Agflation to be with us for some time

 

A couple of weeks ago we warned here about the threat of “agflation” – a clumsy word for a critical issue. The price of rice had spiked, sparking riots on the streets of Cairo and the imposition of emergency measures in the Philippines, where those who felt tempted to hoard sacks of rice were threatened with life imprisonment.

I didn’t realise at the time that this was set to rocket to the top of the global agenda. Sadly it has – along with a dawning in most corners of the world that this is a problem that falls all too heavily on the world’s poor, rather than the rich. But that doesn’t mean it is a problem wealthier nations can ignore.

Economists at Lehman Brothers use a simple method to monitor the stress levels surrounding an issue such as agflation – they simply count up the number of trade or fiscal measures taken by governments to combat the problem.

And this week Lehman’s Paul Sheard noted that his tally of measures taken specifically by Asian governments in recent months to counter rising commodity prices generally had passed 50 for the first time.

Clearly, the impact of food price inflation is much more likely to be felt in weaker or more populous emerging economies than those in developed areas of the world or where the number of mouths to feed
is simply fewer.
 
As Sheard notes: “First, in emerging economies, food occupies a much bigger share of the consumer price basket. Rising food prices can, quite literally, kill people and cause riots in the streets. No wonder governments are prone to pull all kinds of fiscal and trade policy levers to try to keep a lid on food price inflation, even if many of
these ‘starve-thy-neighbour’ policies are counter-productive.
 
“Second, monetary policy frameworks in developed economies – revolving around flexible exchange rates and implicit or explicit inflation-targeting by central banks – are more amenable to absorbing shocks to the economy, including food price shocks, than are many of those in emerging economies, where the monetary authorities often target the exchange rate and have limited autonomy in setting domestic interest rates.”

This can be taken further. One can argue that in some emerging economies, the operation of monetary policy can actually add to the problem. 

Take China, which continues to rack up foreign exchange reserves at a blistering pace – with another $154 billion (Dh566bn) added in the first quarter of 2008 alone. Any economist will tell you that this is clear evidence that China’s exchange rate is too low versus the rest of the world. The natural result of that is the underlying economy tends to move towards a “real” exchange rate through the growth of inflation locally. As Sheard notes, the price shocks China has seen are a possible expression of that.

Western central banks remain confident that they can avoid agflation feeding through into core inflation by continuing their quasi-religious inflation-targeting monetary policies. The evidence to date suggests they have been successful – although observers would say “so far”.

At the end of the day, the factor protecting developed nations from agflation relative to their less developed brethren comes back to wealth.

Abah Ofon, a commodities strategist at Standard Chartered Bank, has been analysing data from the US Department of Agriculture and noted in a recent research brief that when it comes to Southeast Asia and Africa they:

1. Spend a relatively high proportion of their expenditure on food (72 per cent in Nigeria, 62 per cent in Sierra Leone, 56 per cent in Bangladesh and 50 per cent in Indonesia and Egypt). This compares to 10 per cent in the US and 16 per cent in the UK.

2. Have a relatively elastic demand for food (including beverages) versus more developed countries, although food demand is less price elastic compared to other items like clothing, medical care and education.

Ofon adds: “This greater price sensitivity for food implies that adequate food supply is a priority for countries like Egypt, Vietnam and India. Moreover, the need to avert social tensions from high food prices has made the need for food sufficiency even more urgent. The concern is that net food importers in similarly vulnerable regions may be unlikely to meet their own import requirements as a result of a curb on exportable supplies.”

None of which is very comforting. This “agflation” issue is clearly going to be with us for some time to come.

Paul Murphy is associate editor of the Financial Times.
 
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