Surge in World Wheat Prices: Learning from the Past

(csekhar@iegindia.org),

COMMENTARYEconomic & Political Weekly EPW may 17, 200813Australia depleted drastically – from 40,823 thousand tonnes in 1971-72 to 22,350 thousand tonnes by 1972-73. This massive reduction in stocks, combined with lack of adjustments on the consumption side in major importing countries like China and the Soviet Union due to the domestic price stabilisation polices, led to a huge increase in world wheat prices and the world wheat crisis ensued. There is no evidence that any country except India had made any effort to increase domestic stocks to offset the decline in the major exporters’ stocks. One important point needs to be noted here. The shortfall in world wheat produc-tion between 1971-72 and 1974-75 was just 36 million tonnes (mt) compared to a much larger shortfall of 72 mt between 1961-62 and 1965-66. However, the world faced a severe price rise in the 1970s, while there was a much greater degree of stability in the 1960s. This was because of two reasons. The main reason was that the major exporters held their stocks at a much lower level in the 1970s than in the 1960s. The other important reason was that the major importers of the time – China and the Soviet Union – had adopted strict domestic price stabilisation policies in the 1970s. These policies prevented possible adjustments on the consumption side in these countries, leaving the world market to bear the brunt of the price rise (and consequent demand adjustments). 1990s – TrendThe international prices of wheat and maize rose rapidly during 1995 and the first half of 1996 [Andersen et al 1997, 1999; FAO 2001]. The price of wheat peak-ed in May 1996 at around $ 260 per tonne, about 65 per cent higher than the price a year earlier and more than double the price in May 1994. This steep rise in prices resulted from a combination of demand and supply side factors. Between 1994-95 and 1995-96, global cereal production declined by 3 per cent (amounting to 1,728 million tonnes) mainly due to a 9.6 per cent reduction in the production in developed countries. The El Nino affected rainfall and temperature patterns around the world. At the same time, global consumption of cereals outstripped production for the third year in a row, con-siderably depleting stocks and contributing to a rapid increase in prices. By 1995-96, there was a substantial reduction in global cereal stocks to about 258 million tonnes, which was a 20-year low. This constituted only 14 per cent of global cereal consump-tion, well below the 17 per cent considered by the Food and Agricultural Organisation (FAO) to provide the necessary margin of safety for world food security. Much of the drawdowns occurred in the traditional ex-porting or stockholding countries like Canada,US and Australia. The above trend completely reversed in the next two years. Wheat prices (received by theUS producers), which rose by about 50 per cent between April 1995 and April 1996, dropped to less than half of its 1996 level by April 1999. Worldwide, wheat area cultivated increased by 5 per cent be-tween 1995-96 and 1996-97 in response to the high world prices of 1995-96. The world grain stocks were rebuilt and reached 337 million tonnes by 1999, cor-responding to 17.9 per cent of annual world cereal consumption and conse-quently the grain prices fell. Current CrisisThe situation in the world wheat market turned critical when the global stocks-to-use ratio fell to 25.6 per cent in 2006-07 and to 22.9 per cent (forecast) in 2007-08. This is much below the average of 34 per cent for the first half of the decade. The stocks held by the major exporters (US, EU, Canada, Australia and Argentina) have declined from the average level of 49.8 mt during 2003-06 to 36.5 mt and 26.3 mt respectively in 2006-07 and 2007-08 (fore-cast). Not surprisingly, this depletion mani-fested in a steep rise in the world price. The free on board (FOB) price of standard US hard red winter wheat (USHRWW) has almost doubled from its 2003-05 average price of $ 156 per tonne to $ 295 per tonne during 2006-08. In March 2008, it actually went up to as much as $481 per tonne. ConclusionsThe global wheat stocks, mainly those in the major exporting countries, have a crucial bearing on the world wheat prices. Any movement whether that of the aggregate world supply curve to the left, or the world demand curve to the right leads to the depletion of global stocks and an increase in world prices. If the exporting countries are outward-oriented, higher world prices may induce them to increase exports by drawing down their stocks and even increasing the area cropped in subsequent years. This has been seen in the previous instances of world wheat price increases and there are no reasons not to expect similar developments in the short runthis time. There are already some signs of improvement. According to the latestFAO Outlook (April 2008), there is a sizeable expansion in area under wheat and a con-sequent expected increase in production in Europe andUS. As a result, the FOB price of USHRWW has already shown a drop of about $ 125 per tonne in the first week of May 2008 from the level inMarch2008. World cerealproduction in 2008 is forecast to increase by 2.6 percent (over 2007) to a record level of 2,164 mt, unless the climate turns completely adverse in the remaining few months. World wheat production is forecast to increase by 6.8 per cent over that of 2007 and that of rice by 1.8 per cent. However, these recent improvements on the international front should not obscure the importance of lessons to be learnt from the history of world wheat markets. The output and stockholding policies of major exporters hold large implications for price stability in the world wheat markets. The preceding review of the developments in world wheat markets over the last five decades indicates that the stock levels in a few large exporting/producing countries still hold the key to the stability of wheat prices in world markets. These results belie the assumption that the supply in world wheat markets is infinitely elastic. Therefore, highly populous countries like India and China cannot afford to excessively rely on the international market, not in the least for staple food commodities. It would not only make them vulnerable to the developments/policies in the major exporting countries but can also have a major destabilising effect on the world markets. For most of the low income fooddeficit countries (LIFDCs) chronic shortage of foreign exchange reserves makes it verydifficult to rely on imports to meet food requirements, even when international prices are lower. Therefore, it is time for the inter-national community to consider the option

COMMENTARYmay 17, 2008 EPW Economic & Political Weekly14of building up a global food reserve system. Such a system can be operated by a multilateral organisation like the FAO or United Nations with food contributions from all the countries. Empirical evidence suggests that aggregate global food production has rarely tended to fall below the global food requirement [Johnson 1991]. Therefore, such an arrangement should take care of the food security of nations and induce them to integrate their domestic production systems with world markets without making them vulnerable to sudden policy-induced supply shocks fromexport-ing countries. However, the formidable challenges to such attempts in the past should not be lost sight of. Some abortive attempts were made in this direction in the 1970s. The pitfalls of those exercises need to be avoided though [Tweeten 1992]. Large countries like India or China may need to hold a required level of buffer stocks not only in their own nationalinterestbut also in order to preventanymajorinstabil-ity in the world market. Thecurrentcrisis in world wheat markets maysoonpass, but if the important lessons of the past are not learnt by large countriesandthe international community, the frequency of such crises may increase in the future. Note1 For a formal empirical modelling of the effect of stocks and flows on world wheat price, see Sekhar (2003 and 2006). ReferencesAlaouze, Chris M, A S Watson and N H Sturges (1978): ‘Oligopoly Pricing in the World Wheat Market’, American Journal of Agricultural Economics, Vol 60, pp 173-85.Andersen, Per Pinstrup, Rajul Pandya-Lorch and Mark W Rosegrant (1997): ‘The World Food Situation: Recent Developments, Emerging Issues, and Long- Term Prospects’,2020 Vision Paper,International Food Policy Research Institute, Washington DC.– (1999): ‘World Food Prospects: Critical Issues forthe Early Twenty First Century’, 2020 Vision Paper, International Food Policy Research Insti-tute, Washington DC, October.FAO (2001): Global Information and Early Warning System on Food and Agriculture (GIEWS), Food and Agriculture Organisation, Rome. Johnson, D (1975): ‘World Agriculture, Commodity Policy, and Price Variability’, American Journal of Agricultural Economics, Vol 57, pp 823-28. – (1991): World Agriculture in Disarray, Fontana, London.McCalla, Alex F (1966): ‘A Duopoly Model of World Wheat Pricing’, Journal of Farm Economics, Vol 48 pp 711-27.Sekhar, C S C (2003): ‘Price Formation in World Wheat Markets – Implications for Policy’,Journal of Policy Modeling, Vol 25, No 1, pp 85-106. – (2006): ‘Determinants of Prices of Selected Agri-cultural Commodities in World Markets: An Empirical Analysis’, unpublished PhD dissertation, Department of Economics, Delhi School of Economics, Delhi University.Tweeten, Luther (1992):Agricultural Trade – Prin-ciples and Policies, Westview Press, Boulder and San Francisco, p 220.