70883 South Asia Economic Focus A Review of Economic Developments in South Asian Countries Food Inflation June 2011 South Asia Region THE WORLD BANK Washington, D.C. South Asia Economic Focus A Review of Economic Developments in South Asian Countries Food Inflation June 2011 South Asia Region THE WORLD BANK Washington, D.C. Table of Contents A Note on Fiscal Years and Financial Reporting by South Asian Countries . . . . . . . . . . . . . . . . . . . . . . . . . vi Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix CHAPTER 1: Why Food Prices Matter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 CHAPTER 2: Determinants of Food Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1 . The Trajectory of Inflation in Recent Years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 2 . Short-term Pressures: Global Food Prices, Aggregate Demand, and Domestic Supply Shocks . . . . . . .7 3 . Long-term Effects: Productivity Slow-down and Structural Demand Shifts . . . . . . . . . . . . . . . . . . . . . 10 CHAPTER 3: The Impact of Agricultural Policies on Food Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 1 . Historical Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 2 . Government Involvement in Agricultural Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 3 . Policies for Agricultural Inputs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 CHAPTER 4: The Human Impact of Food Price Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 1 . Impact on Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 2 . Mitigating the Impact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 3 . Bank Support to Safety Net Programs in South Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 CHAPTER 5: Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Country Pages: Eight countries – Eight Graphic Economic Narratives . . . . . . . . . . . . . . . . . . . . . . . . 41 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries iii iv South Asia Economic Focus – A Review of Economic Developments in South Asian Countries ANNEx 1: Developments in Global Commodity Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 ANNEx 2: Speculation, Financialization of Commodities, and the “New� Money . . . . . . . . . . . . . . . .63 ANNEx 3: South Asian Food Demand and Supply Balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 ANNEx 4: Impact on Poverty of the Increase in Food Prices – Methodology and More Results . . . . 73 ANNEx 5: Selected Food Crisis Response Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 ANNEx 6: Commodity Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Boxes 2.1 Inflation In China – What is Different? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 3.1 The Opium Economy in the Context of Afghanistan’s Agriculture and Food Security . . . . . . . . . . 20 3.2 Agricultural Produce Markets Act (APMA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 3.3 From the Arabian Nights – A Cautionary Tale from History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 3.4 Gujarat’s Agricultural Success . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 4.1 Recommendations for Safety-Net Policy Responses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Figures 1.1 South Asia: Food Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 2.1 WPI Inflation in Major Emerging Market Economies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 2.2 South Asia: Consumer Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.3 India: Food Articles’ Contribution to WPI Food Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 2.4 South Asia: Contribution to CPI Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 2.5 Global Food Price Index and Its Components . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 2.6 Agriculture and Energy Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.7 International Commodity Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.8 The Price Spikes of 2007/08 and 2010/11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 2.9 Imports of Rice, Wheat and Edible Oils . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.10 Domestic and International Prices of Rice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.11 Domestic and International Prices of Wheat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.12 Subsidization of Diesel Retail Fuel Prices Remains Particularly High in Bangladesh and Sri Lanka . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.13 India: Household Inflation Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.14 General Government Balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.15 Total Government Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.16 India: Monetary Conditions Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.17 Industrial Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.18 Production Growth of Major Staple Food Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 2.19 India: Growth Rates in Consumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 2.20 India: Terms of Trade between Agriculture, Industry, and Services . . . . . . . . . . . . . . . . . . . . . . . . 16 2.21 Annual Per Capita Consumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 2.22 India: Household Survey Data on Consumption of Food and Non-Food . . . . . . . . . . . . . . . . . . . . . 17 2.23 India: Shares of Food Types in Food Baskets, 1987/88–2007/08 . . . . . . . . . . . . . . . . . . . . . . . . . . 17 3.1 Average Food Supply: Crops . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 3.2 India: Food and Fertilizer Subsidies, 1990–2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 3.3 India: Rice and Wheat Yields in Major Producing States, 2006–2009 . . . . . . . . . . . . . . . . . . . . . . 23 3.4 India: Groundwater Use Over Net Availability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 4.1 Poverty Impacts of Recent Price Rises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Table of Contents v A1.1 Rising World Consumption, Variable Supply, and Stock Draw-Downs have Fueled Consecutive Grain Price Spikes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 A1.2 Commodity Price Index (Nominal prices) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 A1.3 Commodity Price Index (Real prices) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 A1.4 Food Price Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 A1.5 Food Price Volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 A1.6 Grain Consumption and Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 A1.7 Fertilizer vs Crude Oil Price Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 A1.8 Food vs Fertilizer Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 A1.9 Copper and Aluminium Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 A4.1 Decomposition of Net Poverty Headcount Change by Commodity . . . . . . . . . . . . . . . . . . . . . . . . 74 A4.2 Decomposition of Net Poverty Gap Change by Commodity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 Tables 4.1 Changes in Poverty Headcount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4.2 Safety Net Readiness Assessment in South Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4.3 India: Household Consumption vs . Grain Delivieries to the PDS, 2007 . . . . . . . . . . . . . . . . . . . . . 34 A1.1 World Wheat and Rice Balances (million tons) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 A2.1 Types of “Speculative Activity� . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 A2.2 Summary of Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 A3.1 Bangladesh: Production and Imports of Food Grain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 A3.2 India: Agricultural Production, 2003–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 A6.1 Overview of Commodity Risk Management Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 vi South Asia Economic Focus – A Review of Economic Developments in South Asian Countries A Note on Fiscal Years and Financial Reporting by South Asian Countries South Asian countries’ national income and product account data refer to fiscal years that cut across calendar years, except for Maldives and Sri Lanka which report according to calendar year. The fiscal years for the respective countries are: • Bangladesh and Pakistan: July 1–June 30 • Nepal: July 16–July 15 • India: April 1–March 31 • Bhutan: July 1–June 30 • Maldives and Sri Lanka: January 1–December 31 • Afghanistan: 1 April–31 March Reporting practices vary. Bangladesh, Nepal, and Pakistan report their fiscal data in the second year of the split, while India and Afghanistan report at the beginning of the fiscal year split. Picture Credits Cover, pp. ix, 11: Michael Foley, pp. vii, 29: Simone McCourtie, pp. 19, 25, 39, 83: Ulrich Bartsch, Copyright World Bank. Foreword W eLCoMe To The FIRST ISSUe oF South Asia economic Focus, a biannual series prepared under the aegis of the Chief economist’s office. This series reviews contemporary economic developments in South Asian countries, with each issue examining a single subject in depth. The analysis seeks to identify key factors underlying the issue, outline the policy challenges it poses to indi- vidual countries and the region, and offer practical solutions where possible. The publication is intended for audiences within the Bank, its partners and client countries in order to enrich fruitful discussion and policymaking. The current issue was prepared by Ulrich Bartsch and Chandana Kularatne with inputs from John Baffes, Sudeshna Banerjee, Julie Dana, Madhur Gautam, Mohinder Gulati, Maros Ivanic, Maria Mini Jos, Ashi Kathuria, Annette de Kleine, Jie Li, Luc Laviolette, Nkosinathi Mbuya, Cem Mete, Mohua Mukherjee, Claudia Nassif, Shilpa Phadke, Martin Rama, Mansoora Rashid, Cristina Savescu, Monika Sharma, hassan Zaman, TG Srinivasan and the World Bank’s country economists in the region, and with editorial support from Peter honey and Robert Reinecke. South Asia Economic Focus – A Review of Economic Developments in South Asian Countries vii Executive Summary W hILe SoUTh ASIAN CoUNTRIeS red tape also restricts food markets in some coun- weathered the Global Financial Crisis (GFC) tries from discharging their resource allocation relatively well, and have since emerged from function smoothly. their economic slowdowns, inflation has accelerated 4. Demand for food is undergoing structural shifts above comfort levels. Food prices were the biggest as incomes rise. Growth in consumption of pulses, contributor to CPI inflation, although core infla- fruits, meat, eggs, and dairy items is more than tion (calculated by excluding food and energy items) double the consumption growth in cereals. Inflation is accelerating in most countries. In fact, it overtook in these items has been higher than in cereals. Public food inflation in India by the end of 2010. intervention in agricultural marketing in India This report focuses on the impact of policies and and Pakistan has high fiscal costs and narrowly exogenous shocks on food inflation. It deals with supports cereal production, while high food infla- four elements: 1) the pass-through of global food tion and continuing high rates of food insecurity (and other commodity) prices, 2) macroeconomic are linked to an inadequate supply response in non- policies, 3) market regulation and short-term supply cereal food products. Input subsidies, on the other shocks, and 4) long-term structural shifts and the hand, contribute to the overuse of water resources, terms of trade between agriculture and other sectors high losses of electricity utilities, and deteriorating of the economy. soil conditions because of skewed application of fertilizer. While these policies therefore do not 1. Food inflation is partly caused by increases in contribute to increasing agricultural productivity, global food prices. They have risen markedly their fiscal costs divert resources away from inter- since mid-2010, which is part of a more general ventions that actually could expand production: phenomenon of rising global commodity prices. investments in agricultural research, education, Policies in the region differ in the extent to which and rural roads are the three most effective public they allow external trade of food commodi- spending items in promoting agricultural growth ties, and pass-through of international prices to and reducing poverty. consumer prices. 2. While South Asian countries have made cautious progress toward rolling back macroeconomic stim- ulus measures they had adopted in the wake of the GFC, they have some way to go to reset their macroeconomic policy stances to neutral. South Asian countries have relatively high fiscal defi- cits and public debt burdens, and fiscal policies are still more expansionary than before the GFC. Monetary policy rates are low, and have not risen as fast as inflation. Policy rates are lower than rates in other regions, but growth in monetary aggregates is broadly in line with macroeconomic stability in most countries. 3. Short-term supply shocks to agriculture are mostly weather related. While sharp, often geographically concentrated price spikes are to a large extent caused by insufficient infrastructure (roads, cold storage), South Asia Economic Focus – A Review of Economic Developments in South Asian Countries ix x South Asia Economic Focus – A Review of Economic Developments in South Asian Countries The poverty and nutritional impact of food price items in consumer baskets; fiscal consolidation would spikes on the poor is significant since they spend a be a priority; 2) foodgrain stock management needs larger fraction of their income on food than relatively to improve, in particular in India; 3) over the longer better-off individuals. Since the last food price spike term, policies aimed at increasing agricultural output in 2008, governments in South Asia have strength- and productivity would alleviate pressures on food ened safety nets, but gaps persist. The largest safety prices; these would include a focus on technology, net interventions in the region—India’s and Pakistan’s improved water management, rural infrastructure, public distribution systems for staple foods—are char- agricultural diversification, and private sector invest- acterized by high leakages and therefore costs, while ment in marketing and the agro industry; 4) govern- errors of exclusion are actually larger than the reverse; ments should exploit the efficiency gains they could that is, large numbers of the deserving poor are not achieve (in terms of protecting and improving nutri- covered. These food based safety net interventions spill tional status) through provision of more nutritious over into agricultural policies, which lower the agri- foods (e.g. foods fortified with essential vitamins and cultural supply response to rising non-cereal prices. minerals) and by increasing beneficiary knowledge The report proposes five policy options for consid- on how to maximize household resources for nutri- eration: 1) in the face of rising inflation caused by tional impact; and 5) governments should explore rising food prices, demand management policies in developments of market-based tools and assistance South Asia may need to be deployed earlier than in for managing risks, particularly those that affect the advanced countries because of the high share of food government’s budget. I Why Food Prices Matter I NTeRNATIoNAL FooD PRICeS ARe oN in international commodity prices, domestic supply the rise again for the second time in four years, and shocks, accommodative demand side policies, struc- are raising concerns about the impact on poverty, tural changes in demand patterns, and long-term agri- overall inflation, and external and fiscal balances in cultural productivity trends. The impact on poverty developing countries. higher and more volatile food is examined, as is the region’s preparedness for food prices threaten food security by diminishing the ability price shocks. of people to access food when they need it. In partic- The priorities laid out in the Bank’s Post-Crisis ular, sudden and large food price increases—by eroding Directions paper (2010) and the mandate given to the household purchasing power—complicate their efforts Bank by the G20 are to focus on food price volatility, to adjust and often result in reduced calorie intake and agriculture and food security, and agricultural produc- deteriorating nutritional content, in turn pushing more tivity. In line with these priorities, the report ends with people into poverty. some policy directions to manage the macroeconomic This report examines food and overall inflation impact of food price inflation, and the potential spill- trends in South Asia, which is experiencing relatively over into generalized inflation, to manage the social high inflation, and is home to a large number of poor. impact of the food price hikes, and to hedge against There are many more poor people who are net buyers risks associated with food price volatility. of food than there are those who benefit from higher The report is organized as follows: Section II prices of agricultural products even in the predomi- discusses the anatomy and short- and longer-run nantly rural countries of South Asia. The report exam- drivers of food and overall inflation in South Asia. ines both short-term and longer-term drivers of rising Section III discusses the impact of government poli- food prices in the region, including developments cies affecting agricultural marketing, inputs and trade FIGuRE 1.1 South Asia: Food Prices (y-o-y change in percent) 80 60 40 20 0 –20 –40 1/2007 4/2007 7/2007 10/2007 1/2008 4/2008 7/2008 10/2008 1/2009 4/2009 7/2009 10/2009 1/2010 4/2010 7/2010 10/2010 1/2011 Bangladesh India Pakistan Sri Lanka Nepal Afghanistan World Sources: CEIC and FAO. Note: Country series show food component of consumer price index changes, World series shows changes in FAO Food Price Index, which is based on international commodity prices. South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 1 2 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries in South Asian countries. Section IV presents an assess- impact. Section V concludes with some policy direc- ment of the impact of food price increases on poverty tions that could be pursued by South Asia to improve and an assessment of the preparedness of South Asian agricultural productivity and mitigate the impact of countries social protection schemes to cope with this food price volatility on its population. II Determinants of Food Inflation 1. The Trajectory of Inflation in the years prior to 2010. Inflation in India has risen Recent Years every year since 2007, notwithstanding the see-saw trajectory in global commodity prices over 2007–09. Inflation rates in South Asia averaged close to 10 percent Non-cereal prices are rising fastest during the in the years leading up to the global commodity price current food inflation episode, unlike during the last boom of 2007–08, reached a high of 20 percent in the such episode in 2007–08, when cereal price increases summer of 2008, and slowed markedly with the collapse were responsible for a larger share of food inflation. of international commodity prices and economic slow- In India for example, the recent surge in food prices downs associated with the GFC. Inflation in most is due to a spike in fruit and vegetable prices, which countries fell to the low single digits toward the end increased by 22.8 percent (Figures 2.3 and 2.4). Items of 2009. Since then, average inflation has been on such as milk, eggs, meat, fish and spices also experi- an upward trajectory and reached 10 percent by the enced double-digit inflation rates. The same is true for end of 2010. South Asian countries broadly share Bhutan and Nepal as prices there closely track food this rebound in inflation with other emerging-market prices in India.1 countries because the rebound is driven in part by The South Asian countries have different infla- the trajectory of international commodity prices (see tion stories: Figures 2.1 and 2.2, Box 2.1). Prices in Afghanistan rose at the end of 2010 Food prices were the biggest contributor to CPI because of difficulties in trade relations with its neigh- inflation, although core inflation (calculated after boring countries. economic growth is high because removing food and energy prices) was trending up of largely donor-financed construction spending. in most countries. In fact, in India core inflation Substantial differences between the Afghan and was driving overall inflation in 2010, although food Pakistani governments regarding the interpretation inflation was the biggest contributor to inflation in of the Afghanistan-Pakistan Transit Trade Agreement FIGuRE 2.1 WPI Inflation in Major Emerging Market Economies (y-o-y change in percent) 25 20 15 10 5 0 –5 –10 –15 M1 2006 M3 2006 M5 2006 M7 2006 M9 2006 M11 2006 M1 2007 M3 2007 M5 2007 M7 2007 M9 2007 M11 2007 M1 2008 M3 2008 M5 2008 M7 2008 M9 2008 M11 2008 M1 2009 M3 2009 M5 2009 M7 2009 M9 2009 M11 2009 M1 2010 M3 2010 M5 2010 M7 2010 M9 2010 M11 2010 India Brazil China Thailand Philippines Malaysia Korea South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 3 4 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 2.2 South Asia: Consumer Prices (y-o-y change in percent) 50 40 30 20 10 0 –10 –20 1/2007 3/2007 5/2007 7/2007 9/2007 11/2007 1/2008 3/2008 5/2008 7/2008 9/2008 11/2008 1/2009 3/2009 5/2009 7/2009 9/2009 11/2009 1/2010 3/2010 5/2010 7/2010 9/2010 11/2010 1/2011 3/2011 Bangladesh India Pakistan Sri Lanka Nepal Afghanistan Average Source: CEIC. Note: Consumer price index (CPI) based; CPI for Industrial Workers for India. FIGuRE 2.3 India: Food Articles’ Contribution to WPI Food Inflation (percent change, y-o-y) 25 20 15 10 5 0 –5 1/2008 3/2008 5/2008 7/2008 9/2008 11/2008 1/2009 3/2009 5/2009 7/2009 9/2009 11/2009 1/2010 3/2010 5/2010 7/2010 9/2010 11/2010 1/2011 3/2011 Cereals Pulses Fruits & Veg. Milk Egg, Meat and Fish Source: CEIC. (APTTA) have resulted in a postponement of its December 2010. It is estimated that 30–40 percent of implementation. The areas of contention relate to Afghanistan’s fuel is imported from Iran. The blockade bank guarantees, international requirements for sealed halted 2,500 trucks and led to a 70 percent increase trucks, biometric systems and the installation of in fuel prices in January 2011. The ban was lifted in tracking systems. Meanwhile, thousands of containers early February, but the government has since tried bound for Afghanistan are stranded in Pakistani to source fuel from other countries. Price increases ports. Iran blocked fuel supplies to Afghanistan in in transportation and fuels were 12.2 percent and Determinants of Food Inflation 5 FIGuRE 2.4 South Asia: Contribution to CPI Inflation (percent change, y-o-y) Afghanistan Bangladesh 40 10 30 8 20 6 10 4 0 –10 2 –20 0 2007 2008 2009 2010 2007 2008 2009 2010 India Nepal 14 10 12 8 10 8 6 6 4 4 2 2 0 0 2007 2008 2009 2010 2007 2008 2009 2010 Srilanka Pakistan 24 21 21 18 18 15 15 12 12 9 9 6 6 3 3 0 0 2007 2008 2009 2010 2007 2008 2009 2010 Miscellaneous Housing and Fuel Clothing Food Source: CEIC, CSO-Afghanistan. Notes: For India: CPI Industrial Workers; Afghanistan, Bangladesh, Nepal, Sri Lanka and Pakistan: National CPI, Calendar Year (January–December). 6 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Price developments in Bhutan closely track Indian prices. The Bhutanese currency, the ngultrum, is pegged to the Indian rupee, and India is Bhutan’s key trading partner. India’s inflation was lower than the regional average prior to the international commodity price boom and only reached the low double digits at end 2008, partly because government policies shielded consumers from higher international energy prices. Inflation started rising in mid-2009 because of the impact of deficient monsoon rains on agricultural production and food prices, and some delayed pass-through of higher oil prices. Indian inflation reached a high of 16 percent in January 2010, the highest in the region at the time, but has since declined to slightly below 10 percent, which is about average. Core inflation has been on a rising trend since mid-2009 and reached 8.9 percent in March 2011. If the recent momentum is main- tained, WPI inflation will again reach double digits by September 2011. Maldives is one of the most open economies in the world, largely because imports are so significant (almost 70 percent of GDP in 2010). Food and fuel products make up almost 40 percent of imports and comprise 40 percent of the CPI basket. The recent rise in international food and fuel prices, therefore, raises concerns over a mounting balance-of-payments deficit and consumer price inflation. economic growth is dominated by developments in the fiscal balance, which has been improving but is still not in line with macroeconomic stability. With accommodative monetary policy leading to high liquidity associated with remittances, inflation in Nepal rose to nearly 15 percent in 2008 and has remained in double digits since. In addition, during most of fiscal 2010, Indian inflation was higher 26.2 percent, which indirectly affected the price of than that of Nepal which, given the open border, food items. resulted in imported inflation. however, the two In Bangladesh, food price increases are the main rates have been converging in recent months. As of driver of overall inflation, and are driven by interna- mid-January 2011, annualized inflation was running tional prices. Non-food inflation was 3.8 percent in at 11.3 percent. January 2011. Growth in monetary aggregates is high Pakistan not only imported higher inflation from and above the government’s target because of high international commodity prices, but macroeconomic growth in credit to public and private enterprises. imbalances and the floods of 2010 also provided Budget execution is better than expected, despite domestic sources for price rises. Inflation hovered pressures from rising food and fuel prices, because around 25 percent from mid-2008 to early 2009, of high revenue buoyancy. however, the fiscal stance came down somewhat at the end of 2009, but is now for 2011 is likely to be expansionary with a deficit again around 14 percent, the highest in the region. The of 4.6 percent of GDP, compared to 3.1 percent in surge after January 2011 resulted from supply short- fiscal 2010. ages mainly in food items after the devastating floods Determinants of Food Inflation 7 of 2010, a widening fiscal stance partly because of a FIGuRE 2.5 Global Food Price Index and Its Components 50 percent wage hike for civil servants, financing of 300 the fiscal deficit through monetization, but also from otherwise welcome adjustments to unsustainable struc- 250 tural policies: an upward revision in electricity tariffs by 17 percent, and an end to interventions by the 200 State Bank of Pakistan in the foreign exchange market 150 to finance oil imports, which resulted in some rupee depreciation. however, the rupee has rebounded some- 100 what in recent months. In Sri Lanka, inflation remained under 7 percent 50 throughout 2010, but rose to 9.8 percent in April 2011. 0 Food prices have determined inflation. Fuel prices 2005H1 2005H2 2006H1 2006H2 2007H1 2007H2 2008H1 2008H2 2009H1 2009H2 2010H1 2010H2 2011Q1 have had a minimal impact on inflation, because inter- national oil prices were not passed on to consumers Soybeans Soybean Meal Sugar until April 2011. Retail gasoline and diesel prices are unchanged since the end of 2009, as the government Meat Fruits Oils Grains Total Food absorbed price increases by lowering fuel taxes. Source: World Bank. Inflation rates in Sri Lanka and Afghanistan show the strongest correlations with international commodity prices, rising in 2008 before falling sharply in the last quarter of the year. however, while Sri Lanka’s infla- FIGuRE 2.6 Agriculture and Energy Prices tion was close to zero through mid-2009, Afghanistan’s Nominal indices, 2000 = 100 was strongly negative. 400 300 223% up 2. Short-term Pressures: Global Food Prices, Aggregate 200 Demand, and Domestic Supply Shocks 100 Global Commodity Prices 50% up From mid-2010, there has been a steep rise in the 0 prices of most agricultural commodities, including 1986 1989 1992 1995 1998 2001 2004 2007 2010 food crops. In February 2011, the World Bank Food Price Index surpassed the record high of June 2008 Agriculture Energy (Figure 2.5). It had registered the largest annual increase Source: World Bank. since July 2008. A large contributor to the increase in global food prices on the supply side is the rising cost of energy (Figure 2.6).2 higher energy prices translate into increased costs of fertilizers, costs of fuel for trans- unlike the food price hike of 2007–08, where 48 percent portation and running machinery, and lower produc- of the increase in the overall food index was due to tion of food stuffs because of competition for land from rising grain prices, fats and oils, meat, soybeans sugar the production of crops for biofuel. on the demand are contributing the bulk of the rise in food prices side, fast income growth in large developing countries (Figures 2.7 and 2.8). has put pressures on the supply-demand balance (See Moreover, food prices have displayed extraor- Annex 1). dinary volatility over 2007–2010 with volatility in Wheat prices have risen markedly since mid-2010 grains, vegetable oil, and soybeans rising. Since the while rice prices have remained mostly flat. however, 1960s, sugar has consistently been the most volatile 8 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 2.7 International Commodity Prices (Index, 2000 = 100) 400 Forecast 350 300 250 200 150 100 50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Palm oil Wheat Crude oil Rice Soybeans Source: World Bank, DEC Prospects Group. agricultural commodity over each decade, while meat investment fund activity will probably not alter long prices have been least volatile on average. The increase term price trends, but it may induce higher price vari- in volatility is due to an increase in the frequency of ability by exacerbating the length and amplitude of supply shocks combined with limited reserves and an price cycles (see Annex 2). increase in the production of biofuels, and an increase in global macroeconomic volatility post-2000. Global Price Pass-through Increasing investment fund activity in commodity futures exchanges is frequently cited as a contributor South Asian countries vary in the extent to which inter- to commodity price inflation. Despite much conten- national food prices feed through to consumer prices tion over the issue, however, empirical evidence shows depending on their openness to global markets and the small or no impact. Most of the evidence suggests that extent to which food prices are insulated from interna- tional prices through subsidies and price caps. Inflation rates in Maldives, Sri Lanka and Afghanistan show the strongest correlations with international commodity FIGuRE 2.8 The Price Spikes of 2007/08 and 2010/11 prices.3 All countries in the region import a large share (percent change, Apr–Jun 2008 from a year earlier and Dec 2010–Feb 2011 from a year earlier) of their consumption requirements of edible oil (see Figure 2.9). The degree of pass-through of international prices Agriculture depends on the commodity. Bangladesh, India and Nepal allow limited pass-through of international Food rice prices to the domestic market. For instance, in Bangladesh the pass-through of rice prices is estimated at only 16 percent while there is complete pass-through Grains of international wheat prices where imports account for 80 percent of domestic consumption. overall, for Beverages Bangladesh, the domestic food price change (caloric- weighted) between 2009Q1 and 2010Q4 is approx- imately 38 percent while for international prices it 0 20 40 60 80 100 is 35 percent. Therefore in general, food prices in 2007/2008 2010/2011 Bangladesh rose with international prices (Figures Source: World Bank, DEC Prospects Group. 2.10 and 2.11). Determinants of Food Inflation 9 Link Between Energy and Food FIGuRE 2.9 Imports of Rice, Wheat and Edible Oils Prices in South Asia Shares of domestic consumption, 2008/9–2010/11 period averages, zeros indicate no data available, ranked by wheat While there is a clear link between energy prices and 140 food prices globally, the relationship is tenuous in South Asia because governments regulate domestic 120 energy prices and pass-through of international prices is 100 limited. Therefore, the contribution of domestic energy prices to food price inflation has been limited so far. In 80 India, the prices of diesel, kerosene and LPG are regu- 60 lated while petrol prices were deregulated in principle 40 last year but still have been adjusted only partially.4 Bangladesh and Sri Lanka allow gasoline prices to 20 adjust over time, but keep diesel heavily subsidized in 0 order to protect their farmers.5 only Pakistan has a Nepal India Pakistan Afghanistan Bangladesh Sri Lanka* formula-based price adjustment mechanism for both diesel and gasoline (Figure 2.12).6 Governments in the region are keeping electricity prices artificially low to the agricultural sector and, therefore, electricity prices Rice Wheat Edible oils do not play a major role in food prices. In India, many Source: FAO. farmers receive free, unmetered electricity. Domestic Supply Shocks FIGuRE 2.10 Domestic and International Prices of Rice Domestic supply shocks contributed to food price infla- (Index, LCU, January 2007 = 100) tion in some South Asian countries. For instance, Pakistan 350 faced higher wheat prices given the crop damage from the 300 flooding of August-September 2010. This led to a jump 250 in food inflation to 21.2 percent in September 2010, from 12.8 percent in July 2010 (y-o-y). The impact of 200 higher wheat prices has been particularly large since 150 wheat is the main grain staple. In India, inflation started 100 rising in mid-2009 because of the impact of deficient 50 monsoon rains on agricultural production, and unsea- 0 sonal rains and transport disruptions in November 2010.7 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 In Sri Lanka, vegetable prices surged after devastating floods in early January. Bean prices rose 55 percent and coconut prices 70 percent compared to a year earlier. International rice price Bangladesh Pakistan Some non-essential foods that are preferred additions Sri Lanka India to dishes rose even more over the year—red onions by Source: FAO. 245 percent and chilies by 77 percent. Macroeconomic Policies is getting ahead of supply. on average, the countries even though the main driver of inflation in South had current account deficits of 2.4 percent in 2010 Asia is food inflation, core inflation has been rising as compared with 1.7 percent in 2009. The deterio- from 2009 pointing to general demand side pres- ration in the current account deficit also reflects the sures. Current account deficits are also widening in real appreciation of regional currencies with the rising the region. While the level is not worrying as such, inflation rate differential between South Asian coun- the widening supports the view that aggregate demand tries and their trading partners.8 10 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 2.11 Domestic and International Prices of Wheat inflation expectations and escalating food inflation are (Index, LCU, January 2007 = 100) encouraging workers to demand higher wages, which 350 contributes to higher core inflation.11 The growth in aggregate demand in the region 300 is supported by an accommodative macroeconomic 250 policy stance. South Asian governments widened their 200 policy stances in the wake of the GFC, but for most it 150 is probably now time to reset macroeconomic policies 100 to neutral. Steps toward fiscal consolidation have been cautious at best so far despite the fact that South Asia’s 50 deficit and public debt to GDP ratios are amongst the 0 highest in the world (Figures 2.14 and 2.15).12 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 With regard to monetary policy, monetary aggre- gates expanded in line with the economic recovery International rice price Bangladesh Pakistan in most countries despite low policy rates compared Sri Lanka India with other regions.13 Credit expansion is still mostly low compared with the growth rates prevalent during Source: World Oil, U.S. Department of Agriculture and World Bank. 2004–07.14 Monetary conditions in India have been * Sri Lanka’s wheat imports as a share of consumption is above 100% due to re-exports. tightened since late-2009, and are broadly neutral as indicated by a monetary conditions index (MCI, Figure 2.16).15 The index combines money supply FIGuRE 2.12 Subsidization of Diesel Retail Fuel Prices growth, interest rates and changes in the exchange Remains Particularly High in Bangladesh and Sri Lanka rate. IMF research shows that changes in the first two (US cents per liter prices as of November 2010, and U.S. retail price reference account for about 25 percent of inflation and changes band of 84 for diesel and 76 for gasoline) in the latter about 10 percent.16 Bangladesh 63 125 While rising core inflation and widening current 119 account deficits hint at general demand-side pres- Sri Lanka 66 115 sures, capacity utilization rates draw a mixed picture. India 82 In India, capacity utilization indicators are stable, Nepal 118 91 while the recent industrial production and imports Pakistan 86 data point to a slowdown rather than overheating 92 China 104 111 (Figure 2.17). Different estimates of potential output 76 measures across the region’s economies (Afghanistan, United States 84 Bangladesh, India, Sri Lanka) suggest output gaps Gasoline Diesel narrowed or closed in 2010. Sources: GTZ, International Fuel Prices 2011, and World Bank. 3. Long-term Effects: Productivity Slow-down and Structural Demand Shifts Meanwhile, surveys show that inflation expecta- tions are rising and this holds risks for further upward After the rapid advances during the “Green pressure on core inflation.9 For example, household Revolution� in the 1960s and 1970s, agricultural surveys in India reveal 1-year ahead expected inflation growth rates in South Asia have been low and fairly has risen to 13.1 percent in 2010Q4 from 6.2 percent stable, although short-term volatility of agricultural in 2009Q1.10 The perceived current rate of inflation output has been high. The production of cereals and has also risen to 11.8 percent from 5.8 percent over the pulses has been increasing by around 2 percent per same period. If this trend continues, households could year since the early 1980s, while the growth in the revise their inflation expectations upwards in tandem production of vegetables and fruits has been around with perceived inflation in 2011 (Figure 2.13). Rising 4 percent. There are, however, weak indications of Determinants of Food Inflation 11 declining growth rates of agricultural production in the region (Figure 2.18).17 With population growth continuing at around 2 percent per year and income growth accelerating, it is not surprising that imports of the staple items: wheat, rice, maize, and vegetable oil, have increased sharply FIGuRE 2.13 India: Household Inflation Expectations (Price change in percent) 16 14 12 10 8 % 6 4 2 0 Sep-06 Dec-06 Mar-06 Jun-06 Sep-07 Dec-07 Mar-07 Jun-07 Sep-08 Dec-08 Mar-08 Jun-08 Sep-09 Dec-09 Mar-09 Jun-09 Sep-10 Dec-10 Current 3-Months Ahead 1-Year ahead Source: Reserve Bank of India. FIGuRE 2.14 General Government Balances FIGuRE 2.15 Total Government Debt (Percent share of GDP) (Percent share of GDP for fiscal years (*calendar years 2008 and 2009)) 2 100 1 90 0 80 –1 70 –2 60 –3 50 –4 –5 40 –6 30 –7 20 –8 10 –9 0 South Asia High-Income countries Middle East and North Africa East Asia and Pacific Latin America and Caribbean Sub–Saharan Africa Afghanistan Nepal Bangladesh Pakistan Bhutan India Sri Lanka* Maldives* Emerging* High-income* 2007–08 2009–10 2007 2010 2013 Source: Reserve Bank of India. Source: World Bank Databases and DEC Prospects Group Projections. 12 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 2.16 India: Monetary Conditions Index 4 Tightening 2 0 –2 Index –4 –6 –8 Loosening –10 2007m1 2007m3 2007m5 2007m7 2007m9 2007m11 2008m1 2008m3 2008m5 2008m7 2008m9 2008m11 2009m1 2009m3 2009m5 2009m7 2009m9 2009m11 2010m1 2010m3 2010m5 2010m7 2010m9 2010m11 Narrow Broad Source: Authors calculations FIGuRE 2.17 Industrial Production (Annual percent change) 30 25 20 15 10 5 0 5 10 15 20 25 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Bangladesh India Sri Lanka Pakistan Sources: Thomson Datastream, Haver and World Bank, DEC Prospects Group. from around 5 million metric tons in the early 1990s do indicate a gap between accelerating demand and to double that level at the end of the 2010 decade. slowing supply growth. Accordingly, the domestic With rising incomes, consumption growth has terms of trade have been shifting in favor of agri- been accelerating and is now significantly higher culture ever since the late 1980s, when the produc- than production growth for major food groups. This tivity advances of the “Green Revolution� petered is most notable in India, where household surveys out (Figure 2.20). suggest that the consumption of food is increasing Within this overall picture, the demand pressure by around 3 percent per year. Within the food group, on cereals is relatively lower as demand is shifting however, growth in consumption of pulses, fruits, toward a higher-protein diet. Accordingly, higher- meat, eggs, and dairy items is around 4 percent, while protein food articles and fruits and vegetables have the growth rate in consumption of cereals is around been the main drivers of food inflation since 2008. 1.5 percent (Figure 2.19). While the data from the The shift to higher protein foods is noticeable across Indian household surveys are highly volatile, they the region (Figure 2.21). Determinants of Food Inflation 13 The shift to a higher-protein, fruit- and vegetable- food items in household consumption, based on Indian rich diet is also supported by Indian household survey household surveys of the last 20 years (Figure 2.23). data showing consumption baskets for different house- For example, in 1987–88 rural Indian households spent hold groups: richer households spend a higher share over 40 percent of their food budgets on cereals, but of their incomes on non-food items and, for food, a by the 2007–08 survey this had fallen to around 30 higher share on pulses, fruits, vegetables, eggs, meat, percent. A similar shift occurred among urban house- and dairy (Figure 2.22). Therefore, as incomes rise, holds, though less pronounced. Such shifts represent households’ consumption patterns shift. This shift also differential growth rates of consumption for different emerges in comparing the average shares of various food items. 14 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries BOx 2.1 Inflation in China – What is Different? China and India have many characteristics in com- budget deficit from 2 .8 percent in 2009 to 1 .6 percent mon . Notably, both countries have more than 1 billion in 2010 . Second, the central bank raised the reserve people each; they are the fastest growing economies requirement for banks six times in 2010 and three in the world; and food prices have played a signifi- times in the first quarter of 2011 (to 20 .0 percent cant role in recent increases in their inflation rates . In for large banks) . It also lifted the benchmark interest China, inflation rose to 5 .4 percent (y-o-y) in March rate between January 2010 and March 2011 to 6 .06 2011, a 32-month high . A combination of domestic percent . These actions helped moderate growth in weather-related shocks and the global food price domestic credit to the private sector to 20 .3 percent increase contributed to rising food prices . Vegetable in December 2010 from 33 .1 percent a year earlier . prices, the key driver of inflation in 2010, peaked in Third, China took actions to curb house prices, includ- February 2011 and have moderated since . Unlike in ing raising mortgage interest rates and down pay- India, non-food inflation in China has been relatively ments, and directing banks not to lend for purchases moderate, registering 2 .3 percent in March 2011 . of third (or more) homes . Fourth, the real apprecia- However, throughout 2010 and the first quarter of tion of the yuan, by about 4 percent, helped tighten 2011, non-food inflation has been rising and is a grow- monetary conditions . In addition to normalizing the ing cause for concern among policy makers . Rising overall macroeconomic policy stance, the government residential property prices—with inflation averaging 12 took measures to boost food supply and reduce the percent for new housing in 70 major cities—have also cost of production and logistics, including releasing been a feature of inflation in China, and have been grain from China’s large reserves, increasing subsidies fueled by rapid credit growth . to farmers, exempting transport of vegetables from The Chinese government has taken several steps road toll, and boosting food imports . More recently, to contain inflation . First, it ended the large fiscal stim- it limited the increase in domestic fuel prices arising ulus implemented in 2008 to support the economy from higher oil prices, and applied moral suasion on in the wake of the global financial crisis, reducing the manufacturers of food and consumer products . 15 20 Rising rates of headline, core and food inflation… With GDP rebounding driven by investment… 10 15 % Year on Year % Year on Year 10 5 5 0 0 –5 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 –5 2005 2006 2007 2008 2009 2010 CPI Non-food Food NX Invest Gov cons HH cons GDP Determinants of Food Inflation 15 BOx 2.1 Inflation in China – What is Different? (continued) 20 6.2 27 Property prices are still rising but at a lower rate .... As monetary policy tightens… Growth in M2/Require reserves (%) 6 25 15 5.8 Lending rates (%) 23 % Year on Year 10 5.6 21 5.4 5 19 5.2 0 5 17 4.8 15 –5 01-Jan-10 01-Feb-10 01-Mar-10 01-Apr-10 01-May-10 01-Jun-10 01-Jul-10 01-Aug-10 01-Sep-10 01-Oct-10 01-Nov-10 01-Dev-10 01-Jan-11 01-Feb-11 01-Mar-11 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Overall property prices New housing Lending rates Required reserves Money supply FIGuRE 2.18 Production Growth of Major Staple FIGuRE 2.19 India: Growth Rates in Consumption Food Items (per capita, in percent) (y-o-y change in percent, actuals and long term averages) 10 25 8 20 15 6 10 4 5 0 2 –5 0 –10 –15 –2 –20 1993/94 2001/02 2004/05 2005/06 2006/07 2007/08 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Consumption Food Cereal Pulse_fruit Cereals Veg.&Fruits Pulses Source: CSO NSS different rounds, author’s calculations. Source: FAO. 16 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 2.20 India: Terms of Trade between Agriculture, Industry, and Services 1.3 1.2 1.1 Axis Title 1 0.9 0.8 0.7 0.6 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Agric-to-Industry Agric-to-Services Source: CEIC. FIGuRE 2.21 Annual Per Capita Consumption 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1990 2010 1990 2010 1990 2010 1990 2010 1990 2010 1990 2010 Bangladesh India Nepal Pakistan Sri Lanka Average Total cereals Pulses Roots & Tubers Edible Oils Vegetables Fruits Milk Meat Eggs Fish Source: Joshi et al. (2007). Determinants of Food Inflation 17 FIGuRE 2.22 India: Household Survey Data on Consumption of Food and Non-Food (Consumption pattern across mean per capita expenditure deciles, 2004–05) Urban Rural 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 0–10 10–20 20–30 30–40 40–50 50–60 60–70 70–80 80–90 90–100 0–10 10–20 20–30 30–40 40–50 50–60 60–70 70–80 80–90 90–100 cereal pulse fruit oil bev salt spice non food Notes: Computed from unit-level data using 61st round of NSS, Consumption Expenditure (Schedule1); the last thick round. MPCE refers to monthly per capita consumption expenditure. Households were split into consumption quintiles, and then average expenditure of households in each quintile of the different consump- tion categories were computed. The components of the food subcategories are: cereals—cereals and cereal substitutes; pulse fruit—pulses and pulse products, milk and milk products, egg, fish and meat, vegetables and fruits; oil bev—edible oil, sugar and beverages; salt spice: salt and spices; non-food 30—total non-food expenditure computed on the base of a 30-day recall period. FIGuRE 2.23 India: Shares of Food Types in Food Baskets, 1987/88–2007/08 (in percent) Rural Urban 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 1987/88 1993/94 2001/02 2004/05 2005/06 2006/07 2007/08 1987/88 1993/94 2001/02 2004/05 2005/06 2006/07 2007/08 cereal pulse fruit oil bev salt spice Source: CSO NSS. 18 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Notes the general government deficit rose to 9 percent of GDP in FY2009–10, with 6.8 percent of GDP central govern- 1. The Bhutanese currency, the ngultrum, is pegged to ment deficit. only a marginal contraction in central the Indian rupee. government deficit is estimated to have been achieved 2. econometric evidence suggests a 10 percent increase with 6.7 percent of GDP in FY2010–11, although some in energy prices leads to a 2–3 percent increase in further contractionary impulse was probably coming food prices (Baffes, 2010). oil prices increased by 223 from India’s states, where borrowing limits were tight- percent increase between 2004 and 2010 leading to a ened. Maldives is struggling to correct macroeconomic 50 percent increase in food prices. imbalances driven by large fiscal deficits of 20.7 percent 3. Maldives is one of the most open economies in the in 2010 while in Sri Lanka the deficit expanded to world, largely because imports are so significant (almost 6.8 percent. Large outlays for interest payments are 70 percent of GDP in 2010) while in Sri Lanka domestic slowing progress toward fiscal consolidation, and while prices follow world prices even though it produces 95 improving in some countries (Afghanistan, Maldives, percent of the food it consumes. and Sri Lanka, for example), and the low tax base in 4. Although in India there is sometimes a considerable countries such as Pakistan makes consolidation partic- lag between change in international gasoline price ularly challenging. Domestic commodity price distor- and domestic gasoline price. The Indian government tions continue to raise big fiscal concerns for South Asia. increased both diesel and petrol prices in May 2011 with 13. In 2009 and 2010, real policy interest rates have been petrol prices rising by 44 percent since February 2010. consistently negative in India, reaching a low of –11.5 5. In both Bangladesh and Sri Lanka the loss is borne by percent in January 2010 (real interest rate calculated the Bangladesh Petroleum Corporation and the Ceylon as the difference between the Reserve Bank of India’s Petroleum Corporation, respectively. As such, it is not repo rate and the concurrent CPI inflation rate). In a direct transfer from the government but recorded Bangladesh and Pakistan, real interest rates were nega- in the respective company’s profit and loss accounts. tive throughout 2010. During 2010, the authorities 6. For instance, in January, the Pakistan government began tightening monetary policy. India’s central bank increased fuel prices, decreased them a few days later has raised interest rates nine times since end-2009, but and increased them yet again in early March, before policy rates were still negative in real terms in early May halving them once again. 2011 (the nominal benchmark repo rate was set to 7.25 7. Some delayed pass-through of higher oil prices also percent on May 3, 2011, while WPI inflation was 9 contributed to higher overall inflation during this period. percent in March). only in Sri Lanka, policy rates have 8. Between January 2007 and December 2010, there been moving in the opposite direction, with declining was a real appreciation of the Sri Lankan rupee of 27 policy rates and positive real interest rates during 2010. percent, the most amongst all South Asian currencies. With real interest rates at 0.2 percent in January 2011, 9. IMF (2010) finds a 1 percentage point increase in the monetary policy stance is relatively accommodative. expected inflation leads to a 0.2–0.4 percentage point 14. In Sri Lanka, growth in credit extension to the commer- increase in core inflation for India. cial sector rose steadily in 2010 to 27 percent of GDP, its 10. See The Reserve Bank of India’s Inflation expectations highest rate since July 2007. In Bangladesh, credit to the Survey of households conducted in 2010Q4 (Round 22), private sector also grew steadily at 27.6 percent, in 2010, 11. In Sri Lanka, the minimum wages for formal private up from 19.2 percent in 2009. Broad money supply has sector employees under Wage Boards increased, raising been climbing between 2009 and 2010 in Bangladesh, the overall nominal wage rate index for the whole sector Pakistan and Sri Lanka, growing at 22.2 percent, 14.9 by 32.0 percent in 2010. Informal sector wages in the percent and 18 percent at the end of 2010, respectively. Agriculture and Construction sectors also increased by In India, growth in non-food credit accelerated to 23 9.1 per cent and 7.3 per cent, respectively, in 2010. percent in the first quarter of 2011. Credit to industry Monthly minimum wage hikes in Bangladesh for was up by 26.5 percent from the previous year, signif- government workers of 80.4 percent occurred with icantly driven by the financing of telecom license fees. effect from July 2010 and in India the average wage 15. The MCI uses coefficients from Kannan, Sanyal and rates in the Indian Railways increased by 30.2 percent Bhoi (2006). in 2009–10. Pakistan experienced a 50 percent wage 16. See IMF (2010). hike for civil servants. 17. Closer analysis of the data shows that changes in trend 12. South Asia had the largest fiscal deficit among devel- growth for pulses and cereals are not statistically signifi- oping countries in 2010, estimated at 8.4 percent, cant; i.e., it is uncertain that production growth rates are as compared with 6.7 percent on average during the indeed declining. Production of vegetables and fruits is period 2007–09. There is wide variation in fiscal defi- so unstable that there is no certainty of a growth trend; cits in the region in 2010, ranging from 2.5 percent for i.e., the production increase between 1981 and 2009 Bangladesh to 22.5 percent for the Maldives. In India, is not statistically significant. I III The Impact of Agricultural Policies on Food Supply S oUTh ASIAN GoVeRNMeNTS ToDAY follow very different approaches to marketing staple foods, but are quite uniform in their attempts to support farmers and food production with input subsidies. While India and Pakistan maintain heavy government control over the marketing of wheat and India also of rice, the other countries have liberal- ized their agricultural sectors to a much larger extent. The Indian and Pakistani systems reduce the ability of the private sector to manage temporary, geographically limited supply disruptions. They are partly responsible for high food inflation over the short-term. on a more structural level, they distort agricultural incentives, and have high fiscal costs. They are maintained by the two governments’ reliance on large-scale distribution of subsidized food items as crucial safety net measures. Input subsidies in the major countries contribute to overuse of water resources, high losses of electricity utilities, and deteriorating soil conditions because of wrong application of fertilizer, and therefore contribute to the long-term slow-down in productivity growth in agriculture. The fiscal costs of current policies divert resources from more efficient interventions: invest- ments in agricultural research, education, and rural roads—the three most effective public spending items in promoting agricultural growth and reducing poverty. role in the handling of the two staples. Pakistan main- tains a similar system for wheat only, because rice is far less important in consumption.1 Afghanistan faces the 1. Historical Perspective uphill struggle of rebuilding its economy after decades of conflict, and the agricultural sector is affected by In the 1950s and 1960s, South Asian countries had the widespread cultivation of poppy (see Box 3.1). similar policies with regard to government involvement Systems for government intervention were set up in the marketing of food commodities, but their poli- with three main objectives: to increase production, cies started diverging in the late 1970s. Liberalization stabilize market prices and risks, and provide subsi- started first in Sri Lanka, then in Bangladesh, and finally dized food to vulnerable households. In the first of these in Nepal in 1998. India and Pakistan, in contrast, still objectives, the countries were remarkably successful. maintain a lot of the features of the systems they had Cereal production in most countries more than doubled established in the 1960s for their main staples, wheat between 1961 and the early 2000s, while it almost and rice. especially in India, the government maintains quadrupled in Pakistan. Per capita availability of food a pervasive system of public procurement, storage, and increased in most countries (Figure 3.1). however, distribution which gives the private sector only a limited production increases were most impressive in the 1960s South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 19 20 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries BOx 3.1 The Opium Economy in the Context of Afghanistan’s Agriculture and Food Security Afghanistan produces more than 90 percent of the The success stories usually associated with areas world’s opium supply on small portions of its agricul- around cities, such as Jalalabad in the east, will not tural land, generating about 15 percent of national be easy to duplicate in more remote regions lacking GDP . Opium is Afghanistan’s most important agri- infrastructure . What is required is sustained, broad- cultural crop in value terms, providing much-needed based, programmatic rural development, ranging livelihoods and jobs for segments of the rural popula- from irrigation investments to horticulture, com- tion in the short run—but distorting the incentives for munity development, and better health for livestock developing a sustainable, formal agricultural sector (see DFID and World Bank, Economic Incentives and in the long run . In addition, the large criminal profits Development Initiatives to Reduce Opium Production, associated with the drug industry seriously undermine 2008) . Value chain development for both exports and governance and fuel corruption, dysfunctional politics, import substitution will be critical, and encouraging and ultimately insecurity and conflict . Thus moving the private sector through innovative programs will be away from reliance on opium is a priority development much more effective than fragmented investments in objective for the medium term . But, since opium is a parts of the value chain . high-value, storable commodity with a ready market Yet, it is also clear that wheat is not the crop of and a secure cash crop for an insecure environment, Afghanistan’s future; nor can it replace opium . Export this will be no easy task . prospects for wheat are extremely limited given the Progress in eliminating opium cultivation in some large production of neighboring countries . Moreover, areas over a number of years suggests that phasing as a low-value, relatively less labor-intensive, yet rela- out opium in Afghanistan over the next 10–20 years is tively water-intensive crop, wheat is not well-suited not impossible . Success factors are multi-faceted: In for expansion in a country with Afghanistan’s resource addition to having a credible threat of law enforcement endowment: limited arable land, sparse irrigation, against opium cultivation and trade (but not massive water a binding constraint, and abundant labor supply . eradication of standing crops in the fields, which is a Shifting all of Afghanistan’s land currently devoted to symptom of failure to deter and fuels resentment and opium cultivation to wheat, even if it were possible, conflict), key ingredients include: would leave significant parts of the rural population less employed, poorer, less food-secure, and more • Reasonably good local resource endowment (agri- vulnerable, with many households forced to take ex- cultural land and irrigation) to encourage a variety of treme measures, such as cutting health expenditures, agricultural activities, not just opium; stopping education of children, or even out-migrating • Close access to markets for licit agricultural crops to neighboring countries . (e .g ., city vegetable markets), so farmers can sell Thus, although efforts to enhance Afghanistan’s produce without traveling far, crossing many check- self-sufficiency in wheat are justified and have good points, or paying many bribes; prospects for success, the way forward for Afghan ag- • Proximity and access to sizable labor markets riculture as a whole—which will also help address the (found in cities), so family members of rural house- opium problem—is to develop licit, high-value, labor- holds can seek work but also return home if there intensive cash crops . This will only be achieved with is no day-labor available, thereby avoiding transport necessary investments and improvements (including and lodging costs associated with more distant private-sector milling and increased grain storage labor markets; capacity) in key factors such as those listed above . • Opportunities for a variety of other activities such as dairy, transport and other services; and • The modicum of security usually found near larger cities is most suited to development of sustainable, non-opium agriculture . The Impact of Agricultural Policies on Food Supply 21 and 1970s, while the 1990s saw a distinct slowing down FIGuRE 3.1 Average Food Supply: Crops in agricultural production growth, and some studies (kg/capita/yr) show that total factor productivity actually declined.2 180 India and Pakistan became net exporters of cereals in 160 the 1990s. With strong production growth, Sri Lanka 140 continues to depend on rice imports, but the share of 120 net imports in availability has declined significantly. In 100 contrast, net imports of cereals as a percentage of avail- ability remained fairly stable in Bangladesh, whereas 80 Nepal has gone from net exporter to importer since 60 the 1980s, although the share of imports in avail- 40 ability is small. 20 After several bumper harvests, India actually now 0 1961–1984 1985–2007 1961–1984 1985–2007 1961–1984 1985–2007 1961–1984 1985–2007 1961–1984 1985–2007 faces a “problem of plenty�: stocks of wheat and rice far exceed requirements and storage capacity. Given the current international concerns about rapidly rising food prices, in particular those of wheat, the “problem Bangladesh India Nepal Pakistan Sri Lanka of plenty� could easily turn into an “embarrassment Cereals Fruits Vegetables of plenty�: a lifting of India’s ban on exports could Source: Joshi et al. (2007). have a significant downward impact on international wheat prices. The question is whether the systems that served India and Pakistan well in the last fifty years are India likely to prove equally successful in meeting the considerable challenges of the coming decades: fast The government notifies Minimum Support Prices income growth and continuing population growth (MSPs) for 24 food articles on the basis of costs and in the context of increasingly binding land and water (increasingly) political considerations for procurement scarcity. evidence in the form of an emerging gap by the Food Corporation of India (FCI), although only between demand and production growth highlighted wheat, rice, and coarse grains are procured in mean- in Section II, the rising fiscal costs of the systems, ingful quantities.5 Covering sometimes vast distances, and the continuing gaps in providing food security the FCI transports grains from surplus to deficit states to large segments of the population tilt the likely and releases grains to the Public Distribution System answer to the negative.3 The systems’ concentration (PDS) to be sold at subsidized prices (see Section IV). on grains also reduces farmers’ incentives to respond The FCI also holds buffer stocks in wheat and rice. to structural shifts in demand. It procures about one third of overall production of wheat and rice.6 The FCI maintains an open procure- ment policy, which means it buys at the MSPs any 2. Government Involvement in quantities of grain being delivered to its procurement centers within a specified time period. The amount Agricultural Marketing of procurement therefore depends on the attractive- Governments in the region are active in the agri- ness of the MSPs relative to the prevailing market cultural sectors by providing public investments in conditions.7 infrastructure and research, and various input subsi- Record quantities of procurement after the MSP dies. only in India and Pakistan, however, do govern- increases in 2008 resulted in stocks of 40–50 million ments play an intricate part in the marketing of food tons in 2010, which was roughly twice the level the grains and impose strong restrictions on private-sector government deems necessary as buffer stocks and storage and trading.4 This section discusses government far exceeded the FCI’s secure storage capacity. The involvement in wheat and rice marketing in India and “problem of plenty� of the large accumulation of stocks Pakistan, and effects of other (input) policies in the is not new: in 2002, stocks had reached 60 million tons South Asia region. under similar circumstances.8 22 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 3.2 India: Food and Fertilizer Subsidies, 1990–2012 implementing the procurement targets set at the federal (in percent of GDP) level. Public procurement absorbs 15–40 percent of 2.5 total production of wheat. About 95 percent of procure- ment by PFDs is undertaken in Punjab province. 2.0 Restrictions on the transport of wheat between prov- inces and ad hoc trade restrictions are used to protect 1.5 prices. International trade of agricultural commodities is handled exclusively by the Trading Corporation of 1.0 Pakistan (TCP). Trading decisions are not always well designed: the 2008 harvest was overestimated and 3 0.5 million tons of exports were allowed, forcing the govern- ment to import almost the same quantity at higher 0.0 prices later. In the face of an expected bumper crop 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–00 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 2009–10 2010–11 2011–12* harvest, the government allowed exports of 1 million tons of wheat in January 2011, the first time since the wheat price rally in 2007. Food Fertilizer Sources: MinFin, CSO, author’s estimates. Note: GDP data fis based on the old seriesup to 2003–04, new series from then on. Bangladesh * Figures for 2011–12 are author’s estimates. The country has come a long way from the pervasive food rationing and government procurement system it maintained prior to the 1980s. There is currently no high stocks lead to high wastage because of inade- large-scale government intervention in grain markets. quate storage capacity and technology. It has been esti- Competitive private traders purchase and retail food; mated that the FCI looses 10–16 million tons of grains their numbers rose to 48,000 in the 1990s from about every year.9 The FCI’s inefficiencies not only lead to 4,000 in the 1960s. Public distribution of grains is high losses of the grains it handles, they also drive up limited to cover social safety schemes, the military, the costs of food handling. Comparisons show that police and low-paid public servants. The government the FCI’s handling and storage costs are significantly maintains public grain stocks for its safety-net programs higher than those of the private sector.10 and emergencies. It targets a level of 1.5 million tons for The increase in procurement has led to a signifi- its public grain stocks, including emergency reserves of cant increase in the fiscal costs of the system. Food and 1 million tons (equivalent to two weeks of consump- fertilizer subsidies have increased to over 1.5 percent tion) with the remainder as safety net. of GDP since fiscal 2009, from around 1 percent in the mid-1990s (Figure 3.2). The last time subsidies Nepal approached 1.5 percent of GDP was in fiscal 2003, another year in which procurement expanded strongly The government initiated liberalization reforms in and grain stocks reached 60 million tons. outlays on 1986, including removal of the MSP. The government food subsidies are far higher than public investment also removed some agricultural subsidies as part of the in agriculture and outlays for extension services, which structural adjustment program supported by the IMF could increase agricultural production and lead to lower in the 1980s. In 1998, the government downsized its prices over time. public distribution system, through the Nepal Food Corporation (NFC) and began restructuring it in 2000. Increasing open market operations led to a decline Pakistan in food procurement by the NFC and consequent The government employs a system similar to India’s declines in government stocks. Liberalization followed for public procurement, storage, and subsidized distri- estimates that marketing costs for private traders were bution of wheat only. Provincial Food Departments lower than those of the NFC by over 40 percent prior (PFDs) and the Pakistan Agricultural Storage and to 2000. The government also liberalized trade policy: Supply Corporation (PASSCo) are responsible for it eliminated all quantitative restrictions and lowered The Impact of Agricultural Policies on Food Supply 23 tariffs to the lowest average in South Asia. however, matter of widespread concern. In the past, domestic a ban on exports was imposed in 2008 to safeguard open market sales were often announced, but the domestic supply of food. The reforms have improved take-up by the private sector usually fell well short of some indicators of food security in Nepal (rising per- target. The reason was the FCI’s attempt to sell grain capita food availability and lower malnourishment), at prices higher than the procurement prices to cover notably in the Terai plains, but the benefits have not some of its costs, which resulted in low or no off-take spread evenly; remoter areas, such as the hills, remain when MSPs were relatively high. Stringent controls relatively insulated from the improvements. were also imposed on buyers, partly to avoid the sale of grains back to the FCI during the next procurement Government Policies and Short-term Inflation round. Grain released through open market operations In India and to a lesser degree in Pakistan, large-scale was therefore sold only to millers in bulk.15 public procurement hampers the private sector not only by pre-emption, but also by taxes and rules for Structural Effects of Government Marketing Rules moving grains across state borders, and caps on storage The concentration of the government’s food policies on of grains designed to facilitate public procurement. the FCI in India, and PASSCo in Pakistan, and their Indian traders also face a requirement of transport in concentration on cereals from a few surplus producing jute bags rather than in bulk.11 The private sector’s costs states have in turn resulted in a skewed development are increased by the uncertainty created by frequent of agriculture. Farmers in areas where the government ad-hoc changes of rules, in particular the stipulations is most active have little incentive to respond to struc- under the essential Commodities Act (eCA).12 The low tural demand shifts and diversify production, because private sector involvement in grain marketing leads to that would greatly increase their exposure to risks. Food insufficient investment in the supply chain, and espe- production (but not necessarily that of wheat and rice) cially in storage facilities. could also increase through extending the benefits of Marketing rules go beyond grains and put a wedge the Green Revolution to eastern states. Yields on the between retail and farm-gate prices for agricultural most productive land are multiples of the yields in produce in general. Farmers in most places are obliged more traditionally operated farms (Figure 3.3). Use to sell products exclusively through mandis or wholesale markets, where a relatively small number of licensed traders can engage in oligopolistic behavior. While many states have made changes to the Agricultural Product Marketing Act (APMA), the system is still in place in FIGuRE 3.3 India: Rice and Wheat Yields in Major many areas (see Box 3.2). The margin between whole- Producing States, 2006–2009 (3-year average, in million MT) sale and retail prices has been increasing over a number of years. Reforms to APMAs in some states opened 5,000 4,500 the doors for contract farming, which has resulted in 4,000 increased incomes for farmers, higher private investment 3,500 in agriculture, and improvements to the supply chain.13 All India Averages 3,000 The lack of development of market infrastructure 2,500 in the wider sense (including oligopolistic conditions 2,000 in mandis) exacerbates food price volatility. Markets 1,500 are not integrated across areas, and buffer stocks are 1,000 not available to tide over temporary disruptions.14 500 Apart from policies in India and Pakistan, the dearth 0 of physical infrastructure across South Asian countries Madhya Pradesh Chhattisgarh Bihar Assam Orissa Maharashtra Gujrat Jharkhand Uttar Pradesh Karnataka West Bengal Tamil Nadu Haryana Andhra Pradesh Punjab is to blame to a large extent, in particular rural roads and cold storage facilities, which leads to large losses of perishable goods, or lowers incentives to produce these goods in the first place. Rice Wheat In India, the simultaneous occurrence of high food inflation and large food-grain stocks has become a Source: CEIC. 24 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries BOx 3.2 Agricultural Produce Markets Act (APMA) The Agricultural Produce Markets Act regulates the and farmers markets for direct sale, contract farming, buying and selling of agricultural products in India’s electronic trading, and promotion of public-private states . Through the act, or local versions of it, states partnerships in the management and development of have established more than 7,000 wholesale markets agricultural markets in the country . Twenty-five states (also known as mandi or APMC markets), and regulate and union territories have amended their APMAs or all aspects of marketing, including the levy of a user made various provisions for the purpose .b fee, or cess . India has twenty-eight states and seven union ter- The acts make mandis mandatory for the trading ritories, and progress in modifying their legislation has of agricultural produce . A limited number of licenses been slow; as the GoI noted last year, “the manner of issued to traders and commission agents restrict the implementation in most states reveals serious weak- choice of sellers and buyers . This stifles competition, nesses which discourage the entrance of new play- and generates economic rents for license holders . It ers� . While some direct marketing options have been also leads to under-investment in physical infrastruc- allowed in selected states, often with significant posi- ture and, ultimately, lowers prices received by farmers tive impacts on farmers and consumers, restrictive and increases prices paid by consumers . clauses remain in most areas—either in the modified Recognizing the “malfunctioning of regulated mar- act or new rules, such as restricting private markets to kets� and the “need for more transparency and ac- a specified distance from existing regulated markets, countability in the functioning of these markets�,a the registration requirements for contract farming, and government of India (GoI) proposed that states adopt variable or short lengths of time in permitting for direct reforms along the lines of a model state APMA . The purchase from farmers, all of which deter investments model act provides for, among others, establishment in storage and logistics . of private markets, direct purchase centers, consumer a GoI, 2007: “Report of the Steering Committee of Agriculture and Allied Sectors for the Formulation of the Eleventh Five Year Plan 2007–2012 . b GoI 2010: “Mid-Term Appraisal for Eleventh Five Year Plan 2007–2012�, Planning Commission, New Delhi . of high-yield varieties and fertilizer is still much lower though investments in agricultural research, educa- in rain-fed areas.16 tion, and rural roads are more effective public spending tools for promoting agricultural growth and reducing poverty.18 Public investment in agriculture is crowded out by food and input subsidies.19 3. Policies for Agricultural Inputs Input subsidies have the detrimental side effects of Countries in South Asia broadly share their approaches “too much of a good thing�. Fertilizer subsidies lead to agricultural inputs: subsidies for credit, fertilizer, and to a skewed application of different types of fertil- irrigation are meant to improve small-farmer livelihoods izer and nutrient deficiencies in the most intensively and agricultural production. They fail on both fronts. farmed areas.20 Water subsidies (through lower prices While they probably have been the key to small-scale of diesel and free electricity for irrigation pumps) have farmers adopting new technologies, especially during led to widespread overuse of underground aquifers and the initial stages of the Green Revolution in the late increased salinity of soils. In fact, a water crisis may be 1960s and 1970s, it is increasingly apparent that large- looming in a number of districts in India and Pakistan, scale farmers now reap the most benefits from input which have seen a rapid decline in groundwater levels subsidies, and public procurement.17 Subsidies also Figure 3.4).21 Water access exacerbates inequities, while command important shares of government budgets, under-pricing of canal irrigation water leads to chronic The Impact of Agricultural Policies on Food Supply 25 funding problems for operations and maintenance.22 FIGuRE 3.4 India: Groundwater use Over Net Availability Free or heavily subsidized electricity for irrigation also (in percent) plays havoc with the finances of electricity utilities, 140 which have become a major fiscal burden. Among the 120 states with the worst overexploitation of groundwater in India are two, Punjab and haryana, from which the 100 FCI procures most farms’ output. 80 The access to water and water-use efficiency are some of the most pressing challenges Pakistani agri- 60 culture is facing. Some studies show an intricate, well 40 entrenched system of “facilitation payments� made by 20 farmers to increase access to canal irrigation water in the absence of official water pricing.23 The Indus Basin 0 Other States Jammu & Kashmir Orissa Chhattisgarh Jharkhand Assam Bihar West Bengal Andhra Pradesh Kerala Maharashtra Madhya Pradesh All India Uttarakhand Uttar Pradesh Karnataka Gujarat Tamil Nadu Haryana Rajasthan Punjab irrigation system in Pakistan is the largest integrated irrigation system in the world. It covers 13.5 million ha of cultivable land, of which nearly 9 million ha can be irrigated throughout the year. Waterlogging and soil salinity have become the major problems impeding agricultural growth and development. Agricultural Source: CentralGround Water Board, cited in: Shankar, Kulkarni, and Krishnan (2011). productivity declines unless adequate drainage and salt export facilities are available, which have high energy and capital requirements, or water use efficiency is participate effectively in markets for high-value agricul- increased significantly to reduce negative impacts on tural commodities. Data from field projects in Nepal the environment.24 and India suggest that the PRISM approach can lead efforts led by NGos for Poverty Reduction through to significant additional income for small farmers Irrigation and Smallholder Markets (PRISM) combine and other micro and small enterprises in agricultural small-plot irrigation technology and integrated service value chains.25 provision (ISP) to enhance small farmers’ ability to 26 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries BOx 3.3 From the Arabian Nights – A Cautionary Tale from History Irrigation has been the key to agricultural production in Abassid Caliphate rose up to rule Baghdad for Mesopotamia (parts of present day Iraq and Iran) for 500 years, from 762 AD . It renovated and greatly 6,000 years . The region has low rainfall and is supplied extended existing irrigation schemes in huge with surface water by two major rivers, the Tigris and projects . This elaborate system provided the basis the Euphrates . for the enormously rich culture of Baghdad, which The main challenges to irrigated agriculture in is still remembered in legends such as those of ancient Mesopotamia have always included: Scheherezade, the Caliph of Baghdad, and the Arabian Nights . • Silting of canals – silt built up quickly in the canal • Institutional failure – When the Abbasid economy beds, threatening to block them; began to fail in the 12th century (mostly from • Soil salinity – evidence points to significant events overspending), the canals became silt-choked, the in about 2000 BC, 1100 BC, and after 1200 AD; irrigation system deteriorated, and the lands be- • Water politics – Tensions often arose between up- came more salinized . The deathblow was an act of stream and downstream users . For instance, long nature: massive floods in about 1200 AD changed ago in Sumeria, the people of Lagash felt disadvan- the courses of the Tigris and Euphrates, cutting off taged because their city was far downstream in the most of the water supply to the Nahrwan Canal . Euphrates canal system . So they cut a canal to tap The government was too weak (or bankrupt) by Tigris water rather than rely solely on the Euphra- then to institute repairs, and the agricultural system tes . But after doing so they were dismayed to find collapsed . By the time the Mongols conquered the Tigris water brackish, which rapidly salinized the region in 1258 AD, they occupied what was the soil and destroyed their farming culture . effectively a wasteland . Iraq has remained mostly a • Over-exploitation of resources – After a wave of desert ever since . Moslem expansion overtook Mesopotamia, the Source: Khan et al . (2004) . The Impact of Agricultural Policies on Food Supply 27 BOx 3.4 Gujarat’s Agricultural Success India’s western state of Gujarat is an outstanding per- so that farmers will use surface water instead of former in agriculture—agricultural output has grown pumping from wells, which uses more energy . by almost 10 percent per year over the last decade, • Drip Irrigation Scheme – This ambitious irrigation more than three times the all-India figure . Research scheme aims to conserve energy by assigning by the International Food Policy Research Institute 80,000 ha of land (with 50 percent grants) to farm- (IFPRI) points to three main sources of rapid growth ers on condition they use drip irrigation . It is ex- in Gujarat’s agriculture: (1) cotton output growth (from pected to cut the agricultural sector’s dependence 3 .05 million bales in fiscal 2003 to 11 .2 million bales on electric power . in fiscal 2008, driven primarily by Bt, or insecticidal, • Jyotigram Yojana for rural electrification – This cotton since 2002); (2) output from the high value scheme provides agricultural consumers with con- segment (i .e ., livestock, fruits and vegetables); and (3) tinuous power from dedicated agricultural feeders wheat, which grew at an average of 28 percent annu- for eight hours each day at preannounced hours . ally between fiscal 2001 and 2008, when production • Mass awareness drive for energy conservation – jumped from 0 .6 million tons to 3 .8 million tons . This extensive public education program employs Four areas of reform have contributed to Gujarat’s various agencies to lead energy-conservation agricultural success: workshops, seminars, exhibitions and live demon- strations . Energy audits of industries and the use Technology development and diffusion. While the of capacitors are promoted . public sector has played a role in production and dis- tribution of high-yielding variety seeds such as wheat, Legislative reform. Gujarat was one of the first the private seed sector has taken a lead in developing states to amend the laws governing the marketing and promoting the use of Bt cotton seeds . In Gujarat of agricultural produce and allow farmers to sell their alone, 26 private seed companies have registered 113 output directly to private buyers rather than official varieties of Bt cotton . Not only has the yield more than procurement outlets. In fiscal 2005, Gujarat allowed doubled in five to six years, more than 50 percent of companies to buy crops from farmers one year in the total cotton area in Gujarat is now under Bt cotton . advance, reducing their market risks by allowing them to hedge against price fluctuation . The hedging guar- A holistic approach to electricity and water use. anteed a minimum price and allowed some flexibility Gujarat is a drought-prone state, with irrigation cover to account higher prices at the time of a transaction . of just 36 percent of gross cropped area . Better water It also has encouraged contract farming by attracting management includes concerted efforts to recharge private companies—for example, ITC and Pepsi—to the water table, regulate electricity for agricultural enter into contracts with farmers . use (by separating feeder lines for irrigation and other uses) and providing subsidies to farmers who use Technological advancement. Rejuvenation of water-saving technologies, such as drip irrigation . the agricultural research systems and introduction of innovative extension services made research and Programs include: know-how available directly to farmers on their farms . Under the “Krushi Mahotsav� program, agricultural • Sujalam Safalam (Water Harvesting) Scheme – scientists, elected representatives, and farmers spend Aims to improve surface water supply and a month, during April/May, touring rural areas demon- recharge the water table through construction strating the best technologies for soil health, organic of check-dams and deepening of existing tanks farming, farming inputs, irrigation, etc . Source: Gulati and Shreedhar (2009) . 28 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Notes 8. Basu (2010). See also World Bank (2004). A high proportion of the grains are stored by building pyra- 1. Ganesh-Kumar et al. (2010). mids of sacks of grain on cement platforms and covering 2. Fang, hazell and haque (2000). them with polyester tarpaulins. The system leads to 3. See Deaton and Dreze (2009) on the long-term decline high losses from pests and moisture, and does not allow in availability of food in India. adequate “first in, first out� rotation, which results in 4. Bhutan has a bilateral agreement with India for the ageing of stocks. duty-free import of food articles. Food markets are influ- 9. World Bank (2004). enced by the Food Corporation of Bhutan (FCB), which 10. Ibid. manages the acquisition, management and disposal of 11. Ganesh-Kumar et al. (2007). a small public reserve of rice, wheat, vegetable oil and 12. World Bank (2004). sugar, and purchases of selected food commodities 13. Chakraborty (2009). from India and subsequent selling at controlled prices 14. Ministry of Finance of the Government of India (2011). in district-level retail shops. The FCB’s strategic food 15. Basu (2010). stocks consist of: rice (1,400 tons), wheat (180 tons), 16. Fan, hazell and haque (2000). vegetable oil (58 tons) and sugar (200 tons). 17. Sharma and Thaker (2009). 5. Purchases are made in bulk only, which excludes 18. Fan, Gulati, and Thorat (2008). marginal and small farmers from the price guarantee 19. Kumar and Mittal (2006). offered by FCI. 20. World Bank (2004). 6. Procurement by the FCI absorbed 57 million tons and 21. Shankar, V., h. Kulkarni, S. Krishnan (2011). 55 million tons of mainly rice and wheat in fiscal 2009 22. Kumar and Mittal (2006). and 2010. Procurement of other crops is limited and 23. Rinaudo (2002), Wade (1990). may not influence prices as much. 24. Khan et al. (2004). 7. This is true to the extent that farmers are able to decide 25. Magistro et al.(2004). whether to sell to the FCI or private traders, a choice which is not always available because of crowding out of the private sector. IV The Human Impact of Food Price Inflation T he PoVeRT Y AND NUTRITIoNAL impact of food price spikes on the poor is signif- icant since they spend a larger fraction of their income on food than relatively better off individuals. The malnutrition status of poor households in South Asia—a result of poor diet, lack of access to health services, poor sanitary environment and lack of aware- ness—was already precarious before the increase in food prices. Afghanistan, for example, has the highest levels of chronic child malnutrition in world. Most countries in South Asia have double the rates of child malnutrition of many Sub-Saharan African countries. The food price increase has further exacerbated this vulnerability. Since the last food price spike in 2008, governments in South Asia have strengthened safety nets, but gaps continue to exist. The largest safety net interventions in the region—India’s and Pakistan’s public distribution systems for staple foods—are characterized by high leakages and therefore costs, while errors of exclusion are actually larger than the reverse, i.e. a large number of the deserving poor is not covered. This section presents results of a simula- when it was mostly confined to traded grains, which tion exercise aimed at estimating the likely impact of will make it more difficult for the poor to compen- recent food price increases on the poor. The second sate for price increases by shifting their purchases to part discusses safety net approaches and their effects cheaper calories, foods which are poorer in protein on food security, and the World Bank’s engagement and vitamins and minerals, as was the case during the with governments in the region on safety nets. 2008 crisis. even short-lived food price hikes reduce calorie intake, compromise dietary diversity reducing access to proteins and essential micronutrient rich food and tend to have long-term consequences, especially 1. Impact on Poverty1 on infants and young children.3 The poor experience large declines in their real incomes To understand the magnitude of the problem, we and poor food producers have little opportunity to simulated the likely poverty impact of the food price respond by increasing output within a short period increases that occurred between June and December of time. The evidence from the 2008 food price spike 2010. The analysis is based on survey data for house- suggests that in most countries poverty increases hold food production, sales and consumption of key when food prices rise substantially, even in rural areas, agricultural commodities.4 Given the relatively fast because both rural and urban poor are typically net change in food prices, the analysis assumed that price consumers of food.2 changes have not yet translated into noticeable changes In 2010–11, the rise in food prices is showing in wages. In addition, we have not incorporated possible across a larger range of commodities than in 2008 policy measures that might insulate poor net buyers of South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 29 30 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE 4.1 Poverty Impacts of Recent Price Rises Change in Poverty Headcount Net Change in Poverty Headcount: Rural vs Urban 2.4 3.0 1.9 2.5 Percentage points Percentage points 1.4 2.0 0.9 1.5 0.4 1.0 –0.1 0.5 –0.6 0.0 Bangladesh India Nepal Pakistan Sri Lanka Bangladesh India Nepal Pakistan Sri Lanka Into poverty Out of poverty Net change Urban Rural Impact on Poverty Gap vs Poverty Headcount Estimated or Observed Price Change (June–Dec 2010) 2.5 3.0 2.0 2.5 Percentage points Percentage points 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 Bangladesh India Nepal Pakistan Sri Lanka Bangladesh India Nepal Pakistan Sri Lanka Change in poverty gap % Net change in poverty headcount Beef Rice Sugar Oils and fats Wheat Source: Ivanic et al. (2011). food from the price hike. The results presented below in the poverty headcount is greater than the impact on are therefore indicative only. the poverty gap. Pakistan experiences the highest net The simulations suggest that the number of poor percentage increase in the poverty headcount whereas increased by 1.4 percentage points in South Asian coun- Bangladesh experiences the highest percentage increase tries (Figure 4.1). In India and Nepal, the increase in in the poverty gap due to the food price increase. Nepal the poverty headcount is less than the median while faces the least net change in both poverty headcount Bangladesh and Pakistan are above, with Sri Lanka at the and gap among the South Asian countries. median. For the impact on the poverty gap, in Nepal, Across all the South Asian economies, the median Pakistan and Sri Lanka, the increase in the poverty gap of people exiting poverty is 0.06 percent while those is less than the median while the opposite is true for entering poverty are 1.49 percent, driving 15 million Bangladesh and India. except for Nepal, the net change South Asians into poverty. (Table 4.1). of the South The Human Impact of Food Price Inflation 31 TABLE 4.1 Changes in Poverty Headcount and minerals) and by increasing beneficiary knowledge (‘000) on how to maximize limited household resources for Out In Total nutritional impact (e.g. adequate intra-household allo- cation of food to women and children). Bangladesh –736 .02 3115 .43 2379 .41 India –4944 .82 14168 .88 9224 .06 Social Protection in South Asia since Nepal –18 .32 61 .07 42 .75 the last food crisis Pakistan 0 .00 3301 .84 3301 .84 Sri Lanka –10 .05 304 .64 294 .59 Numerous social protection schemes currently exist in South Asia, including subsidies on food and energy, Source: Ivanic et al. (2011). cash transfers, social pensions, social assistance, food transfers, workfare, stipends, and social care services. The largest South Asian countries have large systems for Asian countries, while Bangladesh has the largest the distribution of subsidized food, while cash transfer percentage change of individuals exiting poverty with programs are very small-scale, often short-term, and the food price hike, it also has the greatest percentage of lacking robust systems for administration and delivery of individuals moving below the poverty line. In Pakistan, program benefits and services. This has been changing there is no decline in poverty. in recent years, with growing investment in well targeted and administered safety net programs (SNPs) in the region. India, for example, has recently introduced a 2. Mitigating the Impact health insurance program for the poor (RSBY), which As shown in the previous section, the current food price features a cashless and paper less system, with strong shock is likely to increase the poverty headcount and private partnerships and a robust monitoring and eval- the poverty gap in the region. Given that poverty is uation system. Pakistan has also recently initiated a still a pressing problem in South Asia, governments are national cash based safety net program (BISP), which called upon to scale up and improve targeting of existing relies on a modern targeting, administration and delivery social protection programs, and where such programs system. As the development of safety net systems takes are weak and nonexistent, to implement safety nets to time, the current preparedness for a food price shock mitigate the impact on the large number of poor. If food with respect to coverage of the poor, and the targeting is distributed as part of a safety net response, it should and quality of administrative systems varies markedly be fortified with essential micronutrients to ensure its across South Asian countries (Table 4.2). high nutritive value safety nets can have a greater impact The 2008 food crisis provides important lessons upon protecting and improving nutritional status, regarding the effectiveness of different safety net through provision of more nutritious foods when food programs (see Box 4.1). At the time of the previous is distributed (e.g. foods fortified with essential vitamins crisis, it became clear that emergency response TABLE 4.2 Safety Net Readiness Assessment in South Asia Assessment Criteria Countries Crisis Ready Have one or more programs with high coverage of poor, highly progressive None targeting and good administration Moderate Base Have one or more operating and progressively targeted programs to Bangladesh, Pakistan, build on, but with less than full coverage and/or a need for administrative India improvements Weak Base A large scale response would require fundamental changes to range, size, Sri Lanka, Nepal, Maldives or targeting of programs and significant building of institutional capacity Unprepared Very small programs with little institutional development, often geared only Afghanistan, Bhutan to specific sub-groups of the population Source: Authors. 32 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries BOx 4.1 Recommendations for Safety-Net Policy Responses Policy responses should be designed according to the poor nutritional status of poor beneficiaries . country context and need to be administered effec- For example, heavy labor during pregnancy may tively and efficiently to reach the target group . A loose compromise the health of the pregnant woman ranking of programs for the short-run response could and the development of the unborn child . Women’s look as follows . participation in public works programs may also limit their ability to care for their children and thus Direct Transfers compromise the growth and development of these • Targeted cash transfers of adequate coverage, children . generosity, and quality is the best option . Programs • Immediate across-the-board wage increases that also provide quality consumer education will through public sector and minimum wages are not lead to better decisions on how the cash is used desirable . Both instruments represent a permanent (e .g . to purchase nutritious food, to improve intra- increase in wages in response to a shock that may household distribution of the food) . be temporary, thereby fueling inflation and fiscal • Where Conditional Cash Transfer (CCT) programs expenditures over the long run . Moreover, they already exist, increasing their benefit or coverage fail to increase wages among the poor, who are may be a key part of the response . However, es- concentrated in the private, informal sectors . tablishing new CCTs may take too long and exclude the neediest or those suffering from acute but Indirect transfers transitory income shocks . • Fee waivers or vouchers for health and scholar- • Other good options would include raising benefits ships for education help households maintain across a large spectrum of social transfers, such access to services even if households become as social pensions, survivorship pensions, disability poorer . pensions, and unemployment benefits, where they • Lifeline pricing for networked utilities can be ap- cover the poor . Food stamps or vouchers have propriate where the poor are connected to the net- slightly higher administrative costs than cash, but work, have individual meters, volume differentiated can be politically popular . tariffs are used, and the subsidized block of service • Food distribution in-kind is appropriate where is consonant with use by low-income households . markets are functioning poorly, where foreign as- • General food price subsidies are distortive, costly, sistance is only available in-kind, or where stra- and hard to eliminate, although sometimes adroit tegic grain reserves need to be rotated . In other choice of commodities can result in transfers that circumstances, in-kind programs will have higher are nearly neutral in incidence and inclusive of the than necessary administrative costs per unit of poor . They also have physical limitations (quantities value transferred as well as potential leakage as in of specific food items consumed) on how much Bangladesh . They also have a limit on how much income can be transferred in this way . General fuel support can be transferred per beneficiary . Different subsidies tend to be very regressive and often not types of food distribution include take-home rations, well targeted . school feeding programs, distribution of fortified foods, onsite feeding through health centers, and Further considerations: ready-to-use therapeutic foods in the home . • In some, but not all, cases it will be appropriate to • Public works programs rarely achieve sufficient scale back emergency social protection interven- coverage to be the whole response to rising food tions again as food prices find their new long-term prices, however, where public works programs ex- level and households and wages adjust to it . How- ist, increasing their benefit or coverage may help . ever, where safety nets were grossly inadequate it It is also important to ensure that public works may be desirable to keep them at scale . programs, which often involve heavy physical • Specific nutrition and health interventions are often labor, be designed so as to not further compromise needed to complement social protection programs . Source: World Bank (2011) . The Human Impact of Food Price Inflation 33 mechanisms were not well developed and that putting provides low-quality rice, which is not of interest for in place best-practice safety net programs was required. better-off consumers. Rice is sold at a subsidized price As these programs would take time to be crisis ready, of 25 taka per kilogram for up to 5 kg per household second-best options were therefore needed to respond using licensed dealers, which are allowed a commission to the immediate crisis needs. Improving coordination of 1.5 taka per kilogram. The government increased among related (small scale) programs enhances their the number of oMS dealers in Dhaka and coverage ability for effective service delivery. Consolidation of has been extended nationwide involving about 3,000 various duplicative safety net interventions under one dealers. During the first eight months of fiscal 2011, government authority, where politically feasible, is 396,000 tons of rice was distributed through oMS, important for enabling efficient and timely responses representing 72 percent of the annual target.6 to future crises. The second scheme employs Fair Price Cards targeted at the most vulnerable as identified by commit- tees composed of government officials, people’s represen- Country Stories5 tatives and school teachers. The government has so far Afghanistan is the least prepared country in South distributed 69,600 tons of rice through Fair Price Cards Asia because it currently has no scalable, targeted SNP. in FY2010–11, and plans to increase the number of existing interventions in Afghanistan remain small in these cards to 2.23 million to cover the ultra-poor house- terms of coverage and funding. The majority of the holds, village defense police, and third- and fourth- poor and vulnerable are not assisted directly through class employees of public and private organizations. In any government-sponsored programs. Food aid is the addition to these main schemes, the government also core safety net, delivered via small and scattered inter- allocates rice under Vulnerable Group Feeding (village ventions including a mix of school feeding, food for level help in periods of distress), Vulnerable Group work, and emergency feeding. Development (food and training for women), Test over the course of 2010, the Ministry of Labor Relief (food for worker as disaster response), Gratuitous and Social Affairs, the line ministry responsible for Relief (food grants disaster relief ), and Food for Work social protection has been working intensively on (rural infrastructure projects for women). preparations for an IDA-funded unconditional cash The Vulnerable Group Feeding (VGF) program is transfer (UCT) pilot, in close cooperation with other targeted at the more geographically food-insecure parts ministries and non-governmental bodies. It is antic- of Bangladesh using a food-vulnerability map devel- ipated that by early summer 2011, evaluation of the oped by World Food Program (WFP). Within these pilot would be completed and the scale-up of activi- districts, various targeting criteria are used to identify ties would be considered. The new program, if eval- the extreme poor—around 60 percent of VGF benefi- uated as a success, could become an intervention to ciaries are from the bottom 40 percent of the popula- respond to various shocks including increased food tion. The recently established employment Generation prices. A pilot community and geographic targeting Program has been recently assessed as well targeted approach is being put in place in response to the rising and generally effective. It could potentially be used as food prices. The World Bank supports this effort with an additional mechanism of response and its ongoing US$2.5 million. presence already assists more than half a million poor The capacity to respond to the food crisis by the households every year. government of Bangladesh is spread among several Current programs spend over 2.8 percent of GDP programs in operation for at least five years, each and reach 4–5 million beneficiaries (15 percent in progressively targeted but with coverage of less than rural and 5 percent in urban areas). Programs provide ten percent of the poorest quintile and concentrated in-kind transfers, cash, or a combination of the two in rural areas. The key programs used to respond to which could be scaled up to respond to a crisis. the food crisis are fairly well targeted to the poor. The government has started a significant process The main program providing coarse rice in rationed to enhance decentralized service delivery and social quantities in open markets (oMS) is a self-targeted accountability. Bangladesh is also aligning itself to program for the poor as the non-poor have few incen- promote a more efficient response during a crisis, in tives to stand in long lines for small quantities of infe- particular through the strengthening of results-based rior quality rice. Thus oMS is self-targeting because it monitoring and evaluation (M&e). 34 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries In India, a plethora of SNPs exist, including for sales through the PDS are fraught with high leakages, the provision of subsidized food, various other in-kind on the one hand because of failures to identify the transfers (e.g., school feeding), public works, and other poor—both failures of inclusion of non-poor house- cash transfers such as social pensions for the elderly, holds and exclusion of poor households who really widows, and disabled; housing; scholarships, and as should have had access—and on the other hand by noted above has a fairly recently-introduced social diversion of subsidized stocks to the open market. insurance (RSBY, a subsidized health insurance) and one recent study shows that 44 percent of persons subsidized rural credit. Centrally-sponsored schemes who should have had access were excluded.7 Another and state-level programs exist side by side. Most of study shows that a large share of relatively better-off these programs still do not fortify the food which is households buy grains from the PDS, while only 30 distributed, despite this being a low cost and techni- percent of households in the lowest expenditure quin- cally feasible approach which would yield significant tile buy from the PDS.8 nutritional benefits to poor households. Data on food provisions to and purchases from PDS The largest program provides subsidized food stores shows large differences between states (Table 4.3). through the Public Distribution System (PDS). Some states suffer from large-scale diversion of food Inefficiencies in the procurement and storage of food meant for distribution to the poor, while others have by the FCI were discussed in Chapter II. In addition, plugged leaks quite successfully. A comparison of data TABLE 4.3 India: Household Consumption vs. Grain Delivieries to the PDS, 2007 Consumption from PDS as per HH survey Grain deliveries to the PDS Consumption/Deliveries Rice Wheat Total Rice Wheat Total Rice Wheat Total (in thousands tons) (in percent) Bihar 80 100 170 970 660 1,630 7 .9 14 .7 10 .7 Jharkhand 100 50 150 540 290 830 18 .5 16 .0 17 .6 West Bengal 350 210 560 1,030 1,500 2,530 34 .3 13 .8 22 .1 Assam 330 10 330 1,130 260 1,400 28 .7 2 .8 23 .9 Gujarat 120 220 340 450 440 880 27 .5 49 .5 38 .4 Rajasthan 40 470 510 160 990 1,140 25 .0 47 .7 44 .6 Uttar Pradesh 1,220 800 2,020 2,580 1,640 4,220 47 .2 49 .1 47 .9 Haryana 20 140 160 60 260 320 35 .6 53 .2 49 .8 Orissa 860 0 860 1,460 130 1,590 58 .8 2 .7 54 .1 Karnatak 980 190 1,170 1,630 270 1,910 60 .0 69 .4 61 .4 Maharashtra 720 780 1,490 1,120 1,270 2,400 63 .7 60 .9 62 .2 Madhya Pradesh 330 810 1,140 430 1,320 1,750 75 .5 61 .5 64 .9 Andhra Pradesh 3,010 20 3,030 3,600 40 3,640 83 .6 46 .8 83 .2 Kerala 840 120 960 860 290 1,150 97 .1 43 .2 83 .6 Himachal Praddesh 200 190 400 230 220 460 86 .9 86 .3 86 .6 Tamil Nadu 3,260 120 3,380 3,620 90 3,710 90 .1 133 .3 91 .1 Punjab 0 150 150 10 150 160 18 .4 98 .8 94 .8 Chhattisgarh 790 10 800 750 30 780 106 .3 28 .0 103 .0 All-India 14,290 4,640 18,930 22,290 10,830 33,120 64 .1 42 .8 57 .2 Source: Himanshu and Sen (2011). The Human Impact of Food Price Inflation 35 on quantities of grains released to “fair price stores� on the extent comparisons are possible, the costs incurred one hand, and household-survey data on the purchases by PASSCo and PFDs are significantly higher than of such grains on the other, shows nearly two-thirds those of private traders, indicating inefficiencies in of the wheat and 40 percent of the rice that is meant handling wheat.10 to go to poor households ends up in the open market. The system of government intervention is inef- In Bihar and Jarkhand, for example, only 11 percent ficient in the sense that producer surplus losses and and 18 percent of the grain delivered to the PDS is budgetary costs from subsidies are significantly higher accounted for in the 2007–08 round of the household than gains for consumers. A recent partial equilibrium survey.9 on the side of the spectrum are Chhattisgarh, analysis of costs and benefits of the government’s wheat Punjab, and Tamil Nadu, where nearly 100 percent of policy concluded that the millers absorb most of the food delivered to the PDS is purchased through offi- benefits from government subsidies, while consumers cial channels. benefit at the expense of farmers.11 Lower farm-gate The Government of India announced pilot prices lead to lower production of wheat, as shown programs for transforming subsidies on LPG and by another recent study which uses a computable kerosene into direct cash transfers in the FY2011–12 general equilibrium model to simulate the effects of a Budget. While the modalities still have to be worked removal of producer taxes and consumer subsidies.12 out, it is hoped that targeting can be improved and The authors conclude that removal of the distortions fiscal savings therefore realized. A successful implemen- in wheat prices would be welfare-improving across all tation of these pilot programs would open the door household groups. Income effects would dominate for broader move away from subsidies toward cash price effects; i.e., income from increases in factor prices transfers, although there is a vigorous debate in India would outweigh welfare losses from higher prices of about whether cash transfers can be a viable alterna- wheat. higher prices of wheat from a removal of subsi- tive to food subsidies. dies would be mitigated by increasing production. As in India, the government of Pakistan maintains To provide a more direct safety net support, and a large system to provide subsidized wheat and a few eventually phase out untargeted subsidies, Pakistan other goods to poor households. PASSCo and PFDs has initiated a new cash transfer program, the Benazir release wheat to flour mills at predetermined, uniform Income Support Program (BISP), to protect vulner- prices across the country. The release prices are gener- able households against chronic poverty and adverse ally below the open market prices and give the govern- economic or agro-climatic shocks. over the last two ment a handle on wholesale wheat prices, although the years, targeting, administrative and technical capacity wheat subsidy mainly benefits flour mills, which use has been strengthened considerably. By early July, wheat from public stores for some of their processing beneficiaries will be determined on the basis of a new and buy additional wheat in the open market, while transparent targeting system. The introduction of this they sell their entire output at higher prices to shops. national safety net has led Pakistan to more than double Wheat and other commodities are also sold at subsi- its SSN spending-to-GDP ratio from 0.4 percent to dized prices directly to urban consumers by the Utility nearly 1 percent. The volatile security situation still Store Corporation (USC) at prices that are 3–15 percent presents a challenge for program implementation in below market prices. parts of Pakistan. Wheat subsidy is incurred at both federal and Sri Lanka has the large-scale Samurdhi program. provincial level. At the federal level, the government It was conceived to alleviate poverty and create oppor- absorbs the cost differential between the domestic tunities for the youth, women, and the disadvan- support and sales price, and extends budgetary support taged. The bulk of program resources are distributed to the Trading Corporation of Pakistan (TCP) and as consumption grants to households, with eligibility PASSCo for losses incurred in their wheat trading determined by a community based targeting system. operations. At the provincial level, wheat subsidies are Consumption grants are provided in the form of food incurred to meet the shortfall that occurs in the trans- stamps, which account for 80 percent of the program’s action of wheat by the Provincial Food Departments budget. Samurdhi also provides basic banking services, (PFDs), particularly incidental charges being borne by insurance, and food-for-work schemes. Food stamps can the provinces, and direct subsidies to the consumer via only be used in “cooperative� stores, which are a part various schemes (e.g., Ramzan package or Sasti Roti). To of a de facto government owned distribution network. 36 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries The program also employs a large number of village eligible beneficiaries. That said, individuals that the level community workers, the niyamakas. program does reach register a high level of beneficiary The Samurdhi program shares the targeting diffi- satisfaction with program delivery. Cognizant of these culties of the Indian PDS: Samurdhi misses almost issues, the Government is investing in improving the 40 percent of households ranked in the lowest expen- financing, governance and administration of its main diture quintile, while a substantial number of house- cash transfer program. holds with higher relative welfare receive Samurdhi consumption grants and other forms of Samurdhi assistance. Around 44 percent of the total Samurdhi 3. Bank Support to Safety Net transfer budget is spent on households from the third, Programs in South Asia fourth, and fifth quintiles—those who are well-off in relative terms.13 The Government is currently investing The Bank has been engaged on safety net issues in in a modern administration and targeting system for South Asia (with the exception of Bhutan). The partic- the Samurdhi program to improve its ability to read ular focus of our engagement is to improve the design the poor. and administration of safety net systems (including In the Maldives, the government provides small their coherence and coordination) so that countries cash transfers, alongside energy subsidies meant to assist are better able to both address chronic poverty and poor households. To phase out untargeted subsidies help households cope with economic or agro-climactic and ensure transfers reach the poor, the Government is crisis. The Bank has been active for several years in this developing a national targeting system to better direct area and our assistance involves not just diagnostics on cash transfers and subsidies to the poorest households program effectiveness but also both analytic and advi- in the country. sory services as well as financial support to improve In Nepal, according to a recent survey of 1,680 program design and implementation The specific nature rural households, two thirds of the poor faced shocks of our engagement is detailed below. in the last year, and a majority of these were drought The World Bank has helped Bangladesh by modi- and weather related. Coping mechanisms are still largely fying and supporting the 100-day employment guar- informal with only 5 percent reporting government antee program with a $150 million loan. With the or NGo support as a coping strategy. however, that revised design, which includes improvements in for said, quarter of all surveyed households participate in example program registry, MIS and the payment at least one safety net program. system, the program should be more responsive during Compared to other South Asian countries, Nepal any future crisis. With World Bank grant support, the has seen the sharpest increase in social protection Government is also in the process of designing a cash spending over the last three years. Spending on social transfer program conditional on beneficiary households protection (including civil service pensions, social utilizing nutrition services for their children under the assistance, and unconditional cash transfers) went up age of two, and for continued attendance at schools by to 2 percent of GDP in 2010/11, from 0.5 percent of their children. The pilot will also include a base uncon- GDP in 2004/05. The expansion is primarily due to ditional amount to act as a safety net. increases in the target population, such as lowering the In the Maldives, the Bank supported the design age criteria for the old age allowance, and the individual and implementation of social pensions for those older benefits for the unconditional cash transfer programs, than 65 through the Bank’s pensions and social protec- as well as the introduction of new programs. Benefit tion project. The Bank is also providing technical assis- levels in existing programs, including the old age and tance through this project to support the development single women’s allowances, have been raised to keep pace of a national targeting system. with inflationary pressures. The cash transfer programs The modernization of administration and delivery through Ministry of Local Development alone reach of the government of Nepal’s safety net program, almost 1 million beneficiaries. A recent Bank study both workfare and social pension program, is being finds that given that categorical nature of the programs, strengthened through the Bank’s Social Safety Net the social pension programs reach all income groups, Project. A conditional cash transfer is also being but that limited resources and weak administration piloted and evaluated to assess how safety nets can systems mean that the programs does not reach all support improvements in human capital of the poorest The Human Impact of Food Price Inflation 37 and most vulnerable groups (and protect this against • Making financing and technical expertise avail- income shocks). able in a timely manner, yet ensuring consis- In Afghanistan, the Bank is supporting the devel- tency of short term response with longer term opment of safety nets through the Afghanistan Pensions investment in safety nets; and and Social Safety Net project. A pilot program is • Working to enhance the evidence base of how being designed and evaluated for potential scale up impacts are manifest and what works in times nationwide. of crises. The Bank is supporting the development of a modern safety net through the BISP program in Pakistan. As the development of the national system Notes will take time, the bank has also financed short term 1. See Annex 4 for more details. This section and the emergency support for militancy affected families annex are based on Ivanic, Martin and Zaman (2011), through the KP/FATA project and emergency cash Estimating the Short-Run Poverty Impacts of the 2010–11 support to families affected by the recent flood through Surge in Food Prices, World Bank Policy Research the Flood emergency Cash transfer project. The Bank Working Paper 5633. is also supporting the Government transform its uncon- 2. See Ivanic & Martin (2008), Dessus, herrera, & de ditional cash transfer program to a conditional cash hoyos (2008) and Wodon & Zaman (2010) for further transfer program to support human capital develop- discussion. ment of the poorest populations, including avoiding 3. See Skoufias, Tiwari and Zaman (2011), Alderman, adverse impact on health and education of the poor hoogeveen and Rossi, (2006), Mghenyi (2009), D’Souza and Jolliffe (2010), and Ahmed and Jansen during crisis. (2010). The Bank is also supporting the Government of 4. Where available, we used country-level data on actual Sri Lanka’s Samurdhi program through IDF and other changes in domestic food prices from Food Price Watch financing to improve its targeting and administration. (World Bank, 2011). For other commodities, where Given the lessons learnt from the crises, going prices are unavailable, import shares reported in Version forward the Bank will focus on these priority areas: 7 of the GTAP database to link global prices with domestic consumer prices is used (see hertel, 1997). • Developing real time monitoring instruments to In the case of Afghanistan, we were unable to estimate understand the level of risk and response read- the impact of price changes on each household’s real income because an estimate of the quantity of goods iness of client countries; produced by each household is unavailable. Instead we • Developing and strengthening safety net systems, estimated the net change in food consumption from including establishing modern targeting, gover- the increase in price, as observed through household nance and administrative structures to ensure consumption data. effective delivery to target groups; 5. See also Annex 5 for a table on food crisis response • Linking safety net programs to participation safety nets in South Asian countries. of the poor in health/nutrition and education 6. To improve the quality of the diet of households who programs and employment schemes to (i) reduce benefit from the schemes, this rice could be readily the impact of crisis or chronic poverty on human fortified with essential vitamins and minerals. 7. Khera (2010). capital formation and (ii) to reduce benefit 8. himanshu and Sen (2011). dependency and promote economic integration 9. Ibid. • Promoting an integrated response of actions, 10. Slam (2003). combining diverse safety net instruments, along 11. Ahmad et al. (2010). with other sectoral interventions in nutrition 12. Ibid. and agricultural investment; 13. Glinskaya, e. (2003). V Policy Options W ITh FooD BeING SUCh A LARGe Safety nets. Increasing the role of the private sector in component of consumption basket and even food grain marketing in India and Pakistan requires without formal wage indexation, food infla- delinking of safety nets from direct public procure- tion—whether their origin is from supply shocks ment of wheat and rice from farmers. This does not or from excess demand—can get passed through to necessarily entail an end to the distribution of subsi- overall inflation. Unlike advanced countries, where the dized food from public stores as shown by the exam- received wisdom is to “look through� these increases, ples of Sri Lanka and Bangladesh. Also, countries could this may not be the best strategy in South Asia, and better protect and improve nutritional status through this means that demand management policies need to provision of more nutritious foods (e.g. foods fortified be deployed earlier than in advanced countries. In the with essential vitamins and minerals) and by increasing case of South Asia, many central banks have begun the beneficiary knowledge on how to maximize household process of normalizing monetary policy with interest resources for nutritional impact (e.g. adequate intra- rate hikes, but in many of them, ex-post real rates are household allocation of food to women and children). still negative suggesting room for further tightening. Some tightening of monetary conditions has been Managing Risks. over the last few years, volatility in achieved by appreciating real exchange rates. In nearly exchange rates, interest rates, and commodity prices all countries in the region, the process of normal- ization of fiscal policy is not complete and in many cases, fiscal balances have deteriorated. Fiscal consol- idation is therefore a priority in many countries both for demand management and to rebuild fiscal space to cope with future shocks. Foodgrain stock management. Important in the whole region, but especially in India given the current situ- ation of high prices coexisting with excessive stocks, and potentially a new more extensive “right to food� based entitlement. A study is underway by CACP covering optimal level of stocks, efficient manage- ment of food grains, and the role of the private sector in procurement and distribution. More could be done to expand the fortification of stocks with essential vita- mins and minerals. Increasing agricultural output and productivity. Considerable work exists on the necessary policies. For example, the Government of India recognizes the need for a comprehensive strategy with a focus on technology, improved water management, rural infra- structure, agricultural diversification, food security, and private sector investment in marketing and agro industry. The success of Gujarat offers salutary exam- ples of how such a comprehensive approach could work. South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 39 40 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries has reached peaks similar to those seen during the interest among borrowers in market-based tools and financial crisis, a trend which seems unlikely to ease assistance for managing risks, particularly those that given uncertain political and economic conditions. affect the government’s budget. (See Annex 6) Increased market volatility has generated renewed Country Pages: Eight countries – Eight Graphic Economic Narratives South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 41 42 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Afghanistan ... driven by the services sector and uctuating Strong, but volatile real GDP growth... agriculture ouput. FIGURE A GDP Growth FIGURE B Contribution to Real GDP Growth, 60% Production 50% 25 40% 20 1.9 30% 15 20% 10 10% 5 0% –10% 0 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11* –20% 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 Agriculture Services Mining Manufacturing Agricultural GDP Growth Overall GDP Growth Construction Industry-others GDP Source: CSO. Source: CSO, IMF and WB calculations. Private consumption is the motor of growth from donor in ows and the security economy... … but trade is declining, FIGURE C Contribution to Real GDP Growth, FIGURE D Trade in Percent of GDP Expenditure 100% 30 80% 25 f.o.b in % of GDP 20 15 60% 10 5 40% 0 –5 20% –10 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11* 0% Pvt Consumption Net Exports Govt. Consumption 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11* Investment (Gross Dom. Fixed) Real GDP Growth Exports Imports Source: CSO, IMF and WB calculations. Source: DAB, IMF. … the current account de cit has shrunk... FIGURE E Balance of Payments …and the afghani continues to appreciate. FIGURE F Nominal Exchange Rates, to Afs (Index Mar,22, 2009=100) 10% 115 0% in % of GDP 110 –10% 105 –20% Euro –30% 100 Dollor –40% 95 –50% 90 –60% 85 –70% 80 Pakistani Rupee –80% 75 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11* 70 Oct-09 Oct-10 Apr-09 Apr-10 Feb-10 Feb-11 Jun-09 Jun-10 Dec-09 Dec-10 Aug-09 Aug-10 Current Account Balance (excl. Grants) Overall Balance Current account (incl. grants) Capital & Financial Account Source: DAB. Source: DAB. Country Pages: Eight Countries – Eight Graphic Economic Narratives 43 Bangladesh Real GDP growth is projected to rise on the back of …while in ationary pressures have worsened, driven strong domestic demand, private investment, and exports... largely by a double-digit rise in food prices... FIGURE A GDP Growth (%) FIGURE B Inflation(%) Y-o-Y 7.0 16 6.6 14 6.4 12 6.5 10 6.2 6.2 8 6.0 6 6.0 5.7 5.8 4 2 0 5.5 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 5.0 FY05 FY06 FY07 FY08 FY09 FY10 FY11 (P) General Food Non-Food Source: Bangladesh Bureau of Statistics & WB Staff Estimate. Source: Bangladesh Bureau of Statistics. …with exports and imports rising in the rst part of the year, in contrast to the sharp fall in remittance which …and growth in money and credit is expected to has since recovered slightly... remain high, as in 2010… FIGURE D Cumulative Growth (%) in FIGURE C Money and Credit Growth (%) Remittance and Imports 30 45 25 35 US$ Million 20 25 15 15 5 10 –5 5 –15 0 –25 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 (Jan) M2 Private Sector Credit Remittances Import Source: Bangladesh Bank. Source: Bangladesh Bank. …narrowing the external current account surplus and ...leaving scal space to deal with stresses likely to emerge pushing down reserves… from high food and fuel prices. FIGURE E Current Account Balance and FIGURE F Revenue and Annual Development Foreign Exchange Reserves Program 4000 6.0 50 14 3500 13 40 3000 5.5 12 2500 30 2000 5.0 11 1500 20 10 1000 4.5 10 500 9 0 4.0 0 8 Apr-10 Oct-10 Jan-10 Jul-10 Jan-11 Jnn10 Dec-10 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 Feb-10 Aug-10 Feb-11 May-10 Nov.10 Mar-01 Sep-10 Mar-11 ADP implementation in first 8 months (% of Total, right axis) CAB (US$ Million, left axis) Reserves (in months of import, right axis) Revenue/GDP Ratio (left axis) Source: Bangladesh Bank and WB Staff Calculation. Source: Ministry of Finance and IMED. 44 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Bhutan Real GDP has averaged more than 8 percent of GDP, but …driven by uctuating contributions from the electricity growth rates show high volatility… and construction of hydropower projects… FIGURE A GDP Level and Growth FIGURE B Contribution to GDP Growth, 50000 15 Production 120% Millions of 2000 Nu. 40000 Percentage Growth 12 Percentage Contribution to (Year-on-Year) 100% 30000 9 80% Annual Growth 20000 6 60% 40% 10000 3 20% 0 0 0% 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 –20% 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Real GDP (Left Axis) Construction Electricity, Gas, and Water All Other Sectors ...grants and electricity, taxes and dividends are ...and scal prudence has resulted in manageable scal government’s main sources of revenue… balances in recent years… FIGURE C Government Revenue FIGURE D Fiscal Balance 35000 4 RGoB Revenue in Millions 30000 2 Fiscal Balance as 25000 Percent of GDP of Current Nu. 0 20000 –2 15000 10000 –4 5000 –6 0 –8 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Electricity Sector Grants Other Sources Fiscal Balance to GDP Ratio …current account de cits averaged about 7 percent of …the nominal exchange rate has uctuated but GDP, but strong donor in ows brought positive balances… appreciated against the dollar in recent years. FIGURE E Balance of Payment FIGURE F Nominal Exchange Rate 20% 48 Percentage Share of GDP 10% 46 Nu. per US $ 0% –10% 44 –20% 42 –30% –40% 40 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Current Account Overall Balance of Payments Exchange Rate Source: BMacroeconomic Framework Coordination Committee of Bhutan, Ministry of Finance, January2010. The 2010/11 figures are Revised Estimates. Country Pages: Eight Countries – Eight Graphic Economic Narratives 45 India A strong agricultural rebound in 2010 bolstered GDP …private demand was strong, while investment led the growth, but industrial performance fell in Q3… recovery in 2010. But recent quarters saw a strong drop-o … FIGURE A Quarterly GDP by Sector of Production FIGURE B Quarterly GDP by Sector of Use (y-o-y change, in percent) (y-o-y change, in percent) 16% 70% 14% 60% 12% 50% 10% 40% 8% 30% 6% 4% 20% 2% 10% 0% 0% –2% –10% –4% –20% 07–08 Q1 07–08 Q2 07–08 Q3 07–08 Q4 08–09 Q1 08–09 Q2 08–09 Q3 08–09 Q4 09–10 Q1 09–10 Q2 09–10 Q3 09–10 Q4 10–11 Q1 10–11 Q2 10–11 Q3 07–08 Q1 07–08 Q2 07–08 Q3 07–08 Q4 08–09 Q1 08–09 Q2 08–09 Q3 08–09 Q4 09–10 Q1 09–10 Q2 09–10 Q3 09–10 Q4 10–11 Q1 10–11 Q2 10–11 Q3 05–06 Q1 05–06 Q2 05–06 Q3 05–06 Q4 06–07 Q1 06–07 Q2 06–07 Q3 06–07 Q4 Agriculture Services GDP Industry Total Investment Private Government Consumption Consumption Consumption While wholesale price in ation moderated, core in ation …and with a stable rupee-US dollar exchange rate, the in ation increasingly drove overall in ation... di erential with major trading partners led to real appreciation. FIGURE C Components of Wholesale Price Inflation FIGURE D Real Exchange Rate (y-o-y change, in percent) (1993=100) 12 110 10 105 8 100 6 95 4 90 2 85 0 80 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Core Food Energy With a strong revival in exports and slowing of imports in the …non-food credit growth recovered, but is still low second half of 2010/11, the current account de cit stabilized... compared with the 2005–2007 period. FIGURE E Current Account Deficit FIGURE F Non-food Credit (in US$ billion) (y-o-y change, in percent) 20 40 10 35 0 30 –10 25 20 –20 15 –30 10 –40 5 –50 0 Dec-01 May-02 Oct-02 Mar-03 Aug-03 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 1982–83 1984–85 1986–87 1988–89 1990–91 1992–93 1994–95 1996–97 1998–99 2000–01 2002–03 2004–05 2006–07 2008–09 2010–11 Source: CSO, RBI, CEIC. 46 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Nepal Growth accelerated to about 5 percent, post-con ict, with …leaving high food and imported in ation to drive the CPI consumption the main driver and investment and exports into double digits, though non-food in ation has been playing lesser roles… contained… FIGURE A Real GDP growth decomposition by FIGURE B CPI Nepal and India expenditure (in percent) (y/y change) 20 25 15 20 10 5 15 0 10 –5 –10 5 –15 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 F10 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Consumption Gross fixed capital formation Exports GDP growth Nepal Food Nepal Non-Food Nepal CPI India CPI Industrial …but accommodative monetary policy and high remittance allowed consumption-fueled imports and high trade de cits. …partly because scal prudence has been maintained... Slowing remittance brought reserve losses, lower M2 growth. FIGURE C Overall and Primary Balances FIGURE D Remittances and Trade Deficit (in percent of GDP) (as percent of GDP) 1 30 0 25 –1 20 –2 15 –3 10 –4 5 0 –5 –5 –6 –10 –7 2010 2011 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY 10 First six (est.) months Overall Balance Primary Balance Worker Current Reserves, Trade deficit remittances account balance net change incl. sevice Rapid private sector credit expansion fueled a real estate boom, …leading to fewer real estate transactions and a sharp rise now busting on a liquidity crunch, lower M2 growth and in speculative gold imports, while the asset quality of banks central bank interventions... with high real estate exposure looks threatened. FIGURE E Private credit growth and interbank FIGURE F Land revenue and gold imports interest rates (in percent) (in NRs. million) 35 45000 30 40000 25 35000 20 30000 15 25000 20000 10 15000 5 10000 0 0 FY06 FY07 FY08 FY09 FY10 FY10 Six FY11 six Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 months months Land revenue Gold imports Weighted Average Private credit M2 growth Interbank Transaction Rate growth rate Country Pages: Eight Countries – Eight Graphic Economic Narratives 47 Maldives Economic growth is in sync with the fortunes of tourism... …which outstrip the contributions of government and FIGURE A Real GDP Growth, % construction... FIGURE B Contribution to Real GDP 50% 40% 20 30% 15 20% 10% 10 0% 5 –10% 0 –20% –30% –5 –40% –10 2003 2004 2005 2006 2007 2008 2009 2010Est 2003 2004 2005 2006 2007 2008 2009 2010Est Overall GDP Growth Tourism GDP Growth Fisheries Tourism Government Administration Other Construction GDP …while higher import prices drive up food in ation... …and Eastern visitors begin to overstep the Western trend. FIGURE C Inflation, Malé FIGURE D Tourist Arrivals Composition 0.35 2007 2010 0.30 0.25 0.20 5% 6% 5% 0.15 15% 0.10 16% 0.05 0.00 15% –0.05 64% 73% –0.10 –0.15 2003 2004 2005 2006 2007 2008 2009 2010Est Non Food Food Europe Asia excl. China China Others Trade plays a key role... …while BOP pressure begins to undermine the currency peg. FIGURE E Trade, as a percent of GDP FIGURE F Balance of Payments, % of GDP (including Services) 40 140 30 120 20 10 100 0 80 –10 60 –20 40 –30 –40 20 –50 0 –60 2003 2004 2005 2006 2007 2008 2009 2010Est 2003 2004 2005 2006 2007 2008 2009 2010Est Imports to GDP Exports to GDP Current AC Bal Financial AC Bal Overall Balance Source: MMA. 48 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Pakistan Devastating oods in July–August 2010 interrupted ...mitigated by strong growth in workers’ remittances, recovery and resulted in weak real GDP growth… bringing in a positive current account for the rst three FIGURE A GDP Growth quarters of 2011... FIGURE B Current Account Balance 10% 9% 15 8% 10 7% 5 US$ billions 6% 0 –5 5% –10 4% –15 3% –20 2% –25 –30 1% FY06 FY07 FY08 FY09 FY10 (July–Mar) 0% FY11 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Trade Balance Current transfers Services (net) Income (net) CAB …this, along with external disbursements, has improved ...but the biggest concern remains the large scal de cit arising the international reserve position, with mild appreciation from at tax revenue collection and expansionary spending… of the exchange rate... FIGURE D Fiscal performance (as % GDP) FIGURE C SBP Forex Reserves and Nominal 16 24 Exchange Rate 14 20 86 16,000 85 12 16 84 14,000 83 10 12 82 12,000 81 8 80 10,000 8 79 78 8,000 6 4 77 76 6,000 4 0 2007/08 2008/09 2009/10 2010/11* 14-Jan-09 14-Mar-09 14-May-09 14-Jul-09 14-Sep-09 Nov-09 14-Jan-10 14-Mar-10 14-May-09 14-Jul-10 14-Sep-10 14-Nov-10 14-Jan-11 14-Mar-11 Fiscal deficit excl grants Tax Revenue Expenditure (RHS) SBP Reserves (US$ million) NER RS/US$ (LHS) *Projected …which contributes to persistent and worrisome …leading the central bank to keep the policy discount double-digit in ation... rate high. FIGURE E Trend in Inflation... FIGURE F Interest Rates 24 15% 22 20 14% 18 16 13% 14 12 12% 10 5-Jun-09 10-Jul-09 14-Aug-09 18-Sep-09 23-Oct-09 27-Nov-09 1-Jan-10 5-Feb-10 12-Mar-10 16-Apr-10 21-May-10 25-Jun-10 30-Jul-10 3-Sep-10 8-Oct-10 12-Nov-10 17-Dec-10 21-Jan-11 25-Feb-11 1-Apr-11 8 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 12 m moving Average Y-O-Y Core Y-O-Y Policy Rate 6-m KIBOR Country Pages: Eight Countries – Eight Graphic Economic Narratives 49 Sri Lanka Strong and consistent real GDP growth... …driven by services and supported by manufacturing and FIGURE A Real GDP Growth, % construction… FIGURE B Contribution to Real GDP, % 9% 8% 9 7% 8 6% 7 5% 6 4% 5 4 3% 3 2% 2 1% 1 0% 0 2003 2004 2005 2006 2007 2008 2009 2010Est 2003 2004 2005 2006 2007 2008 2009 Overall GDP Growth Agricultural GDP Growth Agriculture Services Mining Manufacturing Construction Industry Others GDP …combined with higher consumption to fuel GDP growth… …though trade declined... 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(2008). “The Commodities Market Commodity Futures Trading Commission on the Bubble: Money Manager Capitalism and the Role of Speculators in Setting the Price of oil.� Financialization of Commodities�, Public Policy Washington, D.C., August 5. Brief 96. The Levy economics Institute of Bard Verleger, Phillip (2010). “Don’t Kill the oil Speculators�, College. International Economy: The Magazine of International Wright, B. (2009). “International Grain Reserves and Economic Policy Winter 2010, 64–66. other Instruments to Address Volatility in Grain Wade, R. (1990). “on the technical causes of irriga- Markets�, Policy Research Working Paper 5028. The tion hoarding behaviour, or why irrigators keep World Bank,Washington, D.C. interfering in the main system. In R. K. Sampath, and R. A. Young (eds.), Social economic and insti- tutional issues in Third World Annex 1 Developments in Global Commodity Markets Food Supply and Demand overall, the world stock-to-utilization balance for Projections1 cereals appears to be in a relatively healthier state than in 2008. however, the wheat markets appear to be more According to FAo projections, the global cereals susceptible to price volatility than rice markets. The market is expected to tighten considerably in 2011 stock-to-utilization ratio is forecast to be higher for with total utilization exceeding world production. rice than for wheat, which largely explains the expec- The evolution of global prices for the remainder of tations in wheat markets driving price increases in the 2011 will depend mostly on harvests of the winter last few months (Table A1.1). crop, with any negative news on weather and harvest Modest but steady increase in global grains leading to further price increases. The winter crop consumption, variable global grains supply due to accounts for the bulk of annual global wheat output weather shocks, trade policy responses to shocks, and and the overall wheat area for 2011 is now forecast to resulting draw-downs of stocks held by the major grains increase only marginally by about 1 percent over 2010. exporting countries have combined to increase both early indications suggest crop sowings were margin- uncertainty in global grains markets and broader food ally reduced in the Russian Federation but close to price volatility since 2005. Global grains consumption last year’s levels in Ukraine. has increased by 26 percent since 1998/99, driven by TABLE A1.1 World Wheat and Rice Balances (million tons) Wheat 2007/08 2008/09 2009/10 Estimate 2010/11 Forecast Change: 2010/11 over 2009/10 (%) Production 611 685 682 653 –4 .3 Supply 722 829 862 833 –3 .4 Utilization 629 647 659 667 1 .2 Ending stocks 144 180 202 189 –6 .4 World stock- to 22 .2 27 .1 30 .2 27 .7 –8 .3 utilization-ratio % Rice 2007/08 2008/09 2009/10 Estimate 2010/11 Forecast Change: 2010/11 over 2009/10 (%) Production 440 458 455 466 2 .3 Supply 544 569 580 591 1 .8 Utilization 436 445 449 460 2 .5 Ending stocks 111 125 130 136 4 .8 World stock- to 24 .9 27 .4 27 .2 29 6 .6 utilization-ratio % Source: FAO. Production data refer to first year shown. Supply is measured by adding production to opening stock. South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 55 56 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE A1.1 Rising World Consumption, variable Supply, and estimated consumption and trade on the other. and Stock Draw-Downs have Fueled Consecutive Grain Price The stock-to-use measure thus includes (conceptually) Spikes all commercial, public and household stocks, whether 2,000 40 or not the stocks in question are actually available for international sale. over half of global stocks of rice and Millions MT (Consumption, 1,900 35 wheat are estimated to be held by China and India, Percent (Stock-to-Use) 1,800 30 where public-sector stocks play a major role.4 There Production) is global uncertainty as to the triggers for release of 1,700 25 these stocks, their actual magnitudes, and their condi- 1,600 20 tion, and it is not clear whether perceptions of these 1,500 15 factors are adequately reflected in international prices. International markets, however, are clearly very sensitive 1,400 10 to changes in perceptions of stocks likely to be avail- 1998/1999 2000/2001 2002/2003 2004/2005 2006/2007 2008/2009 2010/2011 able for sale. When the USDA downsized its estimates of US corn production in the fall of 2010, the upward impact on global corn prices was sharp and immediate. Stock-to-Use Production Consumption For the time being, stock-to-use ratios for major Source: USDA. individual exporters tend to be a better indicator of grain price volatility than global stock-to-use measures. The US, for example, which accounts for 55 percent of population growth in developing countries, higher global exports of corn, presently has a domestic corn consumption of animal protein in response to rising stock-to-use ratio of 5 percent, an all-time low.5 This incomes, and increased demand for biofuels. In the can be compared with a published—and historically same period grain production increased by 20 percent, ample—global corn stock-to-use ratio of 20 percent. but with erratic weather causing significant produc- For wheat, France, a major exporter to North Africa, tion variability over years. Global stock draw-downs has a 7 percent stock-to-use ratio, which is very low compensated for the production shortfalls with overall compared to the global figure of 26 percent. The bottom stocks falling below 20 percent of consumption by line is that improvements in understanding of which 2006/07 (Figure A1.1). FAo projects annual cereals stocks will actually influence international prices may demand growth of 1.4 percent between 2000 and themselves help increase market price predictability. 2030, including demand for grains used for biofuels, The current global grains market situation is similar compared to 2.2 percent during the preceding 40 to the food price spike in 2007/2008 in three respects, year period.2 While such a long-term rate of demand as listed below.6 growth may at first appear modest, it still requires an increase in supply, and in this respect to a very large • Higher energy prices. Agriculture is significantly base. This poses an increasing challenge for growth of more energy intensive than industry with inputs agricultural productivity in the face of growing land such as irrigation, fertilizers and transport most and water constraints and greater incidence of extreme heavily affected. weather events. In some regions demand is outstrip- • Depreciation of the US dollar against major curren- ping supply, and unless there is growth in productivity cies. Trade in many agricultural commodities is they will become increasingly import dependent and denominated in US dollars. expressed in other vulnerable to variations of global prices. currencies, price increases and volatility are less The world grains stock-to-use ratio is often cited dramatic.7 as a measure of both the physical liquidity of grain • Financial investment in agricultural commodi- markets and an indicator of the likelihood of grain ties remains high. The Chicago Board of Trade price increases. historical evidence suggests that grain alone accounted for an estimated US$ 5 trillion prices spike when global stock-to-use ratios are low.3 in wheat, corn and soy futures trading in 2010 Both the FAo and USDA publish stock-to-use esti- (28 percent over the previous year, but down mates. They reflect the difference between estimated from US$ 6 trillion in 2008). Clearly the value production and carry-over stocks on the one hand, of these financial transactions far exceeds the Annex 1. Developments in Global Commodity Markets 57 respective US crops (although the exchange is Moreover, the surge in wholesale food prices is slowly also used for hedging transactions for non-US filtering into retail prices in poor and rich nations alike. crops). however, there is no evidence that the This rise in commodity prices is not restricted to significant increase of financial investment in a particular group of commodities but broadly affects agricultural derivatives influences the level of agricultural, energy and metal prices.10 (Figure A1.2) In prices (see Annex 5). nominal prices, between 2009 and 2010, agricultural prices rose on average by 17.0 percent, energy prices by Yet, the current situation also differs from 2008 26.5 percent and metals and minerals by 47.5 percent. in several critical respects. Firstly, recent international Both the average agricultural and energy price indices price increases are more widespread across agricultural have surpassed the peak reached during the food and commodities than in 2008 and include increases in fuel price rise of 2008. In fact, prior to the current sugar, edible oils, beverages, animal products, and raw price rise, agricultural, energy and metals and mineral materials such as cotton, rather than being predom- prices in 2008 reached their highest level since 1960. inantly driven by major grains. Secondly, weather even though average real agricultural and metal and is more clearly a major factor, and the frequency of mineral prices in 2010 surpassed their 2008 levels, the droughts, floods and extreme temperatures seems to be average real agricultural price in 2010 is still below its increasing. on the positive side, trade policy responses record high of 280.65 in 1974.11 For 2010, the agri- so far have been less damaging than in 2008 when they cultural average real price index is 191.81. Average real greatly exacerbated shortages. commodity prices for agricultural energy and metals The bottom line is that agricultural commodity and minerals are also on an upward trend in 2010 after price uncertainty and volatility are likely to continue declining in 2009. The average real energy price in in the foreseeable future, largely due to the continuing 2010 is 224.77, still below its historic high of 273.56 uncertainty on the supply side. In the short-term, in 2008 (Figure A1.3). assuming a normal 2011/12 crop year, international Although each market has very different demand food prices are expected to decline from the current and supply dynamics, the uniformity of the price peak, but they are likely to remain above their pre-2007 increases across a variety of commodity markets reflects levels. over the longer term, energy prices and total both the interconnectedness of markets and the macro- factor productivity are two key forces likely to shape economic trends influencing prices in these markets. world food price levels. There are numerous factors that may be contributing Since prices of staples remained 25–35 percent to this commodity price surge and each factor may higher in many developing countries in 2009 compared have a varying impact on the individual market’s price to 2006, even when global prices fell,8 many farmers increase. For example, buoyant demand from emerging had an incentive to increase production. higher local economies, supply constraints and restrictions to trade, production allowed developing countries in aggre- gate to enter 2010/11 with higher production (3.8 percent), higher stocks (3.4 percent), and more trade FIGuRE A1.2 Commodity Price Index (Nominal Prices) (5.4 percent) than in 2009/10. This which helped 360 offset sharp, weather-induced production declines in 310 developed countries.9 260 Index, 2000=100 210 160 Commodity Prices 110 The recent rise in global commodity prices, from July 60 2010, is fueling headline inflation in both advanced and 10 emerging economies. of all the different commodity –40 groups, the global price rises and price volatility of agri- 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 cultural commodities has percolated to the top of the political agenda in many of the emerging economies Agriculture Energy Metals & minerals and, in particular, the South Asia region’s economies. Source: World Bank. 58 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE A1.3 Commodity Price Index (Real Prices) Index registered 292.61, slightly above the record high 360 of 292.60 recorded at the height of the food crisis in 310 June 2008. This is the largest annual increase since July 260 2008. The average growth for the first three months Index, 2000=100 of 2011 is 33.1 percent over the previous year. The 210 rise in nominal agricultural prices is a function of 160 recent supply shocks and long-term structural change 110 in global demand. In general, long-run worldwide 60 demand for food has been driven by three factors: 10 (1) rising population growth; (2) rising levels of afflu- –40 ence; and (3) increasing demand for biofuels.12 For 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 instance, demand pressure from across the emerging Agriculture Energy Metals & minerals world, particularly in China and India—with 2.5bn people between them—has placed upward pressure Source: World Bank. on the cost of food. Additionally, arable land is being lost with the increasing use of corn, wheat and sugar cane for the production of biofuel, ethanol in partic- particularly for food, have all contributed to the latest ular. Record ethanol production in the US will also global commodity price rise. The role of emerging swallow up nearly 40 per cent of the US corn crop in markets in driving this price hike is related to rising 2010/11, from 31 percent of output in 2008/09. This income levels in these economies coupled with an jump in food prices may push up long-term general improved standard of living, population growth and price expectations. In addition, real food prices regis- increased urbanization. Also, the weakness of the US tered 249.9 in February 2011, which were last witnessed dollar has fueled the increase in commodity prices, in April 1975. Real food prices have been steadily rising particularly crude oil. since January 2001 after declining from record highs in November 1974. (Figure A1.4) Average food price volatility has increased in the 2000s, with volatility in grains, vegetable oil and Agriculture soybeans rising each decade (Figure A1.5). Since the From mid-2010 there has been a steep rise in the price 1960s, sugar has consistently been the most volatile of most agricultural commodities, including food agricultural commodity over each decade, while meat crops. In February 2011, the World Bank Food Price prices have been least volatile on average. The increase in volatility is due to an increase in the frequency of supply shocks combined with limited reserves and FIGuRE A1.4 Food Price Trends increase in the production of biofuels, increase in global macroeconomic volatility post-2000 and the 450 emergence of India and China. 400 Falling stocks and rising consumption-to- 350 production drive up cereals prices (Figure A1.6). 300 Food Prices 250 In the second half of 2010, cereals prices grew by 200 17.9 percent on average, with corn prices contrib- 150 uting 73.2 percent to the increase. This trend has 100 continued, with February 2011 recording the highest 50 year-on-year growth for cereals: 54.1 percent since 0 August 2008.13 A rapid rise in corn prices since July 2010 has been the main driver of growth in cereals 1960M01 1963M01 1966M01 1969M01 1972M01 1975M01 1978M01 1981M01 1984M01 1987M01 1990M01 1993M01 1996M01 1999M01 2002M01 2005M01 2008M01 2011M01 prices registering 15 percent and 33 percent quarter- on-quarter growth in the third and fourth quarters Nominal Food Price Index Real Food Price Index of 2010. Corn prices hit 30-year highs with stocks Source: World Bank. dwindling rapidly. Given that the US is the world’s Annex 1. Developments in Global Commodity Markets 59 largest corn producer, the decline in US corn stocks- FIGuRE A1.5 Food Price volatility to-demand is a harbinger of higher corn prices in the (Average Coefficient of Variation) future. In 2009/10, for the first time since 2006/07, 0.18 consumption surpassed production with corn stocks 0.16 declining by 1.8 percent. Corn (US No. 2, Yellow) 0.14 prices rose by 52.9 percent in January 2011, its 0.12 highest annual growth rate since August 2008. The 0.10 growth rate in corn prices has been rising exponen- 0.08 tially since July 2010, averaging 34.6 percent in the 0.06 last seven months. The USDA expects corn stocks to 0.04 0.02 decline by 3.5 percent in February 2011 from those 0.00 of the previous month. Increased demand for high- Total Food Grains Vegetable Oils Fruits Meat Sugar Soyabean Meal Soyabeans fructose corn syrup from countries such as Mexico, as they substitute away from higher priced sugar, contributes to higher demand for corn. China, after 1960–79 1980–99 2000–10 years of self-sufficiency, was a net importer of corn in 2010, partly because of drought—bringing in nearly Source: Authors calculations. 1.3 million tons compared to 47 thousand metric tons the previous year. This aggravated the global shortage of corn stocks. In addition, rising wheat against shortages. This “accordion effect� of buying prices prompted corn substitution, further raising more now to guard against higher prices later serves corn consumption, lowering stocks and raising prices. to bring forward price increases. Between June 2010 In February 2011 wheat prices hit their highest and December 2010, the price of wheat increased by level in 34 months. In February benchmark wheat large amounts in Kyrgyzstan (54 percent), Bangladesh prices escalated on average by 79.4 (y-o-y), reaching (45 percent), Tajikistan (37 percent), Mongolia (33 a US$ 350 per ton. This is the highest rate of increase percent), Sri Lanka (31 percent), Azerbaijan (24 since April 2008. Wheat prices have been affected percent), Afghanistan (19 percent), Sudan (16 percent), by a string of supply shocks: drought-induced crop and Pakistan (16 percent). overall, high prices have failures in leading cereals exporters Russia, Ukraine induced farmers across key producing regions (the and Kazakhstan; concern about the La Nina weather european Union, Russia, and Ukraine) to increase phenomenon bringing dryness in the crop belts of acreage. The concerns about fragility notwithstanding, Argentina (the world’s second-largest corn exporter) and Brazil; and a cold snap in the US, the world’s biggest wheat exporter, all of which make approaching harvests seem fragile. Poor harvests have led traditional wheat exporters to impose export restrictions.14 The cumula- FIGuRE A1.6 Grain Consumption and Stocks tive impact of these supply shocks has already dented 2.50 30 wheat stocks. February 2011 production fell by 218 20 thousand metric tons, a decline of 0.12 percent over 2.00 10 the previous month. Ratio China, the world’s biggest wheat producer, with 1.50 0 % 18 percent of the global harvest, may have to buy –10 large quantities on global markets, putting even more 1.00 pressure on wheat prices.15 These production shocks, –20 coupled with narrowing of domestic stocks world- 0.50 –30 wide, have resulted in hoarding of wheat by North 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 African and Middle eastern countries, which are rela- tively dependent on international markets for food supplies. Since wheat is a large contributor to food infla- Consumption-to-Production Ratio Growth rate in Ending stocks (r.h.s.) tion, governments are prone to hoarding it as a hedge Source: FAO. 60 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries better yields are expected for 2011, barring adverse Unlike the food price hike of 2007/08, there is a weather events similar to 2010. shift in the composition of demand towards, not only Rice prices recorded in March 2011 declined 1.9 mean, but also fats and oils and sugar are contributing percent over the previous year. This represents 15 more to the rise in food prices. Between July 2010 and consecutive months of declining rice prices.16 The March 2011, fats and oils contributed 40 percent to falling rice price is indicative of rising levels of produc- the average annual growth. tion and ample global stocks. Good harvests in Thailand Sugar prices rose consistently throughout the global and Vietnam, the world’s two largest exporters, keep financial crisis, hitting a 30-year high. US raw sugar the export market well supplied and the cost of the prices hovered close to 40 cents per pound between rice below the record level of US$ 960 per ton in January 2010 and March 2011, the highest since January May 2008. however, month-on-month the bench- 1975. World sugar prices rose by approximately 100 mark rice price has risen between July and December percent between May 2010 and January 2011, and 2010—partly in response to rice importers in Asia declined marginally by March 2011. Prices have been having stepped up buying. In the last week of January driven by supply shortfalls from Brazil, the largest 2011, Bangladesh, one of the world’s top three rice exporter, and weather shocks in Australia. Globally, importers, raised its overseas buying target to 1.2m stocks of sugar declined by 6.4 percent in the September- tons, up from an initial estimate of 600,000 tons. october marketing seasons of 2008/09 and 2009/10. Coupled with this, crop failures in Indonesia brought Recently, cyclone Yasi provided a supply shock to world- on by heavy rain are contributing to the recent price wide sugar output, damaging cane crops in Australia, rise, given that Indonesians eat more rice per capita the world’s third-largest exporter of the sweetener. In than any other country.17 The domestic price of rice addition, falling expectations for the crucial Indian was significantly higher in Vietnam (46 percent) and crop, and speculation that Russian imports could be Burundi (41 percent) between June–December 2010. brought forward, contributed to rising global sugar Rice prices have increased in line with global prices prices. Rising sugar consumption in BRIC and devel- in Indonesia (19 percent), Bangladesh (19 percent), oping countries has also helped fuel the price rise.19 and Pakistan (19 percent). These Asian countries are Vegetable oil prices have risen at an annual rate large rice consumers, especially among the poor. Rice since october 2009. Since the fourth quarter of 2010, price increases in Sri Lanka (12 percent) and China coconut oil prices risen rising every month above 100 (9 percent) were relatively moderate in the second half percent annually. Coconut oil prices have risen by 192 of 2010, while in Cambodia and the Philippines the percent between october 2009 and January 2010. retail price of rice remained largely unchanged during With most South Asian countries using coconut oil for this period. cooking, this will have an impact on the region. For Both corn and soya bean meal are important ingre- instance, the price of cooking oil rose by 43 percent dients in animal feed as carbohydrate and protein.18 in Bangladesh over the past year. The tightening market partly reflects stronger appe- Fertilizer prices have risen steadily by 47 percent tites for meat in emerging markets. The rising between September 2009 and January 2011. Fertilizer incomes in emerging markets have shifted consump- prices are affected by crude oil prices, with modern tion towards middle-class foods with high protein farming relying on hydrocarbons in the form of fertil- content. Beef prices rose from US$ 2,648 to US$ izer and fuel for tractors and transport (Figure A1.7). 4,140 per ton between october 2009 and March Thus, fuel prices influence fertilizer prices which in 2011, representing close to a 56 percent increase. turn influence food prices. Therefore, as the growth The rising average price of meat and poultry is likely of India and China impacts the cost of energy this to continue in 2011 if the forecast of rising demand inflates the input cost and subsequently the price of by mainly BRIC economies is realized. In addition, food. Moreover, food prices are less volatile than fertil- rising demand for meat has increased imports of soya izer prices; the latter having risen more than food prices bean meal which rose in China by 18.6 percent in during the 2008 food price crisis, lowering the relative 2009/10 (y-o-y). The demand for milk powder is food-to-fertilizer price ratio (Figure A1.8). The rela- also a “middle-class� good whose price has risen in tive food-to-energy price ratio was constant during the past year with increased demand from Brazil, the food-price crisis of 2008. This shows that farmers China and Russia. may not be able to reap the full benefits of higher food Annex 1. Developments in Global Commodity Markets 61 prices because input costs, such as fertilizer and fuel FIGuRE A1.7 Fertilizer vs Crude Oil Price Index prices, may be rising faster than the earnings from 700 their food production. 600 500 Energy and Metals 400 Index 300 Crude oil prices reached their highest levels in two 200 years in January 2011, surpassing US$ 100 a barrel.20 100 The surge continued through March, when they were 36 percent higher than a year earlier. The inability 0 2005H1 2005H2 2006H1 2006H2 2007H1 2007H2 2008H1 2008H2 2009H1 2009H2 2010H1 2010H2 2011Q1 of production to keep up with growing demand has led to a decline in world stocks by 0.1 percent and net demand rising by 0.7 percent annually in 2010. Fertilizers Petroleum crude Though stocks are falling, they are still at comfort- Source: World Bank. able levels, unlike the 2008 fuel price crisis. When the global financial crisis depressed world oil demand, the opec cartel’s effective idle capacity surged to a peak of more than 6 million barrels per day in early 2009. Although aluminum prices rose by 32 percent to Since then, rising consumption in emerging markets US$ 2,555 per ton from mid-2010 to March 2011, has eroded opec’s effective spare capacity to below 5 aluminum remains a long way from its peak of US$ million barrels per day, by the IeA’s estimate. Recent 3,380 per ton, in July 2008. (Figure A1.9) Aluminum political uncertainty in the Middle east-North Africa is used for numerous consumer and industrial prod- region is limiting supply further. ucts, from cars and aircraft to drinks cans. Thus Moreover, there has been a huge structural shift aluminum prices are also rising with growing demand in oil demand. Fifty years ago, the centre of gravity from emerging markets, given that it is the most widely for demand was in the US and europe. Nowadays it used metal after steel. This has pushed the benchmark has shifted to Asia. oil demand in emerging markets aluminum price to US$ 2,500 per ton for the first time provides the bulk of incremental growth. We expect since the collapse of Lehman Brothers. Aluminum non-oeCD oil demand growth to expand at four times prices may continue on this upward trajectory due to the rate of oeCD growth in 2011. supply constraints in the market. China has curbed With rising crude oil prices, alternate sources of energy such as natural gas are becoming increasingly popular. however, the rising supply of shale gas in North America is keeping gas prices low. The US resi- FIGuRE A1.8 Food vs Fertilizer Prices dential gas price has fallen steadily from US$ 15.50 120 1.20 per thousand cubic feet to US$ 9.80 between August 100 1.00 2010 and January 2011. 80 Since coal is relatively cheaper than crude oil, rising 60 0.80 Growth (%) demand has led to rising coal prices throughout 2010. 40 0.60 In January 2011, coal prices rose to US$ 137 per ton, 20 0 0.40 an annual increase of 41.2 percent. Bad weather has –20 hit key coal exporters Colombia and Australia, as 0.20 –40 the market is extremely vulnerable to cold weather. –60 0.00 Furthermore, China is poorly endowed with alter- 2005H1 2005H2 2006H1 2006H2 2007H1 2007H2 2008H1 2008H2 2009H1 2009H2 2010H1 2010H2 2011Q1 native energy sources and the speed of its coal-based electricity expansion has forced it to start importing coal for the first time. China uses coal to produce elec- Fertilizers Nominal Food Price Index Energy tricity, needed for smelting aluminum. This too has Ratio of Food to Fertilizer price Ratio of Food-to-Energy Price pushed up coal prices. Source: World Bank. 62 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries FIGuRE A1.9 Copper and Aluminium Prices Notes 12,000 100 1. This section draws heavily on World Bank (2011a, 80 2011b). 10,000 60 2. FAo (2002). 8,000 3. Wright (2009). 40 4. The USDA made major revisions to its estimates of $/mt 6,000 20 % Chinese stocks in 2001, but this had little impact on 0 4,000 global price behavior at the time, possibly because –20 China in 2002/2003 was a significant grains exporter 2,000 –40 (Wright 2009, op. cit). 0 –60 5. USDA (2011). 6. World Bank (2011a). 2005H1 2005H2 2006H1 2006H2 2007H1 2007H2 2008H1 2008H2 2009H1 2009H2 2010H1 2010H2 Ave Jan–Mar 2011 7. World Bank (2011b). 8. World Bank Food Price Watch, various issues since January 2009. 9. FAo (2010). 10. For instance, oil price increases impact the price of Aluminum Copper Aluminum Copper food: a 10 percent increase in crude oil prices is asso- Source: World Bank. ciated with a 2.7 percent increase in the World Bank Food Price Index. See Baffes (2010). 11. The World Bank Food Price Index is deflated using the World Bank Manufactures Unit Value Index. production of aluminum in order to reduce energy 12. In the run-up to the 2007/08 crisis, the oeCD esti- consumption.21 electricity accounts for 40 percent of mated that about 60 percent of increased demand for that country’s production costs, and corn was due to policies on biofuels and energy in devel- Copper prices have historically been higher than oped countries, which could lead to similar increases aluminum prices. Indeed, copper is now nearly four in the future. times as expensive as aluminum—the highest such ratio 13. Cereals comprise corn, rice and wheat and barley. on record, reaching a peak of US$ 9,868 per ton in 14. Russia and Ukraine placed a moratorium on exports with the onset of drought. February 2011—a 52 percent increase over mid-2010. 15. The United Nations’ Food and Agriculture organization Demand for copper is driven mostly by its use as a announced that 12.75 million acres of China’s 35 conductor of electricity. China’s expansion of its elec- million acres of wheat fields had been affected by tricity grid is fueling the worldwide price of copper, drought. with imports of the metal hitting record levels. The 16. Rice was a key reason for the contagion that precip- limited supply response is contributing to the price itated the 2008 crisis, when many large exporters hike. Copper prices reached US$ 10,000 a ton in the banned its export. first week of February 2011. 17. Indonesia imported 1.2m tons of rice this year. 18. It takes about 11 pounds of grain to produce 1 pound of beef; 7 pounds of grain to produce 1 pound of pork; 3 pounds of grain to produce 1 pound of chicken. Outlook 19. BRIC countries represent 36.4 percent of total sugar Food prices are expected to rise 8 percent above 2010 consumption in 2010/11, a rise 2 million metric tons over previous year. levels, assuming a normal crop year, and that oil prices 20. In late-February 2008, crude oil reached a record high, do not rise further wheat and maize are expected to above US$ 146 per barrel. average 13 and 12 percent higher than 2010 levels while 21. Aluminum production is energy intensive. It takes about rice prices are expected to remain almost unchanged. 15.7 kilowatt hours of power on average to produce Soybean and palm oil prices are expected to be 11 and one kilogram of workable aluminum. 17 percent higher. Metals prices are expected to rise by almost 20 percent in 2011 on persistently strong demand, led by China, and weak supply response for some metals, notably copper and tin. Annex 2 Speculation, Financialization of Commodities, and the “New� Money 1 I N The CoNTeXT oF The PoST-2005 an upward movement in prices will generate profits commodity price boom, speculation has been one of (often referred to as hoarding). Unless such activity the most frequently discussed and, perhaps, poorly entails market manipulation, holding inventories is the understood concepts. We note that the financial and inter-temporal equivalent of Adam Smith’s “invisible popular media speculates widely, giving most atten- hand�: traders buy at current prices to sell later when tion to investment fund activity in commodity futures (in their opinion) the market will be tight, thereby exchanges; some say the funds have caused a speculative balancing the market and hence reducing price vari- bubble, while others argue that they have not only not ability. There is no evidence that hoarding took place affected prices at all but that they have injected liquidity during the recent boom, as known inventories of most into the market, thus facilitating price discovery. We (non-perishable) agricultural commodities reached argue here that although the views on the effects of historical lows. Two exceptions may be rice, during such investment activity on commodity markets are mid-2008 (in various east Asian countries), and cotton very strong and diverse, the empirical evidence is weak, in late 2010 (in China). showing small or no impact. We conclude by noting Third, market manipulation often takes place. There that while it is unlikely that investment fund activity have been many such cases. For example, in the 1950s will alter long-term price trends, it may induce higher US onion producers argued that traders in the Chicago price variability by exacerbating the length and the Mercantile exchange cornered the market. This led to amplitude of price cycles. the passage of the onions Futures Act which prohib- ited futures contracts on onions. other cases include that of the hunt brothers, who attempted to corner What Is Speculation? the silver market in the late 1970s and early 1980s; Sumitomo’s chief copper trader, Yasuo hamanaka, who Kaldor (1939) defined speculation as “…the purchase cornered the copper market in the 1990s; and British (or sale) of goods with a view to resale (repurchase) at a Petroleum’s cornering of the propane market in 2006 later date, where the motive behind such action is the (it resulted in a US$ 300 million fine). Although there expectation of a change in the relevant prices relatively are no known (or proven) cases for market manipu- to the ruling price and not a gain accruing through their lation during the recent boom, even if cases become use, or any kind of transformation effected in them, known, they are likely to be isolated events. or their transfer between markets.� Thus, according to The last three are financial activities often pinned to Kaldor, most financial activities would be classified as speculation: hedge funds, commodity trading accounts speculation. In the context of the current debate, six (or advisors), and investment funds (including various types of “speculative� activities have been mentioned investment, pension, and sovereign wealth funds): in the literature (see Table A2.1). First is that it takes place in the futures exchanges. These speculators are • Hedge funds undertake investment and trading indispensible entities of commodity futures exchanges activities in a broad range of assets, including since they provide the necessary liquidity and ensure commodity markets. The fund may trade and that the market clears. invest in commodity asset classes in order to A second type of speculative activity is when “hedge� the diverse risks inherent in their port- market participants hold inventories beyond what is folios. In such a case, taking a position in the justified by business needs or when they hold large futures market for a particular commodity or quantities of commodities with the expectation that commodity class can represent an investment South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 63 64 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries TABLE A2.1 Types of “Speculative Activity� Activity Function Effect Speculation in futures Important activity for the functioning of futures Injects liquidity into the market and improves exchanges markets price discovery Market manipulation Isolated cases such as the cornering of the cop- These are illegal activities per and silver markets Building up inventories Accumulation of physical stocks with the expec- Traders buy at current prices to sell later, when tation that price increases will generate profits the market will be tight, thus balancing the market and reducing price variability Commodity Trading Accounts Professionally managed commodity invest- They enhance price discovery since they ex- (CTAs) ment vehicles that take consideration of market amine the fundamentals very carefully and use fundamentals technical analysis Hedge funds Short-term profit seeking Believed to be associated short term volatility (i .e ., day-to-day) Investment funds Taking long positions in futures exchanges by in- They may amplify commodity cycles due to their vestment, pension, and sovereign wealth funds size and nature of investment, but are unlikely to affect long-term trends in a non-correlated asset that provides diversi- for the so-called “financialization� of commodities. A fication benefits to the overall portfolio. hedge number of events led to this. First, the publication of funds have existed for decades and their effect an influential book argued that commodities should on commodity markets is typically short term have been part of every investor’s portfolio (Rogers (i.e., they affect short-term price movements). 2004). A little later Gordon and Rouwenhorst (2006) • Commodity trading advisors (CTAs) are asset compared a hypothetical commodity-based portfolio managers who operate almost exclusively in with bond and equity portfolios and concluded that commodity markets. They invest for portfo- the risk premium on commodity futures is essentially lios under management and for clients with the the same as equities, commodity futures returns are objective of earning profits from market vola- negatively correlated with equity returns and bond tility. Because CTAs use fundamentals and/or returns, a reflection of the different behavior of such technical analysis as their guiding principles, asset classes over the business cycle. they may enhance price discovery and thus Second, during the early part of the past decade, reduce market price variability since they iden- investment fund managers—including those of sover- tify movements in fundamentals in advance of eign wealth and pension funds—noted that existing other market participants. classes of assets (such as money funds, equities, and • I n v e s t m e n t f u n d s — r e l a t i v e l y r e c e n t bonds in both developed and emerging economies) were phenomena—represent in many respects the becoming increasingly correlated amongst themselves. flow of “new� money into commodity markets. In their search for new uncorrelated assets they began It is this type of activity that rests (or should rest) including commodities in their portfolios. at the core of the current debate. The next para- Third, during the past decade or so, many high- graphs elaborate on the origins of this invest- income countries have pursued lax monetary poli- ment activity. cies which may have caused what many describe as “excess liquidity�. Many authors (e.g., eckaus (2008), Wray (2008) and Calvo (2008)) have argued that such The Origins of Investing in liquidity may have found its way into commodity markets, causing the “third� price bubble (following Commodity Markets the equity/dot.com and housing bubbles). The commodity price increases of the last decade Finally, numerous authors argued that commodities have often been linked to “new� money that found (especially in the extractive industries) have entered a its way into commodity markets, setting the stage super cycle, that is, a prolonged period of increasing Annex 2. Speculation, Financialization of Commodities, and the “New� Money 65 prices. heap (2004), in an influential report argued behind the grain price spike of 2008, stocks would have that a super cycle is underway, driven primarily by increased. Frankel cited the Congressional testimony economic growth (and hence commodity-demand by the chief economist of the Commodities Futures growth) in China. he noted that there have been two Trading Commission to support in his weblog (July super cycles over the past century (at the beginning of 25, 2008) that, “The evidence does not support the the 20th century and during the Korean War). Indeed, claim that speculation has been the source of, or has World Bank (2009) showed that as of the early 1990s, exacerbated the price increases.� The evidence refers demand for metals by China was so large that it effec- to Congressional testimony (April 3, 2008), which tively reversed global metal intensity (i.e., metal use concluded that: “Looking at the trends in the market- per unit of world GDP) and by 2010 it reached levels place, combined with studies on herding behavior similar to those of the early 1970s. econometric work and the impact of speculators in the markets, there is by Cuddington and Jerrett (2008) and Jerrett and little evidence that changes in speculative positions are Cuddington (2008) for the metals market confirmed systematically driving up crude oil prices.� the super cycle hypothesis. Verleger (2009: 1), citing analysis and data from the International energy Agency (2009), concluded at his US Commodity Futures Trading Commission Blaming “Speculators�: Who Said testimony that the 2007/08 crude oil price spike was What? caused by the incompatibility of environmental regu- lations with the global crude supply. Speculation, he historically, blaming speculation in futures markets argued, had nothing to do with the price increases. Yet, has originated from politicians and populists, often Verleger (p. 2) acknowledged that the possible liqui- reflecting ideology or the search for scapegoats to blame dation of futures positions was one of the key reasons for unpopular price increases (Jacks 2007). Most econ- tied to the collapse of oil prices from July 2008 to omists and market participants, however, have been December 2008; which begs the question why the strong defenders of futures markets, which are viewed decline in oil price would have been caused by liqui- (rightly) as the most important price discovery mech- dation of futures positions when the increase was not anisms. Surprisingly, the “speculation� debate of the caused by activities in that sphere? recent commodity boom appears to have divided even The IoSCo Task Force of Futures Markets (2009), economists and market participants, as the rest of this formed at the request of the G-8, reviewed several section elaborates. reports by international organizations, central banks Krugman, in a series of blogs and editorials, rejected and regulators and concluded that economic funda- the view that speculation fueled the commodity boom. mentals, rather than speculative activity explained he argued (New York Times, May 13, 2008) that, “If the commodity price changes during the boom period. price is above the level at which the demand from end- The report recommended that regulators should (p. 3): users is equal to production, there’s an excess supply— (i) understand with greater clarity the role of speculative and that supply has to be going into inventories. end and commercial activity in commodity futures markets; of story. If oil isn’t building up in inventories, there (ii) gain a more comprehensive view of trading activ- can’t be a bubble in the spot price.� Krugman also ities in, and the structure of, the underlying markets dismissed the idea that commodity trading activity in that may affect price formation on commodity futures futures exchanges may have affected spot commodity markets; and (iii) detect, deter, and prosecute manipu- prices at all: “… a futures contract is a bet about the lation and other trading abuses involving commodity future price. It has no, zero, nada direct effect on the futures, and related commodity markets. IoSCo’s spot price� (New York Times, June 23, 2008). conclusions, however, are somewhat inconsistent. If Wolf shared similar views. he wrote in a Financial regulators do not have clarity on the role of speculative Times editorial (May 13, 2008) that “if speculation were and commercial activity in commodity futures markets raising prices above the warranted level, one would and they need to gain a more comprehensive view of expect to see inventories piling up rapidly, as supply trading activities, how did they conclude that such exceeds the rate at which oil is burned. Yet there is activities did not play a role during the recent boom? no evidence of such a spike in inventories.� Similarly, At the other end of the spectrum, Soros (2008) Wright (2009) noted that if long futures positions were called commodity index trading at his US congressional 66 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries testimony intellectually unsound, potentially destabi- is all speculative demand feeding on it—speculators lizing, and distinctly harmful in its economic conse- and herding behavior.� De Schutter (2010) concluded quences. eckaus (2008) noted that while the most that a significant portion of the increases in food price frequently cited factors—increased demand, dollar and price volatility during 2007 and 2008 could only depreciation, geopolitical concerns, and issues regarding be explained by the emergence of a speculative bubble. depletion of resource—played some role in the crude oil price increases after 2004, speculation played a much larger role than most analysts believe. After comparing Yet, the Empirical Evidence Has the oil price increases with the dot.com and housing Been Weak bubbles, he asked (p. 8): “Is a speculative bubble irra- tional? No, it is rational to ride along and trade in The empirical evidence on whether financial invest- a speculative bubble as long as it is expanding. The ment in commodities contributed to the recent boom moment of truth comes only at the end, when the is, at best, mixed (see Table A2.2). one of the first bubble bursts.� empirical studies was the IMF’s 2006 World Economic Similarly, Khan (2009) examined a variety of indi- Outlook (IMF 2006). Based on a VeCM model and cators that might have affected commodity prices and monthly data for the 1995–2006 period, it examined concluded that while market fundamentals played a the markets of crude oil, copper, sugar, coffee, and key role in the run-up of the oil prices after 2003, the cotton and found no evidence that speculative activity price increase during the first half of 2008 was a price affects price levels in either the short- or long-term. The bubble. he argued that in the absence of speculative IMF reached a similar conclusion in its 2008 World activity, oil prices would have been in the range of US$ Economic Outlook when it examined 50 commodities 80–90 per barrel (oil prices averaged a little more than and weekly data for the 1997–2008 period. Büyükşahin US$ 100 per barrel during the first half of 2008) and and harris (2009) used daily data from 2000 to 2009 concluded that in order to avoid similar episodes in and, based on Granger causality tests, found no statis- the future, more regulation should be put into place. tical evidence that the numbers of contracts held by any Medlock and Jaffee (2009) attributed the oil price group (including index traders) affected crude oil prices. increase of 2008 to the presence of non-commercial A similar conclusion was reached by the US Commodity players, who (p. 3) “have increased their footprint in Futures Trading Commission (CFTC 2008).2 the marketplace dramatically since the late 1990s�. They haigh, hranaiova and overdahl (2007), using also argued that trading strategies of financial players VAR and daily data for the natural gas and crude oil may have influenced the correlation between the US market, failed to observe a link between price vola- dollar and the price of oil. Wray (2008) argued that the tility and changes in hedge fund positions. Kilian commodity price increases was the boom following the and Murphy (2010) examined the crude oil market equity and housing of the late-1990s and mid-2000s. within a VAR framework over 1973–2009 and elim- he linked all three booms to the excessive monetary inated speculation as an explanation of the 2003–08 ease and limited degree of regulation and supervision crude oil price surge. of financial institutions, and assigned responsibility Irwin, Sanders, and Merrin (2009), and subse- to various money managers who created numerous quently Sanders and Irwin (2010), based on results esoteric and complex instruments and practices that (p. of Granger causality tests between open positions and 7) “spread as quickly as a deadly virus in a sci-fi flick�. futures prices for various agricultural commodities, Calvo (2008), responding to Krugman and other expressed strong skepticism that futures trading activity commentators, noted that speculation and low inven- had led to bubbles in agricultural futures prices. Verleger tories are not necessarily inconsistent with each other, (2009) argued that money-flows into oil contracts did and concluded that increases in commodity prices not affect futures markets; his conclusion was based during 2007/08 were a result of portfolio shift against on simple correlation analysis. Moreover, in a subse- liquid assets by sovereign investors, sovereign wealth quent study Verleger (2010: 65) attributed the stability funds, partly triggered by lax monetary policy in the of energy prices during December 2009 and January US. Roubini (2009) said of the early-2009 crude oil 2010 partly to the increase of passive investors who price increase: “… improving fundamentals … justify allocated a portion of their portfolios to commodi- oil going from $30 to maybe $50. I think the other $30 ties, and noted further that credit for the absence of a Annex 2. Speculation, Financialization of Commodities, and the “New� Money 67 TABLE A2.2 Summary of Empirical Evidence Study Model characteristics Key conclusion LITTLE OR NO IMPACT IMF (2006) VECM, monthly data, 1995–2006, crude oil, copper, Little evidence that speculative activity affects either price sugar, coffee, cotton levels over the long run or price swings in the short run . Haigh, Hranaiova, and VAR, daily data, 2003–04, gas and crude oil Failed to observe a link between price volatility and changes Overdahl (2007) in hedge find positions . IMF (2008) Financial returns, weekly data, 1997–2008, fifty com- No apparent systematic connection between financialization modities and price changes . CFTC (2008) Granger causality, daily data, crude oil Failed to find that changes of traders’ positions caused changes in crude oil prices Büyükşahin, and Harris Granger causality, daily data, crude oil Failed to find that changes of traders’ positions caused (2009) changes in crude oil prices verleger (2009) Correlation analysis, crude oil Money-flows into oil contracts have not affected oil prices Till (2009) T index, daily data, 2006–09, crude oil The balance of outright speculators in the US oil futures and options markets was not excessive relative to hedging Kilian and Murphy (2010) VAR, monthly data, 1973–2009, crude oil The results eliminate speculation as an explanation for the 2003–08 oil price surge Irwin, Sanders, and Merrin Granger causality, daily data, 2003–08, ten agricultural Positions of long-only index funds do not lead futures prices . (2009) commodities Sanders and Irwin (2010) Granger causality/T index, weekly data, 2006–09, twelve The evidence that index-fund positions impact returns agricultural commodities across commodities is scant . Stoll and Whaley (2010) Granger causality, weekly data, 2006–09, twelve agricul- Inflows and outflows from commodity index investment do tural commodities not cause futures prices to change . MODERATE IMPACT Gilbert (2007) Granger causality, monthly data, 2003–08, five metals Some evidence that index investment may have been and four food commodities responsible for raising some commodity prices during the recent boom . Plastina (2008) Granger causality, monthly data, 2006–08, cotton Investment fund activity might have pushed cotton prices 14 percent higher . Robles, Torero, and Braun Granger causality, monthly data, 2002–2008, food com- Speculative activity might have been influential . (2009) modities Gilbert (2010) 3SLS, monthly data, 2006–2009, food commodities Index-based investors appear to have inflated food com- modity prices . Tang and xiong (2010) Co-movement analysis, daily data, 1998–2009, twenty- Large commodity price volatility of recent years was related four non-energy commodities to the presence of index investors . Silvennoinen and Thorp Bivariate conditional volatility, daily data, twenty-four Higher commodity returns volatility is predicted, among oth- (2010) commodities (agriculture, metals, and energy) ers, by financial traders’ open positions . price surge during these two months should be given (weekly data) on a number of variable including posi- to the financial engineers who had the foresight to tions by speculators and concluded that inflows and integrate energy markets with investors. Till (2009), outflows from commodity index investments do not based on daily data, examined the crude oil market and cause futures prices to change. concluded that the balance of speculators in the US oil other authors have reached somewhat different futures and options market was not excessive relative conclusions. Robles, Torero, and Braun (2009) iden- to hedging. Stock and Whaley (2010) regressed finan- tified speculative activity in the futures market as a cial returns of twelve agricultural commodity prices source of the 2007/08 agricultural commodity price 68 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Can Investment Fund Activity Affect Commodity Prices? There are four reasons why that may be so. First, invest- ment in commodities is a relatively new phenomenon, and funds have to date flowed mostly in, not out, implying that some markets may have been subject to extrapolative price behavior; that is, high prices leading to more buying by investment funds, in turn leading to even higher prices, and so on. Second, index funds invest on the basis of fixed weights or past performance criteria. hence, invest- ment behaves differently from what market fundamen- tals would dictate, especially in the short run. Third, most of the sovereign wealth funds (a key source of index-fund activity) are commodity-based. Therefore, when commodity prices increase, the value of these funds goes up, in turn increasing their expo- sure to commodities. Fourth, the large size of these funds compared to commodity markets may exacerbate price move- ments as well. While there are no precise estimates on their size, a broadly accepted range, as of mid-2008 increases. Their conclusion was based on Granger was US$ 250–300 billion (Masters 2008). A report causality tests using monthly data during 2002–08 by a major commercial bank estimated that an addi- for a number of food commodities. Plastina (2008) tional US$ 60 billon went into commodities during concluded that between January 2006 and February 2009, placing the 2009 total estimate to US$ 230–240 2008, investment fund activity might have pushed billion, marginally lower than in 2008 due to lower cotton prices 14 percent higher than they would other- commodity prices. A more recent estimate by a major wise have been. Gilbert (2007) found that futures posi- investment bank (october 2010) placed the estimate tions did not affect the prices of metals at the London at US$ 350 billion. In view of the recent spike, it may Metal exchange but they strongly affected the prices have exceeded US$ 400 billion. Almost two-thirds of of soybeans at the US Chicago Board of Trade. In those funds are invested in energy markets. Although a more recent paper, however, Gilbert (2010: 420) these amounts represent a little more than 1 percent concluded that by investing across many commodity of the global value of pension and sovereign wealth futures, index-based investors may have inflated food fund holdings in 2009 (the global value of these two commodity prices. groups was estimated at US$ 20 trillion and US$ 4 tril- Tang and Xiong (2010) looked at co-movement lion) they are large compared to the size of commodity of daily prices for twenty-four non-energy commod- markets. or, as Soros characteristically put it, “… the ities traded at futures exchanges for the 1998–2009 institutions are piling in on one side of the market and period and concluded that the large price volatility of they have sufficient weight to unbalance it�. recent years could be attributed, at least in part, to the presence of index investors. Similarly, Silvennoinen and Thorp (2010) used daily data for twenty-four Tentative Conclusion commodities (agriculture, metals, and energy) and, by examining the conditional volatility and correla- In the context of the post-2005 commodity price boom, tion dynamics between these commodity prices and the question is often formulated as to whether “spec- other assets, concluded that commodity returns vola- ulation� was behind the commodity price increases. tility is predicted, among others, by financial traders’ There are two problems with the way in which the open positions. question is posed. Firstly, among the numerous types Annex 2. Speculation, Financialization of Commodities, and the “New� Money 69 of speculation often discussed in the literature, only one ultimately be determined by market fundamentals. matters: investment-fund activity in commodity futures But, such activities can induce higher price variability exchanges. Second, it is unlikely that even this type in the sense of exacerbating the length and the ampli- of activity would have a monotonic (i.e., increasing) tude of price cycles.� impact on commodity prices. Thus, the question should be reformulated along the following lines. “Is investment fund activity partly Notes responsible for post-2005 commodity price move- 1. John Baffes, 8–1880, jbaffes@worldbank.org, June ments?� A likely answer to this question could be: 1, 2011. “Any commodity-related activity on the financial side 2. haigh, and Robe (2010) and Commodity Futures is unlikely to alter long-term price trends, which will Trading Commission (2008). Annex 3 South Asian Food Demand and Supply Balances Afghanistan: Grain production for 2010 is projected years to be able to retain public stocks at their target to be about 11 percent lower than in 2009, resulting level of 1.5 million tons. Wheat imports have been from a drop in wheat production, from 5.1 million high, reaching 1.8 million tons, which is double the tons to 4.5 million tons. Afghanistan is therefore likely level of domestic production. The Bangladesh govern- to face a wheat deficit of at least 1 million tons this ment has been issuing tenders and buying relatively year, with more details emerging toward the end of small shipments. The government is reportedly plan- the growing season that runs to April. Nevertheless, ning to purchase about 1 million tons by end-June the deficit is expected to be roughly twice that of the 2011, but it has decided not to buy domestically in annual average of about 0.5 million tons over the past order to avoid pressure on prices (Table A3.1). decade, although it has reached 2.3 million tons. India: Food-grain production suffered a significant Bangladesh: Total rice production rose from 26.2 set-back following the 2009 shortfall in monsoon million tons in fiscal 2008 to 32.1 million tons in rains, but recovered well with the near-normal 2010 2010. Aggregate rice (paddy) output in 2009 reached monsoon. The estimate for fiscal 2011 pegs output at a record 50 million tons. For 2010, the output of (irri- around 232 million tons, about 6.4 percent above that gated) main season rice is 28.5 million tons, or 3 percent for 2010. Despite the good 2010 monsoon, production above last year’s level. The winter wheat crop has also is estimated to have been lower in fiscal 2011 than the been good, with production at 1 million tons. Total recent record in fiscal 2009. At the same time, grain wheat production has risen from 7.4 million tons in stocks (mainly rice and wheat) reached 40–50 million fiscal 2006 to 8.5 million tons in 2010. Despite this, tons, which far exceeds secure storage capacity. Food rising grain consumption has led to an increasing need grain output increased by only 1.6 percent in fiscal for imports. Bangladesh is likely to require higher grain 2009, and is estimated to have declined by 7 percent imports this year above the 3 million tons of recent in 2010. Wheat is a winter crop and was not strongly TABLE A3.1 Bangladesh: Production and Imports of Food Grain Production (million MT) Import (million MT) FY08 FY09 FY10 FY11 FY08 FY09 FY10 FY11 Actual Actual Actual Actual Target Estimate Actual Actual Actual Target (Till Mar 13, 2011) Rice 28 .9 30 .9 32 .3 35 .4 … 2 .1 0 .6 0 .1 1 .3 1 .2 Aus 1 .5 1 .9 1 .7 2 .7 2 .1 … … … … … Aman 9 .7 11 .2 12 .2 13 .5 12 .8 … … … … … Boro 17 .8 17 .8 18 .3 19 .2 … … … … … … Wheat 0 .8 0 .8 1 .0 1 .2 … 1 .4 2 .4 3 .4 2 .4 2 .3 Total 29 .8 31 .7 33 .2 36 .5 … 3 .5 3 .0 3 .5 3 .8 3 .4 Source: BBS, DAE, and FPMU South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 71 72 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries TABLE A3.2 India: Agricultural Production, 2003–11 (in million tons unless otherwise specified) 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 2009–10 2010–11 Foodgrains 213 .2 198 .4 208 .6 217 .3 230 .8 234 .5 218 .1 232 .1 Rice 88 .5 83 .1 91 .8 93 .4 96 .7 99 .2 89 .1 94 .0 Wheat 72 .2 68 .6 69 .4 75 .8 78 .6 80 .7 80 .8 81 .5 Coarse Cereals 37 .6 33 .5 34 .1 33 .9 40 .8 40 .0 33 .6 40 .1 Pulses 14 .9 13 .1 13 .4 14 .2 14 .8 14 .6 14 .7 16 .5 Oilseeds 25 .2 24 .4 28 .0 24 .3 29 .8 27 .7 24 .9 27 .9 Sugarcane 233 .9 237 .1 281 .2 355 .5 348 .2 285 .0 292 .3 336 .7 (million bales) Cotton (million 13 .7 16 .4 18 .5 22 .6 25 .9 22 .3 24 .2 33 .9 bales) Jute & Mesta 11 .2 10 .3 10 .8 11 .3 11 .2 10 .4 11 .8 10 .1 (million bales) Memo item: Procurement by 40 .3 40 .3 38 .0 36 .2 51 .6 60 .4 54 .9 … FCI (wheat+rice) Procurement 25 .1 26 .6 23 .6 21 .4 29 .4 33 .6 32 .3 … by FCI (% of production) Source: Ministry of Agriculture, Government of India. affected by the monsoon shortfall in 2009. Production Pakistan: Wheat production for fiscal 2011 is projected in fiscal 2010 actually increased slightly above that of to be 23.9 million tons, about the same as in 2010. 2009, and may have increased by close to 1 percent in however, due to an estimated increase in consump- 2011, to a new record 81.5 million tons (Table A3.2). tion of 1 million tons, ending stocks are likely to be lower; nevertheless, at 9 million tons they are at the Nepal: The principal staple food is rice, which level envisaged for the strategic reserve, and the govern- comprises two-thirds of total cereal consumption, ment has lifted the ban on exports. Despite a sharp with wheat constituting another 12–15 percent. In decline in rice production resulting from flood damage general, the price of rice is influenced by production to 34 percent of the growing area, Pakistan is expected and demand on the domestic side and policy decisions to have an exportable surplus of 1.5–2.0 million tons, by India. As a net rice importer for most of the last two from production of 5 million tons. decades, Nepal has relied heavily on imports—both formal and informal—from India, despite India’s occa- Sri Lanka: The supply of key food items such as fish, sional export bans. Because of Nepal’s long and largely poultry and vegetables continues to be disrupted by unregulated border with India, price levels in Nepal the effects of adverse weather conditions leading to are highly correlated with those in India. even during sharp price pressures. The weather is also of concern India’s rice export ban, quantities imported from India with respect to the forthcoming spring crop, with were not notably affected. Because food availability lower supplies possibly raising prices and main- and access in Nepal are geographically very unevenly taining food inflation at 10 percent for the first distributed, the concept of national food security has half of 2011. little meaning. Rice consumption varies from region to region, because certain remote areas tend to be rice- deficient and people substitute with wheat. Annex 4 Impact on Poverty of the Increase in Food Prices – Methodology and More Results 1 T he MoDeL INCoRPoRATeS A SeT oF on the poverty gap, in Nepal, Pakistan and Sri Lanka, observed and estimated changes in domestic the increase in the poverty gap is less than the median agricultural and food prices for the South Asia while the opposite is true for Bangladesh and India. region countries.2 Where available, the model includes except for Nepal, the net change in the poverty head- country-level data on actual changes in domestic food count is greater than the impact on the poverty gap. prices from Food Price Watch (World Bank, 2011). For Pakistan experiences the highest net percentage increase other commodities, where prices are unavailable, we in the poverty headcount whereas Bangladesh experi- use import shares reported in version 7 of the GTAP ences the highest percentage increase in the poverty database3 to link global prices with domestic consumer gap due to the food price increase. Nepal faces the prices.4 least net change in poverty headcount or poverty gap We then calculate their implications for individual amongst South Asia region countries. households’ costs of living and agricultural incomes Across all the South Asia region economies, the using an expenditure function to characterize house- median of people exiting poverty is 0.06 percent while hold consumption, and factor in supply behavior and those entering poverty are 1.49 percent. of the coun- a profit function to represent household production tries, although Bangladesh has the largest percentage activities through unincorporated enterprises such as change of individuals exiting poverty with the food family farms.5 Based on the simulated changes in indi- price hike, it also has the greatest percentage of indi- vidual households’ welfare relative to the US$ 1.25 viduals moving below the poverty line. Pakistan has extreme poverty line, we determine the changes in the no percentage change in the number of people exiting poverty headcount and poverty gap for each country.6 poverty. essentially, this involves estimating the impact of price The current food price surge has had a varying changes on each household’s real income by multi- impact on the poverty headcount of South Asia region plying the price change experienced by the household countries according to the magnitude of the price by the quantity of the good produced and by the nega- increase for each of the commodities and the consump- tive of the quantity consumed by that household.7 The tion and income pattern generated by the sale of these model also allows for households to substitute away commodities. The increase in rice price had the greatest from commodities where prices increased.8 impact on the rise in the poverty headcount and for the entire South Asia region. This is followed by wheat, then fats and oils (Figure A4.1). Impact of the Current food In Bangladesh, where rice and wheat prices rose substantially, the rice price increase had the higher Price Hike impact on the increase in the poverty headcount, since The median increase in the poverty headcount and it has higher weighting on households’ net consump- poverty gap for South Asia region is 1.4 percentage tion. In addition, Bangladesh is a net seller of wheat, to points and 0.5 percentage points, respectively. In India the extent that an increase in the wheat price resulted and Nepal the increase in the poverty headcount is less in 0.02 percent decrease in the poverty head count. than the median while Bangladesh’s and Pakistan’s are In Pakistan, people are net consumers of wheat above, with Sri Lanka’s at the median. For the impact and wheat has higher weighting than rice in the South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 73 74 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries consumption basket. Therefore, even though the poverty gap, most notably Bangladesh (86 percent of increase in the domestic rice price is higher than that the increased gap) and India (39 percent) across all of wheat, the impact of the poverty headcount is attrib- commodities. In Nepal, 59 percent of the increase in utable more to higher wheat prices. the poverty gap is attributed to the rise in oil and fats In India, the price increase in fats and oils contrib- while in India it is 38 percent. As in the increase in uted to 58 percent of the increase in the poverty head- the poverty headcount, wheat has the highest impact count, while in Sri Lanka the rise in the sugar price in Pakistan (69 percent) and sugar in Sri Lanka (45 had the highest impact on the increase in the poverty percent) (Figure A4.2). headcount. Furthermore, although an increase in the In the case of Afghanistan, the model is unable to price of rice has had the greatest impact on the gross estimate the impact of price changes on each house- reduction in poverty in India, since the country is net hold’s real income because an estimate of the quantity consumer of rice, there is an increase in the poverty of goods produced by each household is unavailable. headcount when rice prices rise. Instead the model estimates the net change in food on average across the region, the increase in the consumption from the increase in price, as observed rice price accounted for most of the increase in the through household consumption data. From this anal- ysis, Afghanistan appears to have been particularly hard hit by the increase in wheat prices. Wheat is the main staple of the Afghan diet, contributing 57 percent of FIGuRE A4.1 Decomposition of Net Poverty Headcount the caloric content in the average bundle of food items Change by Commodity consumed by the poor and near-poor. Furthermore, 2.00 due to large fluctuations in weather and insecurity, wheat production is highly volatile and the country 1.50 is dependent on its trading partners to meet frequent Percentage points 1.00 shortfalls. Analysis of the 2008 food price crisis sheds insight into the poverty impact in Afghanistan.9 The 0.50 2008 food price increases corresponded with a drought year resulting in wheat prices essentially doubling in 0.00 rural and urban areas. This increase in wheat prices had large effects on overall wellbeing. The doubling –0.50 Bangladesh India Nepal Pakistan Sri Lanka in wheat prices resulted in an average decline of 20 Wheat Oils and fats Sugar Rice Beef percent in the real value of food consumption. With many people consuming at levels near the poverty Source: Ivanic et al. (2011). line, subtracting from total consumption an amount equal to 20 percent of food consumption implied a 12 percentage point rise in poverty. FIGuRE A4.2 Decomposition of Net Poverty Gap Change by Commodity 1.50 Notes 1.30 1. This annex is based on Ivanic, Martin and Zaman 1.10 Percentage points (2011), Estimating the Short-Run Poverty Impacts of 0.90 the 2010–11 Surge in Food Price�, World Bank Policy 0.70 Research Working Paper 5633. 0.50 2. The actual and imputed price change for the following 0.30 commodities is collected for the South Asia region 0.10 countries: wheat, maize, rice, other grains, beef, sugar, fruits, coffee, cotton and oils and fats. –0.10 Bangladesh India Nepal Pakistan Sri Lanka 3. See hertel (1997). 4. Note that the model focuses on the commodities Wheat Oils and fats Sugar Rice Beef where actual price change or imputed price (based on Source: Ivanic et al. (2011). imports) for the South Asia region countries exists. The Annex 4. Impact on Poverty of the Increase in Food Prices – Methodology and More Results 75 model accounts for price changes for the majority of to capture the second-order impacts of price changes on the food items. households’ real incomes (hanoch, 1975). Note that 5. Singh, Squire and Strauss (1986); and Deaton (1989). this approach is consistent with imported goods being 6. We use the definition of Foster, Greer and Thornbecke imperfect substitutes for domestically-produced goods, (1984). and the changes in domestic prices being a weighted 7. See Deaton (1989) for a justification of this approach. average of the prices of imported and domestic goods. 8. We do this by introducing constant difference of elas- 9. See D’Sousa and Jolliffe (2010). ticities (CDe) demand system parameters to allow us Annex 5 Selected Food Crisis Response Projects South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 77 78 Measures put in place, with World Bank Country-specific lessons learned Country Social safety nets to for vulnerable groups support, during the last food crisis from the last food crisis Recommended next steps Afghanistan No public safety nets for the poor . Cash A pilot safety net program, using a com- 1 . Timely monitoring and evaluation Development of a well-admin- transfers exist for families of martyrs and munity + geographic targeting approach is is critical . A scale up of the pilot istered and targeted safety net war-related disabilities, alongside in-kind food being put in place in response to the food project will incorporate the results system . aid programs . crisis . The World Bank supports this effort of the evaluation . by the safety net component of the Pen- 2 . Weak coordination among sions and Safety Net project . The safety net related (small scale) programs cre- pilot is expected to be scaled up, incorporat- ates obstacles for effective service ing lessons learned from the pilot . delivery . Bangladesh Employment Generation Program (workfare); Bank helped modify and support by loan a Crises may present opportunities The development a social protec- Social pensions (for disability, widows and the program formerly called the “100-day em- to initiate much-needed reforms in tion strategy outlining a coherent elderly); ployment program� . The revised program the social protection sector . social protection system that Vulnerable Group Development provides 30 kg entitled Employment Generation Program addresses program rationalization, bags of rice for 24 months to poor women . for the Poorest will be more responsive to and administration challenges (e .g ., Vulnerable Group Feeding scheme provides future crises . a unified targeting system, effec- monthly food rations to households affected Also, a RSR-funded conditional cash transfer tive payment mechanisms, and a by disasters and lacking agricultural land and pilot aimed at promoting education and national beneficiary registry) . productive assets . nutrition of children from extremely poor Fair Price Ration Card scheme distributes families in rural and urban areas . cards to poor households enabling purchase of 20 kg bags of rice or wheat/month at a reduced rate . Open Market Sales program provides rice to rural and urban areas, especially in Dhaka—en- abling anyone to buy up to 5 kg of subsidized rice each day . Other programs include Rural Employment and Road Maintenance Program; Food for Work, Test Relief, Hill Tract Area Develop- ment, and Food for Education and Gratuitous Relief . India Range of safety net programs includes The Bank was not asked to work with the — There strengthening of systems for provision of subsidized food, in-kind transfers Government to respond specifically to the identification, targeting, awareness (e .g ., school feeding), public works, and cash last food crisis . generation and benefit payment transfers such as social pensions for elderly, so that safety net programs can widows, disabled; housing; scholarships, and effectively target the poor in times South Asia Economic Focus – A Review of Economic Developments in South Asian Countries recently introduced social insurance (e .g ., of disasters . RSBY—subsidized health insurance), and subsidized rural credit . State-level programs include targeted welfare distribution and implementation of a national targeted public distribution system . (continued on next page) Measures put in place, with World Bank Country-specific lessons learned Country Social safety nets to for vulnerable groups support, during the last food crisis from the last food crisis Recommended next steps Maldives Small-scale cash transfer programs, alongside The World Bank supported implementation Consolidation of various safety net The development of a well- energy subsidies meant to assist poor house- of social pensions for people older than interventions under one govern- administered and targeted safety holds . 65 years . Policy dialogue on developing a ment authority is essential to en- net system . targeting instrument for the national safety able efficient and timely response net program is ongoing . Objective is also to to future crises . better target subsidies . Nepal Social pension system includes old age allow- The World Bank supported the govern- Where no ongoing programs or The development of a well- ance; single women’s allowance; and public ment in scaling up work fare programs engagement in the sector exist, it administered and targeted safety work programs . (with the World Food Program) through the is difficult to respond to crises . net system . Safety Net Project and provided additional financing . The project is also supporting the modernization of the administration of the government’s cash transfer system . Pakistan Benazir Income Support Program provides The World Bank supported the reform of the Putting in place best-practice Emergency-response mechanisms poverty-targeted unconditional cash transfers; Benazir Income Support Program through safety-net programs takes time, have been developed in response Zakat; PBM and various other small-scale a development policy credit and technical particularly in low-income, low- to the August 2010 floods: in three provincial safety net programs exist . assistance project . Reforms included adopt- capacity countries, even when the months, the government managed The government is interested in introducing ing a national targeting system, separation government is fully committed . to support 1 .3 million families conditional cash transfer and skills-training of enrollment, eligibility determination, Meanwhile, second-best options with compensation grants . These components to the base BISP program, to en- and payment systems, development of a need to be employed to address structures need to be consolidated courage household investments in children’s beneficiary registry and other measures to immediate needs; these might in- and made applicable to future human capital and to increase the employabil- strengthen program administration . volve employing poverty targeting emergency recoveries . The govern- ity and productivity of adults . mechanisms that are subjective, or ment is preparing an action plan for utilizing existing payment delivery such a system . mechanisms that may not be technologically efficient . Sri Lanka An unconditional cash transfer program, The World Bank was not asked to work with Building trust and ensuring joint The increase of the safety net Samurdi, aims to provide assistance to the the government in the last food crisis . Nev- decision making in every step of coverage in the Northern Province, poor . ertheless, the Bank managed to initiate and the way with counterparts are and improve targeting of Samurdi . carry forward a dialogue through an RSR- essential to designing sustainable funded grant on reforming the targeting interventions . mechanism of Samurdi and piloting it, along with an MIS system supported by an IDF, to improve both targeting and administration . The government, however, did attempt to put in place price controls in 2008 . Annex 5. Selected Food Crisis Response Projects 79 Annex 6 Commodity Risk Management 1 E VeNTS IN ReCeNT YeARS hAVe hIGh- to a) sharpen the ability to diagnose the fiscal impact lighted that governments face significant fiscal of exogenous shocks, b) incorporate the use of financial risk from exogenous shocks. The fuel and food products into risk management strategies that are put crises of 2007–08, and subsequent price increases in in place ahead of a crisis or shock, and c) strengthen 2010, as well as the greater economic impact of natural confidence in using market approaches and having disasters in populated areas, have a demonstrated nega- sound policy around them. tive impact on public finances and the availability of resources for development priorities and essential public services. For many of these risks, market-based Advisory Services on Risk approaches may help governments mitigate the finan- Management cial impact of these shocks. But in practical terms, typi- These customized technical assistance services can be cally, there are several constraints, including: designed to help governments evaluate exposure to Governments typically do not focus on ex and find ways to manage a wide set of fiscal risks and ante management of food/oil price shocks and on contingent liabilities associated with exogenous shocks assessing the risk as a contingent liability with fiscal such as natural disasters, commodity price shocks (in implications. particular food, fertilizer, and energy), and climate Interactions between public and private actors change. The main components of a commodity risk operating within food import/export supply chains are management advisory program can include: complex. Since price volatility affects different actors in different ways, there needs to be a range of solutions, a. Risk assessment to quantify the impact of ranging from fiscal responses to trading decisions to specific risks on a government’s balance sheet social safety net responses targeted directly to vulner- and fiscal flows able producers or consumers. Identifying specifically b. Development of a risk management framework, who is at risk is an important first step. which includes specifying objectives of a risk management strategy, analyzing the govern- • Governments may not have funds to cover ment’s capacity to absorb risk, and evaluating hedging costs, which, in the case of the purchase strategic alternatives of at-the-money option contracts (which create c. Cost/benefit comparison of available instru- a price cap or a price floor), can range from ments, approaches, and hedging strategies 7–12% of the price level protected. d. Developing an enabling environment to imple- • If funds are available, governments are often ment transactions, which include governance reluctant to make the investment in hedging and legal framework, coordination with other since such decisions are vulnerable to ex-post policies, information systems, public disclosure criticism (and associated political risk). and audit processes, and monitoring procedures • Governments may lack the necessary legal and e. education and capacity building of ministry staff, institutional frameworks to support hedging stakeholders, and decision-makers. transactions. • There may also be a lack of technical capacity to manage hedging programs. Facilitation of Commodity Hedges Since many member countries are vulnerable to Because of the complexity of local market and policy the risk of food and fuel price shocks, the World Bank environments, solutions will need to be highly custom- Group is scaling up assistance in this area in an effort ized, drawing on a mix of different tools and responses. South Asia Economic Focus – A Review of Economic Developments in South Asian Countries 81 82 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries Commodity hedging for governments and private sector customized as an oTC (“over-the-counter�) contract entities could be facilitated by: which would give more flexibility than a standard finan- cial instrument. First, price protection was provided on a. Providing assistance to help governments and a delivered basis, thus combining the price for white private sector entities structure and execute phys- maize on the exchange in South Africa (SAFeX price) ical hedging transactions with existing market plus transport costs to Malawi. Second, the option suppliers, and/or banks (for example for food contract carefully specified terms for physical settle- products that are not well integrated with inter- ment so that it could be used as a contingent import national exchanges, such as rice, edible oils, and strategy if needed. Uncertainty about the extent of the for fertilizer) food shortage, levels of commercial imports, trans- b. Intermediation of financial commodity hedges portation constraints, performance of local traders, (for example for oil/energy products and the humanitarian response, and efficiency of procure- exchange-traded commodities). ment processes made the contingent import aspect of the contract very attractive to the Government. The The following table summarizes various commodity contract with Standard Bank of South Africa, an oTC risk management instruments, along with benefits and call option, represented one of the first-ever instances costs/risks/constraints for each. Also included is a short of macro level hedging by an African government. It description of the government of Malawi’s approach covered imports of 60,000 mt of white maize, had to hedging the risks associated with the price and a total value of approximately $17 million, and a supply of maize. premium payment of $1.53 million. In November and December, 2005 as prices were increasing and the food shortage growing more severe, Example – Malawi Government the government exercised the call option, elected for Hedging of Maize Price & Supply physical settlement, and allocated the majority of the maize to humanitarian operations. The maize Risks purchased through the option contract had a better In 2005/06, Southern Africa experienced a severe delivery performance than most other procurement drought-related food shortage. Affected coun- procedures, and during the delivery period spot prices tries included Malawi, Zambia, Mozambique, and rose USD $50–90/mt above the ceiling price of the Zimbabwe and it was estimated that the volumes contract following increases in the SAFeX white maize of imports needed to supply these countries would price and transport costs over the period october– range from 1.5–2 million metric tons. In the past, January. In May of 2006 and 2007, when the country Governments have attempted to manage this problem was facing a projected maize surplus, the World Bank by subsidizing the price of maize but such responses worked with the private sector to structure contin- tend to have a large cost both financially and in terms gent export contracts, which were presented to the of negative impact on local and regional trade. Government. The contingent export contracts (put In June of 2005, the Government of Malawi options) were structured to help manage concerns announced that it would take an innovative approach about allowing exports and the risk of maize prices to management of the food shortage by using South falling. Although the contracts were not taken up, Africa exchange Market (SAFeX)-based instruments they were useful as a demonstration of how contin- to help cap the cost. The World Bank provided tech- gent contracting could be used to help manage risks nical assistance to support this operation. This included associated with maize surplus. training on futures and options and how the products This approach has a number of indirect advan- could be used to manage specific exposures, risk assess- tages in addition to the hedging benefits. Contingent ment, communication with potential market providers, import strategies based on call option structures help comparison of proposals, negotiation of contracts, and in planning because they can be put in place well overall implementation. ahead of eventual crises, then triggered or “called� on Because the government was concerned not only an as-needed basis. The approach showed the bene- about price increases but also about logistics constraints fits of using customized risk management solutions and delivery performance, the call option contract was to reduce the risk of increasing commodity prices and Annex 6. Commodity Risk Management1 83 supply uncertainty. It also demonstrated that market- to replace traditional ex post reactions which can be based strategies can be less costly and more efficient costly, inefficient, and difficult to manage when the than non-market based attempts to stabilize prices. country is already in crisis. For the Government of Malawi, which spent an esti- mated $110 million on the humanitarian response, the call option was a success. The challenge will be Notes to test similar market-based approaches in an effort 1. Prepared by Julie Dana,World Bank Treasury. 84 South Asia Economic Focus – A Review of Economic Developments in South Asian Countries TABLE A6.1 Overview of Commodity Risk Management Instruments Product Benefits Costs/Risks/Constraints Forwards • Since forwards are physical supply contracts, the risk • May be complex for entities to implement if not directly management solution is embedded in the supply contract involved in physical importing . and there is no need for a separate contract / documenta- • Depending on the pricing formulas used, forwards will have tion . same costs/risks/constraints as the financial products described • Pricing of forward contracts can be customized to the below . needs of the hedger—prices can be fixed, floating, or in- clude caps/floors, and collars (a pre-agreed range or band) . • Depending on the pricing formula used, forwards will have same benefits as the financial products described below . Futures • No upfront costs . • Prices are “locked in� and hedger has limited ability to take • Provides ability to lock in forward prices through a finan- advantage of positive price movements that may occur in the cial contract . future . • Creates unknown and unpredictable future liability since hedger will owe the market counterparty if the market moves in an adverse direction . • Requires financing of a credit line or a credit guarantee . • Requires managing cash flow /liquidity requirements to support (potential) daily margin calls . Options • Provides ability to lock in maximum (minimum) prices • Has an upfront cost, which is market-driven and volatile but can while still providing hedger with ability to take advantage range from 5–12% of the value of the underlying price for a of positive price movements that may occur in the future . 6–18 month coverage . Swaps • No upfront costs . • Creates unknown and unpredictable future liability . • Can be used to create similar price protection as with • Requires financing of a credit line or credit guarantee . futures contracts • Requires managing cash flow requirements to support (poten- • Provides ability to manage two commodity exposures, or tial) daily margin calls . financial flows, at the same time . Commodity- • Could be used on more macro level to connect borrowing • Can be more complex to structure . linked bonds or or financing programs to the performance of a specific • May not be effective as a hedge for specific commercial loans commodity index . exposures . THE WORLD BANK 1818 H Street, N.W. Washington, DC 20433