China's grain reserves are the world's highest, yet the situation is as precarious as a pile of eggs

The price of corn has fallen. In 2015, the listed purchase price for the state temporary corn reserve (national standard third-class quality standard, the same below) was 1 yuan/jin.

Last year's price was above 1.11 yuan per jin, with slight differences among regions: 1.13 yuan/jin in Inner Mongolia and Liaoning, 1.12 yuan/jin in Jilin, and 1.11 yuan/jin in Heilongjiang.

By this calculation, the price of corn has fallen by about 10%. Why did the authorities substantially lower the corn purchase price?

The reserves are simply too high, and there is nowhere to put them. There is also another important reason: if the corn price does not fall, corn deep-processing enterprises will no longer be able to keep going and will have no choice but to close down.

Grain reserves rank first in the world

First, the first reason: China's grain reserves rank first in the world, sitting far above the rest, with other countries unable to catch up.

In the 2015/16 marketing year, China's ending stocks of corn are projected at 90.61 million tonnes. Since the 2011/12 marketing year, China's corn stocks have increased year by year, and in some years the annual increase in corn stocks was nearly 10 million tonnes.

Look next at wheat. In the 2015/16 marketing year, ending stocks are projected at 89.57 million tonnes, also a substantial increase overall.

For rice, ending stocks in the 2015/16 marketing year are projected at 45.6 million tonnes, a slight decline, but still remaining high.

China's corn, wheat and rice stocks together amount to about 230 million tonnes, the highest in the world.

There is another country in the world that also likes to store grain, India, but compared with China it is far behind. Take wheat: India's ending stocks in the 2015/16 marketing year were only 11.9 million tonnes, while China's were 89.57 million tonnes, far ahead.

Is it necessary for China to maintain such large grain reserves?

In more than 30 years of reform and opening up, apart from border conflicts, the country has not fought any major wars; apart from natural disasters such as the Yangtze River floods in the 1990s, and later SARS and the Wenchuan earthquake, it has been basically peaceful and calm. A high grain reserve level of 230 million tonnes is indeed puzzling.

The real reason is that the authorities want to guarantee farmers' incomes and stabilise agricultural production. For rice and wheat, minimum purchase price procurement is used; for corn, temporary storage and purchase is used. Official purchase prices rose again and again, and farmers did indeed benefit, but the situation has also reached a point where it is hard to sustain and as precarious as a pile of eggs.

With so much grain to store, warehouse capacity is a major problem. This year's temporary corn storage and purchase added AVIC Industry Group. AVIC Industry Group does not only develop aircraft; it also has grain trading, and therefore has grain warehouses. Officialdom is now most short of warehouse capacity, and so AVIC Industry Group was able to join the temporary corn storage and purchase.

How tight is warehouse capacity? The State Administration of Grain used two "unprecedented" phrases: “At present, China's grain reserves have reached a new high. The quantity of grain stored by various grain and oil storage enterprises is unprecedented, and the quantity of state policy grain stored in open-air and simple storage facilities is also unprecedented.”

The grain processing industry can no longer hold on

In the last 10 years, official grain purchase prices have risen substantially overall. Farmers are very happy, but the grain processing industry is not. Grain prices have risen, processing costs are higher, but the market selling prices of grain-processed products follow the market and cannot rise, or their increase cannot keep up with the rise in raw grain. Large-scale losses in rice processing and large-scale losses in corn deep processing are voices that appear in society every few days.

Just look at COFCO, China's largest domestic grain processing enterprise.

In 2012, 2013, 2014 and January-March 2015, the gross profit margins of COFCO's main revenue sectors - agricultural product trade including grain, oil and sugar, processing, futures, logistics and related businesses - were 6.96%, 6.56%, 3.89% and 4.50% respectively, with the profit margin declining all the way. Without huge government subsidies, it is hard to say how much profit COFCO would still have, or whether it would have any profit at all.

COFCO's rice processing has already suffered losses for many consecutive years, and COFCO Bio-chemical (000930.SZ), which engages in corn deep processing, is expected to lose 470 million to 530 million yuan in the first three quarters of this year.

For the authorities, grain cultivation upstream is the left hand, and grain processing downstream is the right hand. Neither side can be neglected, and both hands must be strong for the body to feel comfortable.

Agricultural products are an ecosystem. If the processing industry does not make money and suffers large losses, it cannot drive the development of the upstream cultivation industry, and in the end the only one left carrying the burden is the authorities. A “lone ruler” cannot play the ecosystem game, and in the end everyone is bound to fail.

The recently issued “Several Opinions of the Central Committee of the Communist Party of China and the State Council on Advancing the Reform of the Price Mechanism” proposed making coordinated use of both the international and domestic markets, focusing on giving play to the role of the market in price formation, and letting agricultural product prices be mainly determined by the market.

The market mechanism is the foundation for the long-term sustained virtuous cycle of the agricultural product ecosystem. Now that corn prices have fallen sharply, some analyses say farmers have lost hundreds of billions. That is very regrettable, but then again, agricultural products must also follow the market economy, and nothing is guaranteed to make a profit without loss. If China's agricultural product prices continue to diverge from the market and are substantially higher than international market prices, even China, with its strong financial resources, cannot bear it.