In partnership with Continuum Economics


Fast-growing food prices trouble emerging markets

Concerns about high food prices are present across several countries, especially emerging markets (EMs), which tend to spend a relatively large proportion of their income on food consumption compared to DMs (31% vs 17% according to IMF calculations). Changes in consumption patterns and supply disruptions are the roots of soaring food prices. Due in part to the behaviour of food prices, inflation is likely being underestimated in most EMs. Although food prices will likely remain pressured in the short-term, we think they will moderate not too far down the road. However, the risk is that high food inflation contaminates inflation expectations, making the rise persistent. In terms of politics, high food inflation could bring more protectionist measures that damage production capacity in the medium term, as well as social unrest, which could hurt a country’s assets across the board. Monetary policy-wide, high food inflation jeopardises the continuity of easy monetary stances, especially when activity in services recovers and, potentially, services prices go up. The Russian and Brazilian central banks (CBR and BCB) have already tightened their policy rates aggressively because of mounting inflation risks from goods, especially food, while the Reserve Bank of India (RBI) has also hiked its bank reserve ratio.

Figure 1 Share of food in CPI basket (%)

Source: Continuum Economics, IMF

Aon insights

“We are yet to grasp COVID-19’s global impact in its entirety. Beyond hospitalisations and the mortality rate, it has seeped into so many facets of everyday life. Not least, the pandemic has caused food prices to soar, hitting both production and distribution, influencing supply chain dynamics and changes in product consumption. Clients can purchase trade disruption insurance and political risk insurance (for mobile assets) to help protect assets throughout the supply chain. Another factor affecting the food industry is labour constraints due to local outbreaks and border controls, including lockdowns. We have seen this result in civil unrest, covered under political violence within political risk insurance. Inside the Political Risk market, there is appetite for this product with significant capacity available. The rates and coverage offered will depend on the overall risk i.e. country, type of assets, storage, transit routes and security arrangements.” Mairtin O’Griofa Executive Director Political Risks and Structured Credit Global Broking Centre, Aon

Rising food prices are part of the reason why inflation is being underestimated in several EMs, according to an IMF working paper. In particular, the change in consumption patterns associated with the pandemic causes CPI calculations that under-weighed food prices and over-weighed transport prices. To be sure, there are some countries where the COVID-19-induced change in consumption patterns is estimated to have caused an overestimation of inflation, but, notably, these are only DMs.

Russia and South Africa saw a marked increase in food prices in CPI inflation throughout 2020 (Figure 2). The same applies to Mexico, Brazil, and India, where food inflation has most recently eased somewhat while still remaining well above the respective central bank inflation targets. Argentina and Turkey’s longstanding struggles with inflation continue, although their reasons are mostly idiosyncratic.

“The second factor behind the increase in food prices is the supply side of the equation, specifically disruptions in the production chain related to social distancing restrictions.”

Figure 2 Food prices have increased significantly in some EMs (% y/y)

Source: Continuum Economics, Datastream

Aon insights

The global population is forecast to reach ten billion by 2050 and the pressure is on for the industry to become more sustainable. At the same time, consumer demands are influencing the R&D agenda so leveraging technology and data & analytics is the clear route to ensure the world will be safely and sustainably nourished in the future. Against this backdrop of global population growth and changing demographics, the over-arching KPI for our clients in the food, agribusiness and beverage (FAB) sector is ensuring safe products are delivered on time to customers. Operational resilience and agility, supported by robust supply chains, is critical. Supply chains are at risk of multiple forms of disruption, from digital danger and weather to terrorism and geopolitics, as well as more traditional but equally important transport, energy and logistics risks.” Ciara Jackson EMEA Food, Agribusiness & Beverage Industry Vertical Leader

Rising food prices in some EMs can be attributed to several factors directly related to the pandemic. First, the mentioned change in consumption patterns, with the consumption of many services limited by imposed and voluntary social distancing controls. That change resulted in higher demand for goods, including food items. The second factor behind the increase in food prices is the supply side of the equation, specifically disruptions in the production chain related to social distancing restrictions. There have been multiple reports of logistical issues and reduced capacity in food processing facilities during the pandemic. Dry weather in major producing countries such as Thailand, Brazil, Argentina, and Ukraine, plus a shortage of shipping containers, have further aggravated the supply-demand imbalances. There are also concerns about stockpiling in China, given large imports of corn, wheat, soybean, barley, etc., in order to build strategic food reserves amid the pandemic scare and geopolitical tensions. Some of the other Asian countries are seeing food price pressures exacerbated by labour shortages due to the pandemic. Thailand’s seafood industry is witnessing a fresh pandemic wave following an outbreak in its key seafood market, while Malaysia’s palm oil industry is facing a labour crunch due to border controls and migrant worker outbreaks. The Philippines has been dealing with natural disasters such as typhoons at the end of last year which have led to a surge in vegetable prices, and the supply of pork has been dwindling due to the African swine flu. The Philippine Statistics Authority, however, puts more weight on rice than other food products in its CPI, and the drop in rice prices due to the Rice Traffication Law has masked the uptick in vegetable and meat prices. The increase in food commodities that started in mid-2020 added inflationary pressures as well. The FAO food real price index, which measures the international prices of a basket of food commodities (cereals, vegetable oils, dairy, meat and sugar), rose for the seventh consecutive month in December 2020, to the highest level since July 2014 (Figure 3). The increase is mostly explained by vegetable oils and cereals, though the latter has in turn started to affect meat prices, which had been falling in January-September of 2020 but started to increase in October. Rising energy commodity prices since May, with rising optimism that vaccine rollout will unleash a rapid economic recovery, exacerbated inflationary pressures.

Figure 3 Food Commodities’ Real Prices Have Been Rising Since May (Index)

Source: Continuum Economics, Datastream

Authorities react

With global wheat prices and corn prices well up from their lows six months ago, the CBR is concerned about inflationary implications, especially given that in Russia, food represents 31% of the CPI basket. With the September Duma elections in sight, rising food prices also increase the scope for unrest, which the authorities will not tolerate. Russian President Vladimir Putin has also committed to regulating the cost of ‘socially significant goods’, i.e. mainly food staples, if they climb more than 10%. The BCB has recently also admitted it is concerned about the effect that the increase in commodity prices could have on food and fuel prices. And in Mexico, President Andres Manuel Lopez Obrador made a ‘friendly request’ to cornmeal producers not to raise prices. India is one of the rare countries to adopt an inflation-targeting framework, with food and beverages representing over 45% of the inflation basket. For inflation-targeting developed nations, food weights in CPI are far lower. The highly volatile food prices, therefore, make headline CPI difficult to predict, and policy decisions suboptimal. The upcoming review of the inflation targets is, however, unlikely to bring any material change, and we expect the RBI to keep its policy rate on hold even as it shifts the liquidity stance in light of the inflationary pressures. Across ASEAN, governments have stepped up food security policies and subsidies and are also looking at boosting domestic production. Indonesia expanded the coverage of its staple food card programme from 15.2 million to 20 million recipients and earmarked IDR 104trn for food security, including strengthening food infrastructure and technology. Thailand has implemented a co-payment scheme that subsidises 50% of food, drink, and general purchases at small shops. The Philippines has allocated PHP 31bn under its ‘Plant, Plant, Plant’ programme to ensure food sufficiency amid the pandemic. Of this, PHP 8.5bn will go toward increasing domestic rice production from 87% to 93% of rice consumption. Moreover, the increase in food prices during these delicate times of pandemic-induced income reduction gave rise to protectionist measures in Argentina and Russia. Argentina imposed measures to limit corn exports, while Russia did so with wheat and other grains. Although these protectionist measures may, in the very short term, achieve higher supply and lower domestic prices, the risk is that they hurt medium and long-term supply by reducing incentives to produce.

Food price pressures may ease, but not just yet With the reimposition of COVID-19 restrictions in many countries, some supply disruptions will likely continue for some time in H1 2021. At the same time, demand for services will probably remain subdued. This will likely prevent a return to the usual consumption patterns in the coming months, keeping food prices in the CPI inflation measures pressured. Meanwhile, the ongoing increase in food commodities and energy prices will probably keep pressuring final prices, at least in the coming months. Although the rise in global grain prices is reminiscent of the 2000s, stock levels are much higher now than in the 2000s, when they had fallen due to poor harvests. The aggregate stocks-to-use ratio, a measure of demand relative to supplies, has averaged nearly 30% since 2015 vs less than 20% during 2007-11. Also, global agricultural prices could well stop rising if CNY appreciation slows. That is because China, and to a much lesser degree India, seem to have bought up a huge share of the global agricultural surplus, taking advantage of CNY appreciation to buy up stocks of wheat and corn. High global stocks of grains suggest upward price pressures won’t last, and grain price forecasts are in for a correction lower as the 2021 harvest rebounds. Additionally, the scale of further CNY appreciation will be restrained by the Chinese authorities after the currency appreciated significantly against USD since 29 May.

But there are significant risks to this view. Because the elasticity of agricultural commodities prices to the USD is close to one, continued dollar depreciation could prolong food price rises for some time. Indeed, we are looking for USD weakness to extend against EUR and JPY into end-2021. Also, because energy is an important cost component to most crops, if prices for energy and fertilisers rise faster than expected, that would also feed into higher global agricultural prices. However, that is not our baseline scenario. Increasing food inflation has significant implications. In terms of politics, it could bring more protectionist measures and social unrest. Monetary policy-wise, high food inflation jeopardises the continuity of easy monetary stances, especially when activity in services recovers and potentially services prices go up. The CBR and BCB have both tightened their policy rates aggressively because of mounting inflation risks from goods, especially food, while the RBI also hiked its bank reserve ratio. Central European central banks have also joined the tightening bandwagon. And more tightening lies ahead in all these countries, because, although food prices may moderate not too far down the road, high food inflation has contaminated inflation expectations, making the rise persistent, as is particularly clear in Russia.

Figure 4 Top 3 countries by stocks of wheat, million tonnes

Source: USDA, Continuum Economics

“Increasing food inflation has significant implications. In terms of politics, it could bring more protectionist measures and social unrest.”

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