Grain Stranded in Government Reserves

An economist with China's Development Research Center who spoke at a China Grain and Food Security Summit in Beijing on November 13 observed a link between China's huge grain reserves and excessive imports. The economist, Li Wei, reported that China now has nearly 560 million metric tons (mmt) of grain inventories, which he says is a record-high amount. He thinks less than half of this reserve level--200-250 mmt--would be adequate for China's needs.

Li estimates that China is also importing excess volumes of grain, prompted by China's high grain prices. Noting that China imported 130 mmt of grain during 2015, Li calculates the actual deficit between China's consumption and production of grain is just 30 mmt. Thus, Li concludes that China imported 100 mmt of grain more than it needed last year. The main prescription he offered was the "supply side structural adjustment" policy that will switch area from corn to other crops.

Chinese authorities put a priority on disposing of their record-high grain reserves this year, but little of the grain offered for sale at auctions actually sold. An Economic Observer journalist visited grain exchanges in three provinces to explore why the de-stocking of reserves has been so slow.

Glum officials at the three exchanges told the reporter that the sales volume had been disappointing this year. The exchange in Heilongjiang Province sold a total of 2.21 mmt of grain by September 13, but that was only 10% of the volume they planned to sell. From 2012 to 2015, Heilongjiang had auctioned an average of 6 mmt annually. In Hubei, the exchange sold 2.28 mmt--more grain than was produced in the province last year--but an official described the auction results as disappointing, especially for rice. In Hunan, a leading rice-producing province, tens of millions of tons of grain have been offered, but trade has been negligible. 

An official at the Hunan grain exchange says the peak period for grain auctions was during January 6-8 last year, when over 200,000 metric tons of rice was sold. The official explained that the reason for that auction's popularity was a policy that offered buyers 84 tons of import quota for every 100 tons of rice they bought at the reserve auction. That policy has now been abandoned, the official said. Since then, sales have been slow.

Nationwide, a total of 37,568,750 metric tons of wheat from reserves was offered on exchanges from June through September, but only 108,000 metric tons was sold. Last year at the same time, 1.6% of wheat offered was successfully auctioned.

Officials told Economic Observer that the main obstacle to selling off grain reserves is a cost-plus (顺价销售) policy for pricing that was put in place during 1998 to minimize the government's subsidies for the grain reserve system. The pricing policy requires that prices for sales of grain reserves be set to recover the purchase price of the grain plus interest and storage costs. When market prices fall, the price that recovers the cost of procuring the grain is too high to attract buyers and the grain goes unsold. Hence, during periods of falling prices grain goes into reserves (as the government buys up grain to slow the decline in price) but old grain doesn't come out because no one is interested in paying the high price.

Experts told the Economic Observer reporter there are three structural contradictions that prevent destocking of grain reserves: 

First, the reporter was told that new grain sells faster than old grain. An official from the Hubei grain exchange said that nearly all of the 650,000 metric tons of rice sold this year was produced in 2015. Only 23,400 metric tons from 2014 sold, and "not a single grain" of 2013 rice sold.  National wheat auctions on November 8 offered wheat produced in each year from 2009 to 2015 (except 2011 when the government did not buy wheat). Forty percent of the newest wheat from 2015 sold, but only 5.5% of 2014 wheat sold. None of the 10,000 tons of wheat produced in 2009 and 2010 on offer was sold.

Second, high quality grain sells but common grain doesn't. In Hubei, an official explained that rice from several districts known for high quality rice sold at auctions. Interest in Hunan's rice may have been hurt by widespread cadmium contamination in that province. 

Third, insiders told Economic Observer that sale of central reserves is hamstrung by bureaucratic rules. In contrast, local officials have greater discretion and flexibility on rules governing reserve management which helps them sell off local reserves. A Hubei official told Economic Observer that the provincial government bought up a portion of the 2015 wheat crop that was damaged by wet weather. The province auctioned 150,000 metric tons of this wheat between December and March at a price of about 1.1 yuan per 500g that "kept losses to a minimum." The official told the Economic Observer reporter that, "If this wheat was sold according to the plan of central reserves the losses would have been much greater."

The grain exchange officials gave Economic Observer recommendations for speeding up the de-stocking of grain reserves. They endorsed continuation of the minimum purchase price policy for wheat and rice, but suggested reducing the minimum price when there is downward pressure on market prices. They also recommended eliminating the cost-plus pricing for sales of grain reserves, allowing the sale price for auctions to align with market prices. (They did not give any suggestions on who should cover the losses on grain sold below cost.)

The officials also recommended allowing commercial banks to engage in lending for the purchase of grain for reserves. The officials said that another provincial program to purchase of off-quality wheat this year in Hubei and other provinces was slowed by the lack of financing. The officials say that commercial banks are eager to enter the grain-reserve lending business because risk is low and the interest rate is good, but the Agricultural Development Bank of China is the only lender now authorized for such business. The officials say grain-purchasing would be enlivened by allowing commercial lenders to participate.

Several officials told Economic Observer that more responsibility for managing central grain reserves should be devolved to local authorities who have more flexibility. They suggested that the central government send money to the local government and let them handle the business of buying and selling grain.

Finally, the officials said farmers must be encouraged to plant quality grain that is in line with market demand. In their view, the area planted in high-quality grain has atrophied in recent years because the minimum price purchase policy does not offer incentives to produce such grain. The mismatch between the quality of grain produced and market demand contributed to the "high inventory contradiction."