A healthy grain market cannot function without policy reform

This year's domestic grain harvest was bumper, but farmers are hardly pleased, because the sharp drop in grain prices could cause their incomes to fall steeply. Since early autumn, prices of corn and wheat in major grain-producing areas have all declined to varying degrees. The drop in corn prices has been pronounced, with farm-gate prices falling by an average of more than 20% and the largest decline reaching 30% compared with last year, while wheat also went through a cliff-edge plunge before National Day. At present, rice procurement prices are broadly stable, but some areas have also seen small declines compared with previous years. The fall in grain prices has dealt a considerable blow to the grain trade, and according to media reports, markets in some areas have fallen into a severe atmosphere of panic.

Some market analysts say that a simultaneous slump across all three major staple grains is rare in previous years, and both low international grain prices and accumulated domestic stockpiles are regarded as the main causes of this round of price declines. The reappearance this year of the phenomena of “output rising without income rising” and “cheap grain hurting farmers” in the grain market will bring impacts in many areas and deserves particular attention.

First, the sharp fall in grain prices directly affects the incomes of hundreds of millions of farmers; some estimates suggest that this year's price slump could lead to a negative income growth in the hundreds of billions, which has a direct bearing on China's goal of achieving moderate prosperity in all respects. Second, the reduction in farmers' incomes caused by the price slump will not only affect the consumer market. Third, the price slump will dampen farmers' enthusiasm for growing grain and may trigger grain price fluctuations the following year.

In this situation, how China's grain price policy should act requires caution above all. In the view of our research team, although this year's grain price slump hit the market partly because of “accidental factors” such as low international grain prices and accumulated domestic stockpiles, the flaws in the domestic grain procurement and subsidy policy system may be a systemic cause that cannot be overlooked.

Since 2004, China has fully liberalized the grain procurement market and procurement prices, with grain prices formed by the market. After grain prices were liberalized, in order to protect farmers' interests and their enthusiasm for growing grain, from 2004 and 2006 the state respectively implemented a minimum purchase price policy (the “price support”) in major producing areas for two key grain varieties, rice and wheat. Each year the state comprehensively considers factors such as grain costs and returns, supply and demand, market prices and macro-control, determines the minimum purchase price levels for each variety of wheat and rice, and publishes them to society before the crops are sown, guiding farmers' planting and promoting grain production. After the new grain comes to market, farmers sell their grain at market prices; when market prices in major producing areas fall considerably below the minimum purchase price, state-designated enterprises (Sinograin) enter the market to purchase at the minimum purchase price, guiding market grain prices to recover reasonably. Since 2008, the state has raised the minimum purchase prices for grain for six consecutive years; in 2013 the minimum purchase prices for rice and wheat were raised to 1.39 yuan and 1.12 yuan per jin respectively, increases of 92% and 57% over six years.

In actual implementation, although the price support procurement policy has protected farmers' interests, it requires the payment of subsidies (indirectly subsidized by the government to state-owned purchasing and marketing enterprises); the direct consequence of this disguised price subsidy policy is that it raises the market price of grain sales and distorts market-determined pricing. Under this price distortion, first, subsidy costs are high, with large amounts of state fiscal subsidies flowing into purchasing enterprises and the reserve segment, so farmers benefit little directly; second, it raises the processing costs of the midstream and downstream grain industry, making it impossible to optimize resource allocation through market-based means, dragging down the entire midstream and downstream industry, directly blocking the smooth flow of the whole agricultural industry chain and affecting the healthy operation of the agricultural industry.

For example, in Heilongjiang Province, chaotic grain subsidies caused more than a thousand unsubsidized grain enterprises to halt production this year, with large quantities of grain continuously flowing from farmers into state reserve warehouses at the high subsidized prices paid by state-owned enterprises, while processing enterprises cannot obtain raw grain at reasonable prices; Sinograin's warehouses are overflowing, and the grain stored there cannot enter production and consumption links for a long time. Of the 88 large-scale soybean processing enterprises in Heilongjiang, more than 90% have halted production. In Jilin Province, a major corn-producing province, the leading private corn processing enterprise Dacheng Biochemical was recently forced to halt production and had to be taken over by a local state-owned enterprise with a government background; the price subsidy policy is also among the reasons for this.

The United States and the European Union both provide huge subsidies to agriculture and farmers, but their subsidies are closely tied to the market, and their subsidy policies are systematic. The EU's subsidy policy is divided into two types: price support and direct subsidies. Price support means that a unified agricultural product price is to be used within the EU, and market prices may be set freely within the range defined by the common price; once they move outside this range, the Community intervenes to bring them back within the set range. The price mechanism of the Common Agricultural Policy consists of three parts: the target price, the intervention price and the threshold price. Direct agricultural subsidies provide direct monetary subsidies according to the production volume per unit in different regions.

The United States has used agricultural product subsidy tools since 1933, and over more than 80 years its agricultural subsidy policy has continuously evolved, on the one hand circumventing WTO rules and on the other balancing domestic and international price relationships to ensure that US agricultural products maximize their price advantage in international trade. Specifically, US agricultural subsidy policy is mainly divided into five categories: loan deficiency payments, direct income subsidies, counter-cyclical subsidies, resource conservation subsidies and agricultural product trade subsidies. In 2005, US agricultural subsidies amounted to 25 billion USD, an increase of 68% over 2001.

If subsidy amounts are compared, the money China spends on grain subsidies and procurement and storage is not small. Some statistics say that central government fiscal subsidies to agriculture now exceed 1 trillion yuan each year (including grain price subsidies), while the cost of grain procurement and storage also reaches several hundred billion yuan a year. Such high fiscal input, however, cannot bring a significant increase in farmers' income from agriculture, nor a smoothly operating agricultural product market. Why is this so? How should reform proceed? These questions cannot be avoided.

Overall, for the reduction in farmers' incomes caused by falling grain prices, it is no longer possible to simply adjust subsidies as in the past; instead, systematic reform centered on the price mechanism should be carried out. In our view, the core is to give play to the role of the market mechanism, adjust the targets of subsidies, increase direct subsidies to farmers and raise farmers' incomes. In response to the severe distortion of grain market prices brought about by China's price support procurement, reform should be promoted to decouple the grain price formation mechanism from government subsidies, and, on the premise of protecting farmers' interests, the minimum purchase price, temporary procurement and storage, and agricultural subsidy policies should be gradually shifted toward a target price system for agricultural products.

The impact of the grain price slump on farmers' incomes and consumption is only one manifestation of the problems with China's grain price policy. Around the grain price formation mechanism, China needs to advance reform cautiously, systematically but resolutely, using fiscal subsidies as a supporting means, to ultimately achieve the healthy operation and normal development of the grain market.

(The author is a senior researcher at Anbound Consulting)