Today’s high prices of food around the world are the result of the continued failure of large, populous economies such as India and China to reach food self-sufficiency or even near self-sufficiency. In India, successive governments since 1991 have ignored the real economy that is agriculture and pushed it to the background. The country is now paying a heavy price for this, says G. CHANDRASHEKHAR.

G. CHANDRASHEKHAR

Addressing the latest meeting of Development Committee of World Bank and IMF in Washington on April 13, the Finance Minister, Mr P. Chidambaram, lamented that high crude oil and galloping food prices were imposing a crushing burden on developing countries.

According to the Finance Minister, the price of crude (currently at around $110 a barrel) does not reflect either the cost of production or risks inherent in the market, and not even the interplay of demand and supply. Diversion of food crops for bio-fuels resulted in food inflation that hit the poor nations the hardest, he asserted.

While Mr Chidambaram’s concern over high prices may be justified, going by media reports, it may be safe to infer that he was perhaps not fully and properly briefed about the factors that led to developments in the global fuel and food markets.

Crude fundamentals

What’s the correct position as far as the world crude market is concerned? Without doubt, the market fundamentals are tight. The demand side is robust. Admittedly, there is a slowdown among economies in the OECD, which may pare the growth in demand, but this is being largely neutralised by growth in major Asian economies such as China and India, both of which continue voraciously to guzzle mineral oils.

After all, given the status of manufacturing technology and transportation needs, crude is needed to fuel economic growth; and Asian economies are indeed growing rather well. There are no visible signs of any demand compression in the US, either. Those who forecast a sharp downward correction in crude prices resulting from recessionary conditions in the US are hiding their face.

In addition, crude oil stocks in the US are close to their seasonal average, and the fall has been larger than expected. Also, a smaller than normal build-up in global inventory is anticipated. Importantly, there is strong expectation of a recovery in the US economy towards the latter part of the year, which is sure to boost consumption and, in turn, prices.

On the other hand, the supply side is beset with problems. OPEC is rather cautious in its output policy. The decision to enhance output by five lakh barrels a day (effective November 2007) stays, but is inadequate to meet growing demand. Instability in Iraq exposes prices to the upside. Non-OPEC supply growth is sluggish. Going by early data for 2008, output is sure to contract in 2008.

No wonder, prices have set new highs at the front end of the curve; and far forward values too are high still. Those who seriously track commodity markets realise that the market looks not only at current demand-supply fundamentals, but also — more importantly — changes in the fundamentals in future. The market reacts today to the expectation of future changes. The energy market today reflects tightening market conditions ahead. This is reflected in prices.

Low speculative activity

At this point, it may be necessary to explode the myth that speculators are currently driving the crude market up to dizzy heights. A look at the Commitment of Traders report from the US commodity market regulator CFTC (issued every week) would be in order.

Data on crude oil trade on the NYMEX are revealing. The futures net long position held by non-commercials (non-hedgers, better known as speculators) as a percentage of open interest is the key to deciphering the level of speculative interest in rising prices. For instance, as of April 1, futures net long as a percentage of open interest was just about 3 per cent. The all-time high was 18 per cent. Therefore, the level of speculative funds in the crude market is much less than it is widely believed to be.

Contrast crude with, say, gold. There is huge speculative interest in the yellow metal as evidenced by high volatility and fund play. As of April 1, on the Comex, futures net long as a percentage of open interest was 40 per cent. The all-time high has been 49 per cent. In other words, speculative long positions in gold are significantly large.

A large and rising speculative long position potentially creates downside risk to the market. Thus the gold market has a large downside risk, while crude has a limited downside risk.

Importantly, the crude market is fundamentally tight. Output trails demand, albeit marginally at present. Because the probability of output catching up with demand is small, the market sentiment is bullish. The present price level has little to do with rampant speculation, as erroneously believed.

In sensitive and critical commodities such as crude, producers follow a pricing policy that helps skim the market but does not lead to demand compression. That’s why OPEC is cautious in its output policy, which ensures just about adequate supplies or a marginal shortfall so as to keep the mood buoyant. These markets do not work on a traditional ‘cost-plus’ basis.

If Mr Chidambaram laments that crude market rates are unrelated to the cost of production, he would be aghast if told about the cost and price dynamics of palm oil. The average cost of production of crude palm oil is about Ringgit Malaysia 800 a tonne (about $220), while the market rate is about RM 3,200-3,400 a tonne (over $900), four times higher.

There is perhaps no other business in this world today that is as profitable as running an oil palm plantation and producing palm oil. Yet, ironically, India recently decided to permit crude palm oil import at zero per cent duty.

Bio-fuels

In addition to sharing his thoughts on crude prices, the Finance Minister criticised the policy of some countries that support bio-fuels. According to the minister it was a cruel joke on the world’s poor. This kind of emotional outburst may be politically expedient, but nothing more than that. The fact is that today’s high prices of food around the world are the result of continued failure of large, populous economies such as India and China to reach food self-sufficiency or even near self-sufficiency. Particularly, in India, where more than half the population ekes out a living on agriculture or related activities, the policy-makers have failed to pay adequate attention to agricultural growth and self-sufficiency in food.

Chanting the economic liberalisation mantra, successive governments since 1991 have ignored the country’s real economy that is agriculture and pushed it to the background. The stock market became the cosmetic barometer of the country’s economic health rather than farm output.

It seems nemesis is now catching up. India as a country and Indians as a people are paying a heavy price for the omissions and commissions of successive governments that paid lip service to agriculture, but did little real work on the ground.

We as a nation must confess we have failed to uplift the agricultural sector despite the availability of all factors of production. Attacking the bio-fuels policy of industrialised countries is hardly the solution to containing prices in our country.

Countries such as the US, Canada and the European Union produce their own wheat, corn and oilseeds. What they do with their indigenous production is their concern. Whether they eat it or burn it or throw it in the sea or give it as aid or export to the world market is their decision. No one needs to dictate or preach.

India responsible for world food inflation

Indeed, in some sense, India is responsible for current high prices of major foods around the world. Because of our own failure to become self-sufficient, we have not only banned export of foods (rice, pulses, wheat, for instance) but also have turned to the world market as large importers to feed our people. If India and China are self-sufficient in food, the world market dynamics would be vastly different, bio-fuels or no bio-fuels.

Poor African countries can justifiably accuse India of robbing them of food. India’s entry into the world market to buy millions of tonnes of wheat, pulses and edible oil pushes prices higher. We have contributed to global food inflation. Indian politicians must realise this before taking a public position.

(This article was published in the Business Line print edition dated April 19, 2008)
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