Is Another Food Crisis on the Horizon?

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Includes: AGF, CRBA, DBA, GAF, JJA, MOO, PMNA
by: Carnegie Endowment

The recent spike in wheat prices has reaffirmed the vulnerability of the international food market to minor shocks in supply. A repeat of the 2007–2008 food-price crisis is unlikely at the moment, given the relatively high levels of global grain stocks and relatively low price of oil. However, with food prices already rising and food markets in the most vulnerable developing economies experiencing great volatility, further policy and weather disruptions may significantly worsen the situation.

If the price increase spreads to other food crops, the world’s poor will suffer disproportionately. A general increase could also spur inflation in developing economies—where food prices make up 20–50 percent of consumer price index baskets—and prompt them to tighten monetary policy, which may be inappropriate given the slowdown in advanced economies. Better international coordination—including discouraging protectionist policy responses and promoting public investment in agriculture—would help shield against future supply shocks.

Wheat Price Surge

As shown by the recent spike in wheat prices, international food prices have become increasingly volatile and vulnerable to sudden, minor shocks. Drought in Russia, Ukraine, and Kazakhstan—which together account for 26 percent of world wheat exports—reduced world wheat supply by less than 2 percent, but prices have surged by 50 percent since June. The 20 percent decline in Russia’s wheat production—equivalent to a 1.6 percent decrease in global wheat supply—prompted the Russian government to ban wheat exports until next year’s harvest is known.

The rise in wheat prices could spill over to other food crops if consumers switch to other staples. Corn and wheat prices, for example, are linked, as both are used for human consumption and animal feed. The spillover has been limited so far, however, with rice and corn prices having risen by 22 percent and 16 percent, respectively, since early June.

A look beyond this recent spike suggests that the 2007–2008 food-price crisis—during which the international prices of basic food crops reached their highest levels in 30 years—never fully went away. Even though the Great Recession pushed international food prices down—corn, wheat, and soybean prices are now 30–40 percent below their 2008 peaks, for example—they remain 55–60 percent above their 2002–2007 averages. In all but two of the twenty most vulnerable developing countries,1 domestic staple food prices remain significantly above their pre-food-crisis levels, and half have seen prices rise by more than 40 percent since 2006–2007.

The hike in domestic food prices has had largely different effects across the countries, however. In half of the most vulnerable economies, domestic staple prices declined in the twelve months to August, compared to the year before. Favorable weather and an abundant maize harvest helped these countries, including Malawi, Uganda, Ethiopia, and Brazil. On the other hand, high international prices, lower output due to bad weather, and unfavorable macroeconomic conditions (such as currency depreciation in food-importing nations) led to large increases in other vulnerable economies.

Despite this difference in price movements, however, most of the vulnerable economies saw the volatility of their domestic staple prices increase over the last year. In fifteen of the twenty countries, domestic staple prices were less stable last year than they had been before the 2007–2008 crisis. This could have serious implications for farmers’ incentives to invest in agriculture as greater uncertainty tends to lead to the adoption of low-risk technologies.

A Repeat of the 2007–2008 Crisis?

Despite the risks it poses, the current wheat price shock is not likely to lead to a return of the 2007–2008 crisis, which followed three years of bad crops and affected multiple commodities.

This time, stocks of wheat and other major crops are sufficiently large to cushion against the smaller decline in production. In the United States—which accounts for a quarter of global wheat exports—reserves are three times larger than the expected decrease in Russia’s wheat exports and are greater than Russia’s total wheat exports in 2009. Though the spike mainly affects the wheat market, global stocks for other major crops remain sufficiently high as well. The Food and Agriculture Organization projects that the stocks-to-use ratio of world cereals will be 23 percent in 2010–2011—well above the 19.5 percent level of the 2007–2008 food crisis.

Global demand is also weak compared to the surge that triggered the 2007–2008 food-price crisis and the boom that preceded the Great Recession. From 2003 to 2008, world GDP had grown by nearly 5 percent per year, while it fell by nearly 2 percent in 2009 and is projected to grow by less than 4 percent in 2010.

Furthermore, the world price of oil—whose heightened level was a major driver of the 2007–2008 food-price spike, as it increased production costs and pushed companies to use corn for ethanol production—is now more than 40 percent below its 2008 peak. While a large proportion of corn—one-third in the United States—still goes to biofuels production in major exporting countries, the drop in the oil price erodes some demand for biofuels, discouraging the use of corn for biofuels production.

Despite the healthy levels of grain stocks, depressed demand, and relatively low energy prices, however, policy- and weather-related disruptions may lead to significant food-price inflation. The wheat price spike showed that even a minor supply shock—less than 2 percent of world production—can drive a sharp increase in prices.

In addition, though above 2007–2008 levels, the global wheat stocks-to-utilization ratio is still significantly below its five-year pre-crisis average. Because major exporters may engage in hoarding, grain stocks may not be available across the market when needed. During the 2007–2008 food-price surge, for instance, large warehouses in India and the Philippines reportedly hoarded rice. In addition, export restrictions like the one in Russia and expectations of a supply shortage may drive prices much higher.

Policy

The spike in wheat prices has immediate policy implications for individual countries—especially in the developing world—and also points to the need for international cooperation in managing the global food market.

The spike directly affects the fiscal balance of major food importers, including those in the Middle East and North Africa (MENA), who are the largest importers of Russian wheat. For MENA countries—such as Algeria, Egypt, Lebanon, and Morocco—net food imports account for 2–4 percent of GDP; a large increase in food prices will worsen their trade balances.

In addition, a general rise in prices will challenge the sustained recovery in developing economies, where food prices make up a large portion—about one-third in China and 46 percent in India—of consumer price index baskets. In India, wheat prices have increased by 21 percent (y/y), inflation has been at or above 10 percent since January, and the central bank has raised the policy rate four times in the last six months. Such inflation could prompt tightening in major developing economies even as the global economy slows. Policy makers need to balance the risk of inflation against that of a sharp slowdown in GDP growth.

A continued price hike could also have severe implications for the food security of the world’s poor in developing economies, who typically spend more than 50 percent of their incomes on food. This effect was seen in 2007 and 2008, when high food prices helped push an additional 115 million people into chronic hunger. According to a study by the International Food Policy Research Institute (IFPRI), a 1 percent increase in the international price of wheat translates into a 0.20 percentage point rise in the growth rate of the domestic price of bread. Recently, a 30 percent increase in the price of bread led to violent riots in Mozambique, illustrating the danger of rising food prices in vulnerable economies.

Because there is no guarantee that the global market can resolve the price spike by itself, international cooperation is needed. Such cooperation should encourage the pooling of grain reserves and monitoring of misguided trade policy responses in the world’s major grain exporters. Policy makers need to learn from the recent food-price crisis, and realize that a rise in food prices can quickly spread across the world and lead to disruptive export controls. Those countries that distort the global trade of commodities must face international pressure. In the long term, global coordination could also help increase public investment in agriculture to improve supply, while making sure that such investment is sustainable.

Shimelse Ali is an economist in Carnegie’s International Economics Program.


1. Defined as developing countries with the world’s largest populations of impoverished people. Countries were ranked according to the size of their population living under $1.25 a day. The list includes India, China, Nigeria, Bangladesh, Pakistan, Ethiopia, Vietnam, the Philippines, Mozambique, Nepal, Uganda, Brazil, Madagascar, Malawi, Niger, Burkina Faso, Zambia, Kenya, Colombia, and Guinea.