Noteworthy Insights on the Rice Crisis

Some important insights on the Rice Crisis…

All highlights mine

From Tyler Cowen published at the New York Times…

“Restrictions on the rice trade run the risk of making shortages and high prices permanent. Export restrictions treat rice trade and production as a zero- or negative-sum game where one country’s gain comes at the expense of another. That’s hardly the best way to move forward in a rapidly growing world economy.

“This lack of support for trade reflects a broader and disturbing trend. An increasing percentage of the world’s production, including that for agriculture, comes from poor countries. Over all, that’s good for rich countries, which can focus on creating other goods and services, and for the poor countries, which are producing more wealth. But it can slow the speed of adjustment to changing global conditions.

“For example, if demand for rice rises, Vietnamese farmers — who remain shackled by many longstanding regulations of communism — aren’t always able to respond quickly. They don’t even have complete freedom to ship and trade rice within their own country.

“Poorer countries also tend to be the most protectionist. To make matters worse, about half of the global rice trade is run by politicized state trading boards.

“The reality is that many of today’s commodity shortages, including that for oil, occur because ever more production and trade take place in relatively inefficient and inflexible countries. We’re accustomed to the response times of Silicon Valley, but when it comes to commodities production, many of the relevant institutions abroad have only one foot in the modern age. In other words, the world’s commodities table is very far from flat.

“Many poor countries, including some in Africa, could be growing much more rice than they do now. The major culprits include corruption in the rice supply chain, poorly conceived irrigation systems, terrible or even nonexistent roads, insecure property rights, ill-considered land reforms, and price controls on rice.

“The ability of a country to grow rice depends not just on its weather, but also on its institutions. Burma, now Myanmar, was once the world’s leading rice exporter, but it is now an economic basket case and many of its people go hungry.

“Of course, wealthy countries are partly at fault, too. Japan, South Korea and Taiwan all protect their native rice farmers; you’ll even see rice being grown in Spain and Italy, aided by European Union subsidies and protectionism. The United States spends billions subsidizing domestic rice farmers.

From Steve Hanke published at Cato.org...

“The economics of commodity markets provides the key to unlocking this mystery. The net cost of carrying inventories is equal to the interest rate, plus the cost of physical storage, minus the "convenience yield".

“The convenience yield is driven by the precautionary demand for the storage. When the convenience yield is zero, a market is in "full carry", future prices exceed spot prices and inventories are abundant.

“Alternatively, when the precautionary demand for a commodity is high, spot prices are strong and exceed future prices, and inventories are unusually low.

“As the term structure of rice prices makes clear (see chart), the precautionary demand in Thailand is not elevated and inventories are ample. Indeed, for the term structure of prices to be signaling unusually low inventories, the term structure would be negative in slope, not positive.

Chart courtesy of Cato.org

“In most countries, rice production and trade are subject to a plethora of laws and regulations. Subsidies to rice producers and consumers are widespread. Tariffs on imports and exports are common, as are import and export quotas.

“Many of these policies derive from a food security rationale and the desire to keep a large proportion of rice production at home. In consequence, rice markets are segmented, with wide differences in rice prices (adjusted for rice quality and transport costs) among countries.

“Not surprisingly, a relatively small proportion – only 6%-7% – of world production is exported.

From IMF’s Dominique Strauss-Kahn

“Although aid is the first step, we must be bolder in tackling the long-term challenges of food supply.

“Many farmers are not increasing output because they are not equipped to gear up production or because market distortions mean they do not benefit from higher food prices. So, just waiting for the market to self-correct is not a satisfactory option.

“We must not lose sight of longer-term solutions. This calls for a more global approach to policies. Agricultural policies must change. Higher food prices over the past few years in part reflect well-intentioned, yet misguided policies in advanced economies, which attempt to stimulate biofuels made from foodstuffs through subsidies and protectionist measures.

“High food prices also reflect imprudent agricultural pricing policies in some developing countries, and these too need to be improved.

“No one should forget that all countries rely on open trade to feed their populations. But we are already seeing actions at the national level, such as curbs on food exports, that have a damaging global impact. Completing the Doha round would play a critically helpful role in this regard, as it would reduce trade barriers and distortions and encourage agricultural trade.

“The International Monetary Fund and the World Bank are also engaged in discussions to improve both industrial and developing country policies. Multilateral agencies are stepping up lending to the agricultural sector in poorer and middle-income countries to encourage and support good policies. But there is more to do, and the World Bank's New Deal on Global Food Policy is a big step forward.

“We also need a new approach to risk mitigation and insurance at the level of both individual farmers and countries. Important steps are being made in this direction by aid donors with regard to catastrophe insurance and developing robust futures markets. This can greatly help assure farmers that, if they make investments, they will reap the rewards.

“We should consider adopting a similar philosophy to dealing with shocks - including, but not limited to, energy and food prices - at the macroeconomic level. Countries need to feel more assured that insurance-type financing will be available in times of need. The IMF will play its part in this regard.

From Martin Wolf of the Financial Times...

“Are prices going to remain high? Two opposing forces are at work. The first is the market, which will tend to bring prices back down as supplies expand and demand shrinks. But the latter is also what we want to avoid, at least in the case of the poor, since reducing their consumption is not so much a solution as a failure. The second force is the current intense pressure on the world's food system. This is true of both demand and costs of supply. Prices are likely to remain relatively elevated, by historical standards, unless (or until) energy prices tumble.

“This, then, brings us to the big question: what is to be done? The answers fall into three broad categories: humanitarian; trade and other policy interventions; and longer-term productivity and production.

“The important point on the first is that higher food prices have powerful distributional effects: they hurt the poorest the most. This is true both among countries and within them. The Food and Agricultural Organisation in Rome recently listed 37 countries in substantial need of food assistance. Moreover, according to the World Bank, soaring food prices threaten to make at least 100m more people hungry.

“Increases in aid to the vulnerable, either as food or as cash, are vital. Equally important, however, is ensuring that the additional supplies reach those in greatest difficulty. The options depend on the sophistication of a country's bureaucratic machinery. But they include work paid directly with food (which is a good way of screening out the better-off), a rationed supply of cheap food for the poor or cash vouchers. Those most in need will be the landless, both rural and urban, and marginal subsistence farmers.

“Now turn to the policy interventions. Protection, subsidies and other such follies distort agriculture more than any other sector. Alas, the opportunity to eliminate protection against imports offered by exceptionally high world prices is not being taken. A host of countries are imposing export taxes instead, thereby fragmenting the world market still more, reducing incentives for increased output and penalising poor net-importing countries. Meanwhile, rich countries are encouraging, or even forcing, their farmers to grow fuel instead of food.

“The present crisis is a golden opportunity to eliminate this plethora of damaging interventions. The political focus of the Doha round on lowering high levels of protection is largely irrelevant. The focus should, instead, be on shifting the farm sector towards the market, while cushioning the impact of high prices on the poor.

“Finally, far greater resources need to be devoted to expanding long-run supply. Increased spending on research will be essential, especially into farming in dry-land conditions. The move towards genetically modified food in developing countries is as inevitable as that of the high-income countries towards nuclear power. At least as important will be more efficient use of water, via pricing and additional investment. People will oppose some of these policies. But mass starvation is not a tolerable option.

From Caroline Baum of Bloomberg,

“Many Asian countries, including India and Vietnam, are banning rice exports to ensure adequate domestic supplies. Last week, Indonesia stepped up border patrols to guard against rice smuggling.

“By barring producers from selling overseas, demand for rice in any given country is lower than if the Asian food staple were freely traded internationally. The demand curve shifts back, the price and quantity demanded are reduced….

“It may be a noble idea for poor countries to transfer income from producers to consumers, but it's one that comes with a long history of unintended consequences.

“Governments continue to interfere with the law of supply and demand; that's to be expected. What's surprising is that so many practitioners of the dismal science can't seem to get it right either.

Rice Crisis: Adverse Side Effect From Hefty Political Subsidies

``Inflation is like sin; every government denounces it and every government practices it." - Frederick Leith-Ross 1887 -1968 civil servant and authority on international finance

We have cited the negative impacts of the ongoing rice crisis in How Surging World Rice And Food Prices Could Impact the Philippines and Rice Crisis: The Superman Effect And Modern Agriculture to the heightening the risks of social instability, more intrusive government policies which may hamper market mechanisms that may have a lasting side effect and harm the economy over the long run aside from impairing the balance sheets of the national government. In addition, we attributed the inefficiencies and imbalances of the industry to the lack of market signals aside from the webs of laws that has severely distorted the marketplace.

Combined, these added risks may impose a hefty risk premium to our asset class, where the hurdle rate of investments returns must significantly be greater relative to the given risk environment. And with today’s risk averse environment, high risk premiums represents an unattractive proposition for investors.

Yet, in vigil to the unfolding crisis, what we have observed was that anecdotally speaking, the problem of rice shortages is one concerning government “subsidized” National Food Authority (NFA) rice more than a general or nationwide rice shortage.

We don’t see people lining up for commercial rice because commercial rice partially reflects market prices. Whereas subsidized rice is entirely and artificially sold cheap to the “poor”, at a loss to the account of the government and charged to future taxpayer’s money in order to buy political stability. As an aside, we don’t see “riots” in the street yet (as reported by some news accounts) although we do see snaking queues for NFA rice.

The problem is that government subsidies have been compounding on the dysfunctional government controlled market for rice. The greater the price difference between commercial rice and subsidized rice, the greater the tendency to have a “crisis”, as some people have used such opportunity to “arbitrage” for profit -buy subsidized NFA rice, repackage and resell them at commercial rates, thus leading to more speculative pressure.

The following news reports depicts of the harsh realities from perverted government policies,

``The governor also directed the mayors to assess economic conditions in their areas, investigate the reported adulteration of rice through the mixing of cheaper NFA rice with commercial supply, and to submit periodic reports and recommendations to his office.” (Inquirer.net)

``Justice Secretary Raul Gonzalez personally caught at least one dealer mixing National Food Authority (NFA) and commercial rice in his home province of Iloilo over the weekend.” (gmanews.tv)

As we have written earlier, government policies create the incentives from which the people respond to, yet they get arrested from skewed regulations.

Yes, there is indeed a global rice problem. But the problem in the domestic setting is a basically an adverse side effect from hefty political subsidies.

Price Signals Work In Some Areas

Just consider; record food prices have started to impact investments decisions elsewhere in the world.

For instance, Russia plans to be a major exporter of grains within 5 years banking on the unused 20 to 25 million hectares of land for such purposes. (agrimarket.info).

Amazingly, even in Afghanistan the food crisis have borne a rare positive unintended effect, swapping heroin for wheat, this excerpt from Telegraph’s Con Coughlin (highlight mine),

``In parts of Helmand Afghan farmers are this year sowing wheat instead of poppy - not because they have suddenly been converted to the argument that producing heroin is not in the national interest.

``Market forces have been the deciding factor - with wheat prices doubling in the past year, and the street price of heroin falling, it is now more cost effective to grow wheat.”

In the US, farmers have started to opt out of the cropland conservation program which HAD KEPT THEM FROM CULTIVATION to cash in on the booming agriculture industry pls. refer to figure 6. See how government policies even in the US have contributed to the underinvestment-overinvestment cycle?

In the past, depressed food prices benefited consumers, yet the program was designed aimed at sustaining US farmers by effectively curbing supply through subsidies. Farmers were paid for not producing on their cropland!

Figure 6 New York Times: As Prices Rise, Farmers Spurn Conservation

Now that agricultural prices are skyrocketing, half of those enlisted in the conservation program have dropped out.

This from New York Times’ David Streitfeld

``Born nearly 25 years ago in an era of abundance, the Conservation Reserve Program is having a rough transition to the age of scarcity. Its 35 million acres — about 8 percent of the cropland in the country — are the big prize in this brawl…

``Such problems were never contemplated when the Conservation Reserve was conceived as part of the 1985 Farm Bill. Participants bid to put their land in the program during special sign-ups, with the government selecting the acres most at risk environmentally. Average annual payments are $51 an acre. Contracts run for at least a decade and are nearly impossible to break — not that anyone wanted to until recently…

``The program peaked late last summer, with more than 400,000 farmers receiving nearly $1.8 billion for idling 36.8 million acres. Put all that land together and it would be bigger than the state of New York.”

Price Signals Don’t Work On Some

As you can see, market prices have impacted investment decisions in some parts of the world, but others have not responded to the price stimulus because agricultural inputs (as fertilizers, seeds and fuel) have likewise risen and have posed as a deterrent to increasing production.

This excerpt from MSN’s analyst Jim Jubak (underscore mine),

``There, higher costs for fuel, seed and fertilizer have led farmers to cut back on planted acreage. The promise of higher prices for crops harvested in the future doesn't work if you can't afford the materials you have to pay for now, especially when credit comes at ruinous interest rates -- if it's available at all. Farmers in these areas also don't have access to the commodities futures market, so they can't lock in today's higher prices for future grain delivery.

``That means paying today's high costs is too big a gamble for poorer farmers, who can't afford to bet that grain prices will be as high tomorrow as they are today. All this has led to situations like this one: In Pakistan, farmers will produce a smaller wheat crop this year because they've cut their use of fertilizers after a 50% price increase in the past year.”

As we have previously argued, the lack of commodity markets have prevented farmers in developing countries as the Philippines from capitalizing on today’s higher prices to fund their inputs or for capital investments, thus access to capital.

Whereas the complete dependence on the traditional networks (traders or merchants) for the sales of their products and limited access to funding has been a major obstacle to the farmers to increase output since they are subjected to market inefficiencies emanating from a wall of laws, distortive subsidies and are in bondage to special interest groups for their markets.

Technically speaking the market price signals have not filtered to these economic agents enough for them to allocate capital and resources efficiently.

Copious But Fallow Agricultural Lands

Yet, the irony is that the Philippines has been blessed with a sizeable area for agriculture, this according to the Philippine Department of Agriculture,

``The Total area devoted to agricultural crops is 13 million hectares. This is distributed among food grains, food crops and non-food crops. Food grains occupied 31% (4.01 million hectares), food crops utilized 52% (8.33 million hectares) while 17% (2.2 million hectares) were used for non-food crops.

``For food grains, the average area utilized by corn was 3.34 million while rice occupied 3.31 million hectares.

``Of the total area under food crops, coconut accounted for the biggest average harvest area of 4.25 million hectares. Sugarcane with 673 thousand hectares; Industrial crops with 591 thousand hectares; 148 thousand hectares for fruits; 270 thousand hectares for vegetables and rootcrops; 404 thousand hectares for pasture and 133 hectares for cutflower.

``According to land capability, 78.31% of the alienable and disposable land are prime agricultural areas, 6.1 million hectares are highly suitable for cultivation.

Statistics are a mirage. The assumption presented here is that these all these lands are in production, but somewhere somehow this doesn’t account for the complete picture as Philippine agriculture land is punctuated with idle lands following years of underinvestment.

In fact, last year, the Philippine government arranged to lease over ONE MILLION hectares or close to 10% of the country’s agricultural property to the China’s Jilin Fuhua Agricultural Science and Technology Development Co., Ltd. (Fuhua Co.) because of idle, uncultivated or undeveloped properties!

This from Gemma Bagayaua of GMA Newsbreak, ``Would you rather let a million hectares of agricultural land remain undeveloped due to lack of capital or lease them to a foreign company?

``This, according to a ranking official of the Department of Agriculture (DA), is the government’s main consideration when it decided to lease to China’s Jilin Fuhua Agricultural Science and Technology Development Co., Ltd. (Fuhua Co.) some one million hectares of Philippine land under vague terms. The area covers about a tenth of all Philippine agricultural land.

``The DA says that the memorandum of understanding (MOU) with the Chinese company is just an additional strategy to meet the department’s goal under the Medium Term Philippine Development Plan (MTPDP), which is to develop two million hectares of agricultural land…

``Fuhua Co. intends to plant hybrid rice, corn, and sorghum in these lands. The contract is expected to bring in about US$3.87 billion in investments.

As you can see low productivity from the lack of capital investments brought upon by market contorting policies are essentially responsible for this recent crisis.

Bottom line: the government’s predicament can be resolved by inducing more investments to the industry by eliminating these supply rigidity barriers through dramatic reforms by eliminating or reducing subsidies, by opening the industry to competition and the development of a commodity spot and futures market for increased capital access and for pricing efficiency. Yes, there will be some social costs, some people will starve with temporary high prices. But private socio-civic groups can work with government to provide for charitable donation instead of placing the burden squarely on the government.

The rice cropping cycle is a short one (3-6 months) from which fallow lands can easily be cultivated and contribute to the supply output and stabilize the present situation. Thus I think, this problem can be settled in the medium term.

Unfortunately, with the populist tendencies tilted towards more socialism, the next step by the leadership would probably be to force other croplands into rice production, thereby yes, providing short term solutions of having sufficient supplies but at the expense of the farmers (rice prices will go down and squeeze income) or for other crops which we will see prices go to the roof (think sugar, vegetables and others).

Philippine Peso and The US Dollar Burdened By Socialization

Finally, many argue that the Philippine Peso will fall as a consequence to the increased subsidies by the Philippine government. Our view is that they are only partially correct because in the analysis of the valuation of currencies requires studies on BOTH the circumstances underpinning the currencies to which are valued against. To illustrate, if the Philippine Peso is gauged against the US dollar (which is the traditional benchmark), then the factors in support of the probable value of the currencies, both the US and the Philippines, should be assessed. Remember, the currency market is a zero sum game where one wins, the other losses.

True enough, the present actions to subsidize the poor with cheap rice by the Philippine government may impair its fiscal conditions, BUT the US government is likewise undertaking a massive nationalization of its financial and banking system aside from the borrowers afflicted by the US housing bust. In other words, two countries whose currencies are valued against each other are both effectively debasing their currencies for political expediency.

One thing we can be sure with, the more government intervenes with our lives the more we are likely to see a diminished standard of living.