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Going against the grain

Rising worldwide demand, drought-hit supplies, industry consolidation and aggressive trading by hedge funds are causing a global upheaval in commodity prices, reports Arun Kumar.

business Updated: Apr 15, 2008 01:35 IST
Arun Kumar
Arun Kumar
Hindustan Times

It never rains, it pours.

The current round of inflation – in which the wholesale price index-based inflation has touched a 41-month-high of 7.41 per cent, can be described as more symbolic than real.

Consumer prices tend to be higher than wholesale prices anyway. Add to this the fact that the government had not even passed on the rise in global oil prices – which recently cross $112 a barrel – there is a big overhang of inflation in the system.

A depreciation of the US dollar, stronger crude prices and crop failures in some of the leading wheat and rice producing nations have collectively put commodity prices on the upswing both in food and non-food items.

While deeper factors at work, the bad boys of the global financial markets, the hedge funds are also being blamed for the current crisis. Hedge funds are aggressive, privately run investment agencies that serenade and dump assets with speed and vigour, pushing up the prices of assets and moving quickly to where they see easy – or hefty profits.

Of late, hedge funds have been courting commodities, sensing the demand-supply gap that gives them a chance to make big bucks.

In some commodities such as minerals, industry consolidation has helped manufacturers drive up prices. In iron ore, the control of the vital commodity used in the making of steel in the hands of firms such as BHP Billiton, Rio Tinto etc is choking broadbased supply. Such firms, said to be operating in tandem with hedge funds, are trying to make up in minerals the fortunes they lost in other assets such as stocks and dollars.

Iron prices, around $170 per tonne, are three times what they were last year. This in turn has affected the price of commodities like steel.

But the shoe is really pinching in food grains. While the rise of populous Asian economies and growth worldwide are driving demand for food grains, supplies are not easily catching up. Supplies have also been affected by factors like drought.

In food grains, global buffer stocks are coming down, making speculative traders sense an opportunity to drive up market prices.

The UN Food & Agriculture Organisation (FAO) has estimated that 35 countries are currently facing a food crisis, out of which 21 are in Africa. Last year, Australia — a key grain exporter — experienced its worst drought in over a century and its wheat crop has shrunk by 60 per cent. A number of wheat and rice exporting counties have introduced measures to discourage export and in some countries exports have been banned altogether.

Last year, one quarter of the US maize crop was diverted to ethanol for a use as alternative fuel for vehicles. Since crude prices are ruling at more than $100 per barrel, the conversion of maize into ethanol is effective and turns out to be cheaper, experts feel. But that has an indirect impact on food prices worldwide.

According to estimates of the International Grain Council last month, the production of wheat is estimated to be 604 million tonnes for 2007-08 as against the consumption of 612 million tonnes, creating a critical shortage of 8 million tonnes.

According to a Consumer Affairs Ministry official, “even though the present estimates of world production is at 642 million tonnes, the forecast may undergo change depending on the climate condition in major wheat producing countries, particularly Australia, which has seen severe droughts in the last two years.”

In fact, wheat production is continuously declining since 2004-05, when it peaked at 628 million tonnes. It declined to 620 million tonnes in 2005-06 and 593 million tonnes 2006-07. As a result the stock level is also coming down from 141 million tonnes in 2005-05 to an estimated 112 million tones in 2007-08.

Given the price trend, on the Chicago Board of Trade (CBOT), the futures prices of wheat have also risen substantially since January 2007. Wheat price for the month of September has gone up to $ 377 per tonne as against the May price of $ 182.61 per tonne.

In India, according to the second advance estimate for Rabi 2008-09, the production of wheat is likely to be 74.81 million tonnes. As on April 1, the buffer stock with the government was 5.24 million tonnes and procurement is expected at 14.5 million tonnes. However, the offtake in the new fiscal year is estimated at around 14.4 million tonnes at 12 lakh tonnes per month. This would leave the estimated buffer at the end of this fiscal at around 5.34 million tonnes, which is only marginally above the buffer norms of 4 million tonnes.

The global production of rice is estimated at 420.6 million tonnes as against the consumption of 423.7 million tonnes. The buffer stocks are estimated at 72 million tonnes, which is the lowest in the last 20 years. Of these 72 million tonnes, China accounts for 36 million tonnes, but that country is not an exporter. As a result, the global exportable surpluses are estimated to be the lowest in recent years. In fact, global grain stocks are at their lowest in the last 30 years. The government has banned the export of non-Basmati rice and raised the minimum export price of Basmati rice to $1,200 per tonne in an effort to curb overseas sales.

Even the global availability of rice is expected to remain tight in view of restrictions on exports placed by many countries, said a senior official in the Consumer Affairs Ministry. “Vietnam is reportedly not offering any rice to the global market at present. It has announced a cut in rice export by 22 per cent, limiting the same to 3.5 million tonnes as against 4.5 million tonnes. Egypt has banned rice exports from April to October 2008. There are reports of defaults in contracts by rice exporters in Thailand, as they are facing difficulty in procuring rice from the domestic market.”

Edible oil, which like rice and wheat is a politically sensitive commodity, has its own story. The estimated total demand for edible oils in 2007-08 (November-October) in India was 131 lakh tonnes. The projected target of 82 lakh tonnes of domestic production is unlikely to be met due to the failure of the mustard crop in certain areas. “It is, therefore, necessary to import about 50 to 60 lakh tonnes of oil this year to ensure availability of and stabilise prices,” said a government official.

Since India is a major buyer of edible oils, the shortage in India directly affects global prices. Out of total import of 6 million tonnes of edible oils, India imports around 2.5 to 3 million tonnes of palm oil from South East Asia — particularly Malaysia — and another 2.5 million tonnes of soya oil from Latin America.

Government sources confirmed that import of edible oil would be canalised through four state-owned agencies – MMTC, STC, Nafed and PEC. “These agencies have been asked to import 100,000 tonnes of edible oil per month for 2008-09 which would be distributed through government channels at subsidised rates in retail packs,” a senior government official said.

The Centre recently took a policy decision to allocate Rs 4,882 crore for the National Food Security Mission (NFSM). Its primary objective is to raise the production of rice, wheat and pulses during the 11th Five-Year Plan period (2007-12) and ensure food security in the country.

Assuming a requirement of 175 kg of cereals and 11 kg of pulses per capita per annum, India needs 265 million tonnes of cereals production and 17 million tons of pulses production by the end of 2050. Achieving this level of production is not a big task as India currently produces only around 210 million tons of food grains.