Agflation!!

What would the RBI do next? are global variables having a upper hand..?
Just brooding over inflation... and rising food prices ('agflation')?


Demand Supply Equation!! Demand drivers and love for monies!!
Wrt Emergining Economies: Say India, China...


1) Rising population >> More bread, chapattis and Kellogg’s consumed.....>> more cereals required to make them...


2) Data points indicate rising income levels are highly co-related with meat consumption...say avg. Chinese consumed 20kg of meat in 1985, now consumes more than 40kg of meat...!! so more meat required, means, more chickens and pigs need to be slaughtered...and hence more fodder required to feed them (chickens/pigs)!!... also comes in the 'love for money'... as meat fetches
higher realization -- farmers would love to switch their occupation to animal husbandry... and hence more pigs/chickens for you, but as the number of pigs/ increase.... they would take away more of your chappatis/bread/kellogs... (I mean equivalent raw material to produce them (i.e. cereals) to feed and grow healthy pigs and chickens)



3) Now, Mr. Bush... and Ethanol policy (most Imp factor, as i see it...)
Did you ever think this could bother you: "... to increase the use of renewable fuels almost fivefold though 2017, primarily relying on ethanol"... in a pledge by President Bush in state of union address some time back...



Few stats:
"113 ethanol distilleries are operating and an 77 new are under construction, will have potential capacity of 11.8 billion gallons, or 44.7 billion liters in USA, according to the Renewable Fuels Association" .... "Record output of 4.9 billion gallons of ethanol last year — triple the 1.6 billion gallons produced in 2000 — accounted for 2.8 percent of the U.S. fuel supply"!!!!!, a trade
group in !! (--extract from nytimes)



As per (news) articles.. US is the largest corn grower and exporter, accounting for 40% of world supply...however, with rising demand for ethanol, CY07 saw 20% of its corn harvest feed ethanol (ignoring stomachs!!) and corn harvest feeding ethanol distilleries is expected to rise to 50% over next two years... if new distilleries come up on schedule... In 2000, US consumed 15mt of maize to produce ethanol, same variable is expected to touch 85mt in current year.. hence the largest exporter of maize (USA)... wont export as much as it used to in the past.. .as it has to feed its fuel guzzling SUV's, hurting.. D-S equation further!!



--- IMPACT ON US!!
Wheat prices up 120% last ten months... corn, maize (up 50% from 06 levels), soyabean, etc.. follow the trend...!! (Wheat prices also impacted by drought in Australia over last two years…)



I love money.. !! So do (now) Richie rich US (maize) farmers...
As prices of maize shot up in US on account of increased demand, farmers began to ‘switch the crops’ from wheat, soyabean and rice...
Articles indicate... maize production for US for 2008 to be almost a quarter high than last year.. which can only happen if the yield of the crop increases or more land is brought under cultivation or the former (starts switching crops).. which would feed D-S gap further....for other crops!



US Govt. has done everything to encourage the same, from subsidies to import tariffs (esp. for cleaner Brazilian ethanol)!! I believe, doing this... .US Govt. achieves a number of objectives... first it reduces its deficit, by decreasing oil imports (though would be a very minute amount), plus... it would able to reduce its farm subsidy bill.. as farmers would now get good prices for their produce.. and could gradually do away with the subsidies, and in turn ..thou not very sure... also help negotiate in the DOHA WTO round... on green box subsidies..and agri product negotiations.. not much of clue on the latter..!!



--Who benefits from these?
The farmer... if he gets the right price (removing the middle man), would stand to benefit maximum…but in our country we have MSP (ie. minimum support price); i.e. the price which the govt. (I believe FCI) pays to the farmers to buy their produce, e.g for wheat currently at Rs1000.
Moreover, to see a political angle, in favour of farmers... CPI (M) would ask the govt. to increase the MSP on agri products as the farmers, not being able to sell their produce at lucrative global prices... (Which can fuel inflation, its not impossible :))!!!



A middle class guy, would stand to lose the most,... as the price of end produce rises, it lowers the price of the money. I would consider the demand for agri produce to be elastic in cases, say some one like me would have the option to switch from Kellogg’s to bread or to biscuit... or some fruit…or say would have a option to cut down on the number of movies i see in a month... keeping the quantum of atta I consume constant *so partly elastic*. However, for a poor guy (migrant, construction worker, etc.), who uses atta (the basic component) of chappatis/rotis -- and atta being the first in the value chain (and also the lowest cost), wont have the option to switch to anything else, but to decrease his consumption of atta.. means *so partly inelastic in nature*, and forced to reduce his consumption... and would feel the pinch the most...!!



--Why only India’s inflation is rising? :)

Developed economies like US and EU... have less than 10% of inflation weight on food, hence minimum impact... vis-à-vis, for developing nations like India (WPI-15.4% Food +6.1% - Non food articles; commonly rffd index), however CPI continues to have 57% wt. on food items; for Bangladesh and Nigeria almost 66% of the consumer price index.



--What would India do? Food for thought...
Despite good domestic harvest of wheat, rice and cotton... we see the domestic prices rising up? why so? a common trend across all products.... I see it as a direct impact of global (US induced) agri-price...hike!! do u... (Check the last paragraph... 'more food for thought')



To keep a check on inflation... countries have imposed price controls on domestic prices... and also banned exports to feed the domestic demand. India has done the latter, and wont be surprised to see the former being implemented (any take on this??)



More Importantly, I don’t see agflation (15%+9% wt. in WPI) directly related (correlation) to softening interest rates,... considering the elastic (middle class)-inelastic (daily wage workers) impact scenario explained above, (i.e. more of Maslow’s hierarchy... staple food...basic necessity) !!



***Hence to conclude, I wont be surprised to see RBI's softening interest rates (to boost IIP- primarily manufacturing growth); as i believe agflation to be mutually exclusive (being impacted by more of global D-S gap, rather than domestic factors). To keep the India growth story alive, one needs capex... and with ECB route frozen (US$20m cap), IPOs going phusssss... bank lending seems the only alternative... hence... softening rates is a must...!! Also not to forget of Tax buoyancy & FD targets, considering.... Corporate taxes contribute (~32%) of total tax revenue!!***


More Food for thought:
"Globally, Food reserves were at their lowest level in 30 years .... with emergency deliveries for 53 days, compared with 169 days in 2007. ".... bbc.com and FED Chief Bernanke admits "US tariff on ethanol imports being eliminated" -- on 8th March, 2008. !!!!


I believe US ethanol demand has global repercussions, with many countries riding high on exports say Indonesia, Malaysia (land exploited, crops shifting to produce more palm-oil), S. America-Brazil (maize, sugar), India(jathropa crop, not really, as it is grown on arid land), US (soyabean produce). This has resulted to alteration in global cultivation on crops, and hence can continue to impact global agri prices, if US doesn’t change its stance on biofuels (ethanol). Not to forget…sugar prices jumped up some time back… on ethanol news in India J



Open to thoughts, views, and debates!! – Views expressed are personal.



Regards,



Ritesh Shah
( wrote on 8th March 2008)