Global food prices and Vietnam’s inflation

The recent surge in commodity prices has usually been ascribed to the U.S. stimulus package, which is said to exert inflationary pressure in developing economies. This view is tempting, but rests on shaky theoretical and empirical grounds.

The first phase of quantitative easing in the U.S. took place from January 2009 to March 2010. While there was inflationary pressure, food prices were less prone to upward movements than those of industrial goods. According to the International Monetary Fund, industrial products were increasingly expensive even when the world’s industrial output hit rock bottom (in February 2009). Meanwhile, food prices did not oscillate wildly (Chart 1) but started to accelerate in August 2010, when inclement weather adversely affected crops in Russia, Ukraine, Kazakhstan and so on.

The relationship between food supply and demand in the world is worthy of scrutiny, too. Global food prices peaked in April 2011, when, according to the U.S. Department of Agriculture (USDA), total cereal output slid by almost 3%. The fall was practically 5% in the case of cereal output per capita.

Why, then, did prices jump by nearly 100% even though supply sank by only 5% or so? Part of the answer lies in demand growth, which surpassed population increase. For example, China is a giant net importer of cereals as its local demand for animal feed balloons. More importantly, demand for cereals is extremely inelastic, which means the quantity purchased drops noticeably only if prices rise sharply. USDA estimates that prices must leap by 25% for the quantity demanded to ebb by 1%.

While stimulus packages probably aggravated recent food price increases, the main culprit was dismal supply in 2010, bred by harsh weather.

Forecasts

Food supply in 2011-2012 is expected to far exceed that of 2010-2011. A report by the Food and Agriculture Organization (FAO) and USDA, released in July 2011, estimates that the total cereal supply in 2011-2012 will be 2.5-2.9% higher than in 2010-2011. Consequently, cereal prices have decreased over the past three months. Corn and wheat prices, in particular, have fallen by 6-10% since April after rising by almost 100% for a while.

Stockpiles no longer plummet and can even increase. In particular, rice reserves continue to swell after posting a record in 2010-2011. If the weather does not undergo dramatic changes, food prices will not go up as much as it did in 2010 and early 2011.

Structural problems

It is worth pondering why food prices in Vietnam, a net exporter of this commodity, tend to outpace those in Thailand, India and China, with which it shares many economic similarities, by up to 2-3 times. Many factors are at play here, with fiscal and monetary policies assuming only a limited role (this explains why food, which accounts for a significant share of the consumption basket in most countries, is often excluded from the formula for core inflation).

Countries can be classified into groups: importers and exporters of rice. Vietnam is arguably the only rice exporter (and a big one at that) which saw its rice prices jump by nearly 37%, twice as rapidly as their global counterparts (Chart 2). The 7.2% drop in the dong value alone is insufficient to fully account for such glaring disparity.

The root cause probably runs much deeper and centers on distribution, which is plagued by hefty intermediary costs. In early July, the retail price for pork in Hanoi was about 82% higher than in January, far above the price increase that pork traders have to shoulder (approximately 51%). This indicates that inflation is considerably attributable to structural problems. That retail prices have kept climbing regardless of movements in input costs since early 2011 reflects severe market inefficiency.

Important yet frequently overlooked, market shortcomings such as price watch mechanisms, the scale of animal husbandry, as well as intermediate phases in the sector, have left a pronounced impact on prices, but are obvious only when inflation expectation spirals upward. Altogether, these weaknesses have made Vietnam’s food price unbelievably unstable. In the absence of thorough research and bold action, inflation tends to strike hard.

Perhaps too much hope has been pinned on monetary policies. Vietnam’s anti-inflationary recipe must entail policy coordination and a long-term strategy that goes beyond fighting price rises in the short run. Channeling more financial and intellectual capital into agriculture can be a vital ingredient in this regard.

Source: SGT

Tags: Vietnam food prices