Food Prices and Inflation in Developing Asia Economics and Research Department Asian Development Bank 11 June 2008 The views expressed herein are those of the author and do not necessarily reflect the views of the Asian Development Bank.

Spike in Food Prices World Price of Thailand White Rice and Hard Red Winter Wheat Source: IMF, Primary Commodity Prices, available: www.imf.org, downloaded 9 June 2008.

Falling World Stocks Cereal grain stocks have decreased; this indicates that consumption for all uses has exceeded production for 6 of the past 7 years. Low stocks have induced countries to adopt beggar thy neighbor policies restricting exports and have spread panic to importers and consumers alike. Source: Foreign Agricultural Service, United States Department of Agriculture, available: www.usda.gov, downloaded 16 April 2008.

Cereal grain stocks have decreased; this indicates that consumption for all uses has exceeded production for 6 of the past 7 years.

Low stocks have induced countries to adopt beggar thy neighbor policies restricting exports and have spread panic to importers and consumers alike.

Food Weights in CPI Food price inflation is a regressive tax: it reduces real incomes most for the poor who spend the largest portion of their budget on food. Sources: National statistics offices; ADB resident missions. 33.20 China, People’s Rep. of 26.94 Hong Kong, China 57.00 India 42.30 Indonesia 14.00 Korea, Rep. of Share (%) Economy 30.00 Malaysia 46.58 Philippines 23.38 Singapore 25.00 Taipei,China 32.71 Thailand Share (%) Economy

Food price inflation is a regressive tax: it reduces real incomes most for the poor who spend the largest portion of their budget on food.

Food Prices: Structural vs. Cyclical Factors (1) Structural factors : These are Long-Term in Nature Economic growth has strengthened and population growth has continued; improvement in diets, particularly in populous emerging Asia, have underpinned rising demand for grains (dairy and livestock products are highly grain intensive); Bio-fuel substitution for oil as oil prices have skyrocketed takes land out of food production; Urbanization and commercial property development have taken over crop land and have increased competition for scarce supplies of fresh water making irrigation less reliable;

Structural factors : These are Long-Term in Nature

Economic growth has strengthened and population growth has continued;

improvement in diets, particularly in populous emerging Asia, have underpinned rising demand for grains (dairy and livestock products are highly grain intensive);

Bio-fuel substitution for oil as oil prices have skyrocketed takes land out of food production;

Urbanization and commercial property development have taken over crop land and have increased competition for scarce supplies of fresh water making irrigation less reliable;

Food Prices: Structural vs. Cyclical Factors (2) Structural factors : These are Long-Term in Nature Productivity growth in agriculture has stagnated as a result of low levels of investment in infrastructure, R&D, and the deterioration of institutions and poor conservation practices; Years of low prices at the farm gate for output coupled with general subsidies for consumption and rising input prices related to oil/fuel costs have damaged incentives for farmers. Climate change may impact production and productivity in coastal and drought prone regions (cyclone in Myanmar may be an example).

Structural factors : These are Long-Term in Nature

Productivity growth in agriculture has stagnated as a result of low levels of investment in infrastructure, R&D, and the deterioration of institutions and poor conservation practices;

Years of low prices at the farm gate for output coupled with general subsidies for consumption and rising input prices related to oil/fuel costs have damaged incentives for farmers.

Climate change may impact production and productivity in coastal and drought prone regions (cyclone in Myanmar may be an example).

Food Prices: Structural vs. Cyclical Factors (3) Cyclical Factors: Food prices have spiked far beyond what market fundamentals would indicate driven by a number of short-term factors including: Cyclical peaking of economic growth in Asia in 2006-2007 at the highest rate in nearly two decades; New demand from portfolio investors seeking higher returns in light of the low returns in equities and bonds and relief from the weak US$; Supply disruptions owing to disease and adverse weather conditions in key exporting countries: PRC, Vietnam and Australia; Beggar thy neighbor trade policies of using administrative controls over domestic prices and restricting or banning exports or rice and wheat (Argentina, India, Vietnam, PRC, Cambodia, Indonesia); Panic buying by importing countries as well as by consumers and traders and related efforts to build stocks in the face of rising prices;

Cyclical Factors: Food prices have spiked far beyond what market fundamentals would indicate driven by a number of short-term factors including:

Cyclical peaking of economic growth in Asia in 2006-2007 at the highest rate in nearly two decades;

New demand from portfolio investors seeking higher returns in light of the low returns in equities and bonds and relief from the weak US$;

Supply disruptions owing to disease and adverse weather conditions in key exporting countries: PRC, Vietnam and Australia;

Beggar thy neighbor trade policies of using administrative controls over domestic prices and restricting or banning exports or rice and wheat (Argentina, India, Vietnam, PRC, Cambodia, Indonesia);

Panic buying by importing countries as well as by consumers and traders and related efforts to build stocks in the face of rising prices;

Breakdown of World Rice and Wheat Supply World trade in rice is extremely small relative to production/consumption—over 90% of rice is produced and consumed in Asia—with only a few countries supplying the international market--this makes international rice prices volatile. Wheat is exported by a more diverse range of countries and wheat trade is relatively liquid and developed compared with rice trade. Rice Wheat Source: Foreign Agricultural Service, United States Department of Agriculture, available: www.usda.gov, downloaded 16 April 2008.

World trade in rice is extremely small relative to production/consumption—over 90% of rice is produced and consumed in Asia—with only a few countries supplying the international market--this makes international rice prices volatile.

Wheat is exported by a more diverse range of countries and wheat trade is relatively liquid and developed compared with rice trade.

Increasing Inflation Total Inflation Food Inflation Note: Bangladesh, India and Pakistan refer to respective fiscal year data for each country Source: CEIC Data Company, Ltd., downloaded 9 June 2008. 34.2 13.8 19.2 8.3 Viet Nam 8.4 6.3 5.7 2.3 Thailand 9.6 4.2 6.9 2.8 Philippines 15.0 8.7 10.2 7.8 Pakistan 4.7 3.2 2.7 2.0 Malaysia 14.2 11.2 8.5 6.4 Indonesia 5.0 9.5 7.4 4.4 India 21.3 5.0 8.2 4.8 China 12.6 6.6 10.5 7.2 Bangladesh YTD 08 2007 YTD 08 2007

Macroeconomic impacts Simulation analyses #1: food prices increase by 57.5% in 2008 #2: #1 plus 66.5% rise in oil prices Rising oil prices critical in food price analysis Petroleum/natural gas feedstock used for chemicals production, such as fertilizers and pesticides, and in diesel pumps for irrigation

Simulation analyses

#1: food prices increase by 57.5% in 2008

#2: #1 plus 66.5% rise in oil prices

Rising oil prices critical in food price analysis

Petroleum/natural gas feedstock used for chemicals production, such as fertilizers and pesticides, and in diesel pumps for irrigation

Macroeconomic impacts Higher global prices translate to rising inflation in Asia Food carries a large weight in consumer baskets Many are net importers of food and oil GDP growth declines Higher prices crimp consumption If central banks respond by raising interest rates, it results in sluggish fixed investment Effects magnified in year 2 as model takes time to adjust to global price shocks

Higher global prices translate to rising inflation in Asia

Food carries a large weight in consumer baskets

Many are net importers of food and oil

GDP growth declines

Higher prices crimp consumption

If central banks respond by raising interest rates, it results in sluggish fixed investment

Effects magnified in year 2 as model takes time to adjust to global price shocks

Macroeconomic impacts: Change from baseline projections for Asia #1: food price increase only #2: food and oil price increase

Policy implications If monetary authorities do not tighten policy, negative impact on growth is smaller, but they run the risk of inflation getting ingrained and undermining long-term growth Targeted subsidy programs may be implemented to alleviate inflationary impacts on the poor in the short term

If monetary authorities do not tighten policy, negative impact on growth is smaller, but they run the risk of inflation getting ingrained and undermining long-term growth

Targeted subsidy programs may be implemented to alleviate inflationary impacts on the poor in the short term

Fiscal costs For India, 10%,20%, and 30% increases in the procurement prices of rice and wheat would increase budgetary costs by 4%, 9%, and 13%, respectively. For the Philippines where most of subsidized rice is imported, a 50% increase in rice import prices leads to a 329% increase in total subsidy cost. PHI IND

For India, 10%,20%, and 30% increases in the procurement prices of rice and wheat would increase budgetary costs by 4%, 9%, and 13%, respectively.

For the Philippines where most of subsidized rice is imported, a 50% increase in rice import prices leads to a 329% increase in total subsidy cost.

Impact of Rising Food Prices on Households Effects of rising food prices are different across households. Some households may lose from higher prices, and some households may benefit from higher prices. Many urban and rural poor who are food consumers and not necessarily producers will suffer the most from rising food prices.

Effects of rising food prices are different across households.

Some households may lose from higher prices, and some households may benefit from higher prices.

Many urban and rural poor who are food consumers and not necessarily producers will suffer the most from rising food prices.

Impact of Rising Food Prices on Households Concerns over high prices are mounting because inflation eats into real incomes and expenditures. Rising food prices can undermine the gains from poverty reduction and human development that the country has experienced over the last decade or so. In developing countries, the poor spend about 60% of their total expenditure on food items.

Concerns over high prices are mounting because inflation eats into real incomes and expenditures.

Rising food prices can undermine the gains from poverty reduction and human development that the country has experienced over the last decade or so.

In developing countries, the poor spend about 60% of their total expenditure on food items.

Share of Food Expenditures to Total Expenditures (%) 36.4 37.9 36.4 45.2 5 th 47.7 49.0 50.8 58.7 4 th 54.1 54.1 56.2 63.2 3 rd 59.2 58.1 59.4 66.9 2 nd 64.6 63.3 62.0 69.3 1 st Philippines Indonesia India Bangladesh Quintile

Rising food prices increases poverty. The sharp rise in food prices is expected to increase the hardship of those who are already below the poverty line, and is also expected to drive other vulnerable groups into poverty. Using household data, our simulation results show that: - a 10% increase in food prices will push an additional 2.72 million and 7.05 million people into poverty in the Philippines and Pakistan, respectively.

The sharp rise in food prices is expected to increase the hardship of those who are already below the poverty line, and is also expected to drive other vulnerable groups into poverty.

Using household data, our simulation results show that:

- a 10% increase in food prices will push an additional 2.72 million and 7.05 million people into poverty in the Philippines and Pakistan, respectively.

Rising food prices leads to higher inequality. Our simulation results show that an increase in food prices by 10% will increase the Gini index by 0.55% points for the Philippines and by 0.39% points for Pakistan. Because of the food price increases for the first quarter of 2008 – 7.19% for the Philippines and 18.31% for Pakistan – inequality measured by the Gini index worsened by 0.39% points and 0.71% points for the Philippines and Pakistan, respectively.

Our simulation results show that an increase in food prices by 10% will increase the Gini index by 0.55% points for the Philippines and by 0.39% points for Pakistan.

Because of the food price increases for the first quarter of 2008 – 7.19% for the Philippines and 18.31% for Pakistan – inequality measured by the Gini index worsened by 0.39% points and 0.71% points for the Philippines and Pakistan, respectively.

Higher prices put upward pressure on the cost of living and thus lower the overall standard of living, particularly among the poorest.

How much would be required to help the poor consumers to enable them to cushion the negative effect of high food prices? 0.29 0.27 Compensation to old and new poor (% of GDP) 0.22 0.23 Compensation to old poor (% of GDP) 40.40 25.45 Number of poor after price increase (million) With a 10% food price increase 33.35 22.73 Number of poor before price increase (million) Pakistan Philippines

What Safety Net Measures? Safety net measures are required for the poorest of the poor to be able to mitigate impact of rising food prices on them. Conditional cash transfer (CCT): feasible but require high administrative costs that include monitoring conditionality and identifying the targeted groups. School feeding program: feasible and leakages could be minimized.

Safety net measures are required for the poorest of the poor to be able to mitigate impact of rising food prices on them.

Conditional cash transfer (CCT): feasible but require high administrative costs that include monitoring conditionality and identifying the targeted groups.

School feeding program: feasible and leakages could be minimized.

Public Sector Investments in Agriculture and Returns to these Investments in Agriculture Sector have been on decline – 30 to 40% decline between 1990 and early 2000s for some of the major Asian Economies Decline partly due to lower economic returns to investments in the sector due to low prices of major commodities in 1990s and early 2000s Higher food prices mean higher returns to investments in the sector despite higher input prices A Case in Point – investments in irrigation in Pakistan that were not economically feasible in 2002 exhibit economic viability if the current levels of output and input prices were to pertain during medium to long run

Investments in Agriculture Sector have been on decline – 30 to 40% decline between 1990 and early 2000s for some of the major Asian Economies

Decline partly due to lower economic returns to investments in the sector due to low prices of major commodities in 1990s and early 2000s

Higher food prices mean higher returns to investments in the sector despite higher input prices

A Case in Point – investments in irrigation in Pakistan that were not economically feasible in 2002 exhibit economic viability if the current levels of output and input prices were to pertain during medium to long run

Higher Returns Contingent Upon Improvements in the 5 ‘Is’ Setting the Incentives Right (price and trade policy reforms for major products and inputs) Ensuring easy and timely Inputs Availability (improved seed, fertilizers, pesticides and capital) Providing the timely Market Information Investing in Infrastructure (irrigation and farm-to-market Roads) Reviving and Strengthening Institutions (investments in research and technology and extension services)

Setting the Incentives Right (price and trade policy reforms for major products and inputs)

Ensuring easy and timely Inputs Availability (improved seed, fertilizers, pesticides and capital)

Providing the timely Market Information

Investing in Infrastructure (irrigation and farm-to-market Roads)

Reviving and Strengthening Institutions (investments in research and technology and extension services)

The Political Economy of High Food Prices: the Imperative for Inclusive Growth Food Price Inflation worsens income inequality and undermines social cohesion; Bad inequalities (those associated with unequal access to opportunity rather than incentives to seize opportunity) will be exacerbated and this will undermine poverty reduction and ultimately take a toll on economic growth; Attempts to paper over relative price change through administrative controls will not prevent inflation—they will merely create hidden inflation and will result in shortages and the poor will not benefit; Institutional innovations are necessary but require time and investment and trust to succeed;

Food Price Inflation worsens income inequality and undermines social cohesion;

Bad inequalities (those associated with unequal access to opportunity rather than incentives to seize opportunity) will be exacerbated and this will undermine poverty reduction and ultimately take a toll on economic growth;

Attempts to paper over relative price change through administrative controls will not prevent inflation—they will merely create hidden inflation and will result in shortages and the poor will not benefit;

Institutional innovations are necessary but require time and investment and trust to succeed;

Inclusive Growth through Improvements in Agriculture Sector – An Action Plan Improve Infrastructure Revive Institutions Medium- to Long-Term Rationalize Incentives Ensure Input Supply Market Information Short-Term (6-24 months) Targeted Price Subsidies Immediate (2-3 months) Maximize Economic Opportunities Ensure Equal Access to Economic Opportunities Ensure Minimum Economic Well-Being Inclusive Growth Poverty Reduction

Improve Infrastructure

Revive Institutions

Rationalize Incentives

Ensure Input Supply

Market Information

Targeted Price Subsidies