should be coordinated internationally. This argument works not only on a moral level but also in economic terms, as the social costs of inaction in terms of treating malnutrition and dealing with threats to social and political stability would massively outweigh the costs of action.

Redistributive solutions – transfer payments to the distressed, changes to subsidy, importation and export regimes – will be short-term in scope. What is more important is the need to raise output and productivity in the agricultural sector, to meet growing demand and relieve the tremendous pressure on prices.

Businesses which thrive in this environment would be those that can contribute positively to the growth in agri-investment from governments, including those providing non-farm goods and services to the agri-food sector, such as infrastructure developers, automotive manufacturers, financial service providers, food processing firms and their supporting industries. Those that can contribute to the knowledge work needed to raise agricultural productivity are also poised to benefit. And most importantly, all businesses need to address the inevitable fall in discretionary spending that will be seen from the masses of lower income consumers in emerging economies.

 

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