Dear wheat

The surge in global wheat prices is attributed mainly to rising margins garnered by monopolistic processors and retailers and speculation in futures markets.

ACROSS the world, food prices, especially those of staples such as grains, have been rising sharply in recent months. Wheat, the staple used to make bread, pasta, chapatti and much else, epitomises this trend.

The free-on-board price of the United States-exported No. 2 hard red winter wheat, which stood at $194 a tonne in August 2006, rose by 75 per cent to touch $340 a tonne in August 2007. Much of this increase (70 per cent) occurred between May and August. The surge in prices of this globally consumed staple has triggered widespread protests. Italian consumer organisations even called on their members to sacrifice their pasta consumption for a day to register dissent. Protest of this sort has set policymakers in search of explanations for what investment-banking firm Merrill Lynch has reportedly termed agflation.

With agricultural prices conventionally seen as being determined by the relative levels of demand and supply, attention is focussed on the United States Department of Agricultures (USDA) estimate this September that global stocks of wheat would touch 112.4 million tonnes at the end of this marketing year (May 2008), their lowest in 30 years.

Year-end stocks have been declining continuously since the end of marketing year 2003-04, when they stood at 151 million tonnes. That figure, too, was below the May 1999 high of 209 million tonnes. Clearly, consumption has been running ahead of production, almost halving year-end inventories over a decade. Given this tendency, any short-term changes either in consumption or supply can result in imbalances that influence price movements.

Moreover, global surpluses are concentrated with a few nations. Of all the wheat produced around the world, 18 to 20 per cent is exported. And six countries or groupings Argentina (8.9 per cent), the European Union (9.9 per cent), Russia (11.3 per cent), Australia (12.2 per cent), Canada (13.2 per cent) and the U.S. (28.2 per cent) account for close to 85 per cent of world exports.

Given this context, the USDA blames supply-side developments in these countries for the upward pressure on prices. For example, Canadas wheat output is expected to fall by roughly a fifth this year because of bad weather. Weather-related factors are also expected to reduce supplies from major exporters such as the E.U., Australia and Argentina, restricting availability in global markets.

The increase in wheat prices this has triggered has not reduced demand. Big wheat buyers such as Brazil and Egypt continue to buy and even import-dependent countries such as Japan and Taiwan have rushed into the market early to secure their supplies. Moreover, occasional buyers such as India have also been significant purchasers in recent times. The net effect, argue analysts, has been a surge in prices.

However, even accounting for these factors, the extremely sharp increase in prices in recent months is not easily explained. Although global stocks have been falling, they are still at a comfortable 114.8 million tonnes or 18.8 per cent of global production a figure equivalent to the proportion of production that is globally traded in a year.

Taking into account the fact that rising prices would encourage farmers to plant more wheat, production would also be expected to adjust, even if with a lag. For instance, although exports in 2007-08 from the E.U. and Canada are expected to fall by 1 million tonnes each and that from Australia by 1.5 million tonnes because of reduced crop prospects, exports from Russia and the U.S. are expected to rise by 1 million tonnes each because of improved production and the incentive created by higher prices.

In the circumstances, the sudden and sharp rise in prices seems difficult to explain based on demand and supply alone.

The Financial Times reported that Carlo Rienzi of the Codacons consumer association berated politicians, wholesalers, retailers and speculators everyone but farmers and consumers while protesting against rising pasta prices outside the Parliament in Rome.

Their actions are seen as having resulted in the accumulation of large margins as wheat passes from the field to the supermarket shelf.

The set of players whose trades are least transparent and whose effect on prices is least obvious are investors in futures markets. When in September, a December wheat contract traded at the Chicago Board of Trade (CBOT) at a record $9.11 a bushel, it was unclear whether traders were capturing the level at which prices are likely to settle in December or influencing the way prices would move in the weeks to December.

What is clear, however, is that financial investors (speculators by design) see much gain in commodity, including wheat, futures. Noting that financial investors have been increasing their stake in these markets, The Economist (September 6) reported: Trading in agricultural futures, once a backwater, has boomed in recent years. In addition to agri-businesses, more institutional investors ranging from hedge funds to pension funds are investing. Last year nearly $3 trillion in grain futures was traded on the Chicago Board of Trade (now part of CME [Chicago Mercantile Exchange] Group), the worlds largest such market. And wheat is one of the favoured commodities.

The extent to which these factors have actually contributed to the recent price increase is yet to be ascertained. But the fact that demand-supply imbalances and stockholding levels cannot explain the recent price surge in wheat and other agricultural commodities has strengthened the suspicion that they have indeed had an effect. India is partially insulated from the effects of these global trends.

Exports are not permitted and the minimum support price rules well below import prices, so that global agflation is not being imported into the country. But the governments decision to allow private players, including large international firms, a major role in domestic markets has created a curious situation.

Even though production of wheat during 2006-07 is estimated at close to 75 million tonnes compared with 69 million tonnes in the previous year, procurement fell short of expectations because the procurement price of Rs.8.5 a kg ruled well below market prices that ranged between Rs.10 and Rs.12 a kg.

Though by July 19 procurement, at 11.1 million tonnes, was higher than the 9.2 million tonnes recorded in 2006-07, it was way below the 16.8 and 14.8 million tonnes recorded in 2004-05 and 2005-06.

With offtake likely to remain high, this implies that buffer stocks could fall below comfort levels. If low global stocks are seen to trigger inflation, an inadequate buffer stock generates similar fears domestically.

Faced with the prospect of an early election and the evidence of inflation in global wheat markets, the government, which had earlier reversed a decision to import wheat, has now decided to import 7.95 lakh tonnes of the grain.

This has proved controversial since the government is paying a weighted average price of $389.45 a tonne as against $263 a tonne at which imports were available in May.

A recent clarification attributed the cancellation of the earlier import decision to the expectation that global prices would fall in the wake of the harvest in major wheat producing countries and the consequent view of the Integrated Finance Division of the Department of Food and Public Distribution that a very high benchmark price would be established for future wheat imports.

With these expectations not being realised the government has now decided to make the best of the bad situation created by wrong decisions on domestic trade, procurement and imports.

As clarified by Union Food and Agriculture Minister Sharad Pawar, the Empowered Group of Ministers took the decision to import, influenced by the downward revision of the global wheat production, apprehensions about some major wheat producing countries placing restrictions on wheat exports and the Chicago Board of Trade futures showing an upward trend of wheat prices for December 2007 and March 2008.

It was possibly the Indian decision that resulted in the sharp rise in U.S. export prices in August. Unfortunately, neither the Indian farmer nor the Indian government is gaining from these trends. And it is not clear how long the Indian consumer would be even partially insulated from their effects. Maybe Carlo Rienzi had got it right.