Falling Chinese Agricultural Prices May Weigh on Global Prices

Reference News Network reported on September 21 that Japanese media said that measured by The Economist's Big Mac index, the value of China's renminbi still appears to be undervalued. Yet the prices of the ingredients used to make this hamburger present a completely different picture, namely high farm-gate prices for Chinese agricultural products.

According to a September 15 report on the website of Japan Economic Review, as China's efforts to support agriculture run into obstacles, global markets may see greater downward pressure on agricultural prices.

The report said that in July the price of a Big Mac in China, converted into US dollars, was 42% cheaper than the price in the United States. The wholesale price of Chinese beef is twice that of the international market. The farm-gate prices of Chinese wheat, corn, rice and hogs are also 75% to 90% higher than in other major producing countries.

After years of failed efforts to fend off the deflation that has harmed global agricultural prices, China's agricultural market has been unstable. The recent 4% depreciation of the renminbi narrowed this huge gap, but Chinese agricultural products still face strong downward pressure to force that gap to disappear. Prices of some agricultural products have already fallen sharply, while officials are trying to push up the prices of others.

Artificially Stimulated Prices

The report said that the seeds of the crisis were sown in 2009, when China launched massive bank-lending stimulus to cushion the impact of the global financial crisis on its domestic economy. Soaring wages drew migrant workers out of the countryside.

As interest in farming faded, “hollowed-out villages” that had lost their prime-age labor became commonplace. Money sent home by migrant workers injected unprecedented amounts of capital into rural areas. The prices of agricultural raw materials, the cost of hired labor and land rents all rose.

This stimulus money flowed into agricultural markets. In 2010, as investors used cash earned from real estate deals and equity purchases to bet on rising agricultural prices, the prices of corn, garlic, ginger and chili peppers saw strange spikes. The government cracked down hard on speculators, but also tolerated inflation by raising agricultural support prices every year. The surge in meat prices in 2011, and the rise in agricultural prices, were accepted as a reality.

Let the Market Play Its Role

The report said that the government initially feared that, as the agricultural cost structure inflated, falling prices would prompt farmers to abandon their land. Now, the government is letting it be.

Officials explain that they are following the Communist Party's new creed that the market should play a “decisive role” in resource allocation, but mounting pressure from reserves and a surge in imports is likely the real driving force.

In 2014, floor prices for cotton and soybeans were abolished, and this year price support for rapeseed was also abolished. According to Ministry of Agriculture data, cotton and rapeseed prices fell 30% from last year, and soybean prices fell 13%. Due to weak demand and the sharp drop in global prices, other agricultural prices are also falling.

The report said that China is still trying to support wheat and rice prices because they are considered key to food security. The focus is now on corn, China's largest crop. Most observers expect the government to lower the floor price for the upcoming harvest season to avoid increasing already huge stockpiles. However, cutting the price would also reduce the incomes of millions of farmers and cause a huge depreciation of the government's corn reserves.

The report said that while the government deliberates, expectations of falling market prices have already formed. Early corn harvested in August sold for less than last year, and some grain depots sold last year's corn at a discount to make storage space for the new corn. China's corn futures contract for January delivery traded at about 15% below the spot price, signaling expectations of falling prices.

The Danger of Spillover

The report said that there is a danger that turmoil in China's agricultural market will have an impact, thereby putting greater downward pressure on international prices. So far, China has been easing deflationary pressure by maintaining huge agricultural reserves and allowing record imports of soybeans, grains and meat. But as its determination to avoid falling agricultural prices reaches a tipping point, imports may shrink, and officials may resort to dumping reserve stockpiles at any cost.

This has already happened with cotton. China's cotton imports in the first half of 2015 fell 30% year on year. Import quotas were cut to negligible levels in order to absorb swollen reserves. Similarly, the expected fall in corn prices is expected to block imports of sorghum, barley, brewing grains and other substitutes for Chinese corn used by feed processors.

Signs of danger are also appearing in other agricultural products. After Chinese companies built up excessive inventories in 2014, import prices for milk powder plunged this year. However, as small family farms are replaced by large factory-style dairy farms, imports of hay, breeding cattle and bull semen have risen.

The report said that driven by low international market prices, China has been importing soybeans at a record pace. But the corresponding decline in the prices of final products made from soybeans in the Chinese market may slow the increase in imports.

There are a few bright spots for global producers, especially in meat. China's demand for meat appears encouraging. High beef prices, rampant smuggling and idle slaughterhouses prompted the government to relax controls on beef imports. Officials have reached agreements with several countries to import live cattle and beef.

Although demand is lukewarm, pork imports are expected to grow because of rising prices. China's hog producers reduced their herds by tens of millions of head over the past year, making supply tight enough this summer to push prices up. A new industrial park dedicated to handling imported pork recently opened in Henan to serve Shuanghui Group. Shuanghui is now the owner of US meat producer Smithfield Foods.