Saturday, July 18, 2015

China Signals Corn Price Liberalization?

Some Chinese market analysts see a signal of imminent corn price liberalization in an obscure document posted on a Chinese Ministry of Agriculture web site last week.

The text consisted of two paragraphs on agricultural commodity price liberalization buried in a Ministry of Agriculture response to a policy recommendation offered by a National Peoples Congress member from Zhejiang Province. The main focus of the document is on cropland-consolidation policies, but two cryptic paragraphs offer an unusually incisive evaluation of Chinese agricultural price-intervention policies and sets forth a general blueprint for reduced interference that will allow market forces to have the "decisive role" demanded by top Chinese leaders. Rice and wheat will continue to have minimum prices, but prices of other major commodities--corn, soybeans, rapeseed, and cotton--will be determined by market forces.

The document briefly recounts the 30-year history of gradually liberalizing farm prices. It notes that the government no longer directly sets any farm prices after it stopped setting tobacco prices at the end of 2014. After withdrawing from direct price-setting of grains in 2004, the government installed a system where prices are basically set by market supply and demand but the government intervenes to stabilize prices when needed. A minimum procurement price system was set up for rice (in 2004) and wheat (in 2006) that was intended to set a floor under market prices. "Temporary reserve" policies to support prices were set up for corn, soybeans, rapeseed, and cotton in 2008. The MOA document says that raising the support prices each year contributed to food security by boosting grain production to a new level, but the document acknowledges that Chinese prices rose above global prices when there was a "major shock" in international grain prices.

According to the MOA document, "The next step [in the liberalization process] is for the National Development and Reform Commission to adopt differing policies for different commodities."
  • For food grains--rice and wheat--the minimum purchase price policy will continue, but the policy will no longer build in expectations of ever-rising prices, and the role of minimum prices as a tool for boosting income will be weakened. For wheat and rice, a combination of price intervention and subsidy payments will be used. 
  • For corn, soybeans, rapeseed, and cotton--"commodities that have elastic demand, longer industry chains, and are more closely attuned to international markets"--there will be more attention to the "decisive role of the market" in price formation. According to the document, sustained, healthy industry development will be promoted as market price signals guide production and adjust supply and demand. 
The document appears to be a general blueprint with no specifics or timetables. However, several articles appearing in China elaborate on forces shaping the presumed liberalization and interpret the document as a signal that the price support program for corn will be abandoned in 2015.

Global Business News (第一财经) described the MOA document as an "Historic transition in grain price intervention" and emphasized the benefits for hard-pressed downstream users of corn and relief for the dangerously-stressed grain reserve system. The article elaborated on the problems faced by corn users as a result of the huge gap between domestic and imported corn prices, noting that domestic prices of 2400 yuan per metric ton at Guangzhou are 800-900 yuan higher than the cost of imported corn.

The Global Business News journalist emphasized that downstream industries can no longer bear the high costs of Chinese corn. The journalist reported that Wen's Group, the largest pork and poultry-producing company in China, had "no choice but to import sorghum" with domestic corn prices so high and "very little" access to corn import quotas. High corn prices are passed on in the form of higher pork prices. The surge in Chinese pork prices in the last two months puts the meat's price at about double that in foreign countries.

The journalist says marketization of prices is needed because "Chinese people not only eat more expensive grain than people in developed countries, but their pork is more expensive too." He adds that Chinese consumers are threatened by "zombie meat" because high prices lead to rampant meat smuggling. He also cites COFCO's fuel ethanol division: facing rising corn costs and stagnant/declining fuel prices, it reportedly lost 300-to-350-million yuan in the first half of 2015 and turned to use of cassava "from domestic and international sources" to manufacture its ethanol.

Global Business News says liberalization of prices will also benefit Sinograin--the government's reserve-holding company--which has run out of space to store all the grain it has purchased to support prices. Sinograin has had to hire local granaries to store the grains which cannot be properly supervised. One of the contractors, a rice-milling company in Anhui Province, was caught issuing IOUs for grain purchased from farmers. The company used grain purchased for reserves on Sinograin's behalf for its own processing and trading activities and ended up with no funds to pay farmers. Sinograin quickly investigated and rectified the situation, but the article warns that additional incidents could occur and it's Sinograin is in effect "sitting on a volcano."

Futures Daily emphasized that the current policies need to change because they put pressure on domestic industries, result in high government costs, distort production structure and marketing and result in "all sorts of strange phenomena across the board" in agricultural markets. Futures Daily reports that many market analysts interpret the "spirit" of MOA document as a signal that the temporary reserve policy for corn will be removed.

In a daily newsletter, JCI (one of China's premier ag market analysis companies) makes a similar judgment that the MOA document means that corn prices will be fully liberalized after the 2015 harvest. They anticipate that temporary reserve purchases and subsidies for industrial processors will both be abandoned this year, and the domestic corn price will align with the international price.

The rumored liberalization is consistent with what officials are calling the "deep reform" of agriculture this year. Most of the attention is on restructuring agriculture by consolidation of land, improving financial and technical services for commercial-scale farms. The initiative reflects a conclusion that Chinese agriculture must become more competitive by raising productivity and hence reducing unit costs. More cost-competitive Chinese farms, in theory, could survive at prices aligned with those in the global market. Authorities probably wanted to move in this direction gradually over 5 years or so, but the mounting pressures on processors, surging meat prices, rampant smuggling, imported sorghum and barley rushing in, soaring budgetary/financial pressure and a creaking grain reserve system on the brink of collapse may have forced officials into action sooner than planned.

The rumored corn price liberalization is welcomed, and the MOA document reflects more lucid economic thinking than is typical of this relatively conservative corner of the Chinese bureaucracy. However, a snap liberalization this year would be adventurous and could have huge consequences. The abandonment of temporary reserve purchasing for cotton and soybeans resulted in plummeting prices for both commodities over the past year. Target price subsidies were not sufficient to prevent cotton and soybean production from falling this year, but that's partly because the high price of corn continued to suck resources away from cotton and soybeans. A liberalization of corn prices would alleviate this imbalance. However, there is no subsidy program to replace the temporary reserve for corn. And corn is China's largest crop--its output and number of producers are more than ten times those of cotton, soybeans, or rapeseed. This year's abandonment of rapeseed temporary reserve purchasing left it up to provincial authorities to figure out how to subsidize producers.

The rumored broad-brush liberalization does not address how the huge existing stocks would be disposed of. Progress has been slow in drawing down cotton stocks and corn reserve auctions have not seen much success this summer. If corn prices are allowed to plummet, there would be no hope of recovering the acquisition and holding costs of its corn reserve which is likely far above 100 million metric tons. Taking a loss and selling the corn into the market at a discount would push market prices for corn down even faster.

It's too soon to evaluate the impact of this rumor, but there will surely be more to come over the next four months.

2 comments: said...

Thank you yet again DimSums. Not only did your report come in way ahead of the wire outlets, but you provided the background and context necessary to make sense of the government's announcements. I hope you will notify this reader if there is anything the audience can do to support your ongoing excellent reports. said...

Thank you yet again DimSums. Not only did your report come in way ahead of the wire outlets, but you provided the background and context necessary to make sense of the government's announcements. I hope you will notify this reader if there is anything the audience can do to support your ongoing excellent reports.