RIYADH, 8 June 2008 — On March 31, a Saudi Cabinet decision was taken to reduce customs duty for a period of at least three years on 180 major foodstuffs, consumer goods and construction materials. The move is a shift from the Kingdom’s strategy of high agricultural tariffs to a policy of protecting consumers from rising food prices. This year alone, Saudi Arabia will spend more than SR12 billion in subsidizing food prices, on top of an estimated SR7.9 billion in indirect subsidies, such as water and electricity.
Clearly, the impetus for these subsidies and the lowering of custom duties is rising inflation in food prices. To tackle inflation, reducing or eliminating food tariffs on key staples is the best option; some twenty-four countries have recently lowered import duties in the wake of rising food inflation. The revenue loss from reducing tariffs is not significant for Saudi Arabia. In an environment of rising food prices, governments should also not be tempted to increase wages to combat food inflation, as wage-price spirals in the private sector may develop, fueling further inflation.
Forward View
Looking ahead, there are two main schools of thought on the global food situation. Optimists argue that supply shortages will not last beyond 2009, as farmers begin to increase their capacity in the food staples that have rallied and prices become attractive to agricultural investors. Speculation in food commodities will eventually fade, say the optimists, and a new equilibrium will be found. On the other hand, a less optimistic view is that there will be no significant improvement in the stock levels of key food products over the next decade; that price volatility will continue; and that potential or actual shortages will persist, as the world consumes more food.
We take the view that the global food market is facing some unforeseen demand dynamics, which are exacerbated by unusually low food stocks and by the demand for biofuels in developed markets. In such a tight market, SABB believes that speculators thrive and push prices to new highs within the food commodity asset class.
The Saudi Position
Saudi Arabia is the Middle East’s largest food importer. The Kingdom’s foodstuff imports have increased by an average of 19 percent between 2004 and 2007, reaching SR 44.8 billion last year. Rice is estimated to represent around 3 percent of the cost of living index in Saudi Arabia. But as the government has intervened with a subsidy to cushion the blow, the effect of higher rice prices has been somewhat mitigated.
Poultry and meat, which we estimate to carry more than twice the index weighting of rice, contribute significantly more to the overall inflation than other products. Fruit and vegetables which lie somewhere between the weightings of rice and meat products, but their tendency to upward price fluctuations can also impact heavily on the overall inflation figure.
Addressing the issue of wheat and rice import security, the potential for shortages and the impact of rapid inflation is crucial for many countries, including the Kingdom. Rice and wheat are “basic” foods, for which there are few substitutes or alternatives in the short term, especially for low-income groups.
Given that the food exporters, such as India, are also faced with growing domestic demand and rising inflation, the export of foodstuffs will take second place to securing local demand. This will not only lead to shortages in food-importing countries, but also create even more price-pressure, especially on rice. As food prices rise, social tensions between the well-to-do and the less fortunate members of society could become more visible, leading to a wider social rift.
The Kingdom is not alone in its attempts to forestall the rising cost of food imports. Recently, India scrapped tariffs on edible oil and maize and banned exports of all rice, except the high-value Basmati variety, upon which Saudi Arabia heavily relies. Vietnam, the world’s third-biggest rice exporter, announced it would cut rice exports by 11 percent in 2008. The unintended consequence of limiting exports could be that global food prices rise still further.
Global Drivers
Food price inflation is not a uniquely Saudi phenomenon. Food prices in Saudi Arabia are rising due to the high prices of agricultural commodities around the world. Global agricultural prices rose sharply in 2006 and 2007 and, so far, have increased by around 30 percent in 2008. Domestically produced foodstuffs are also rising as a lot of the agricultural inputs are on an upward trend in Saudi Arabia.
Historically, global agricultural prices have gone through short-lived highs and long-lived lows. Today’s rally is unusual due to its persistence. Furthermore, the current rally is not concentrated on a select few products, but on nearly all major agricultural products. Unlike other items, agricultural goods reach the consumer with very little time delay; so, as wholesale prices rise, there is an almost immediate impact on retail prices.
One of the main reasons for rising prices is the growth in world population — which, according to the United Nations, is expected to reach 9.2 billion by 2050, rising from 6.1 billion in 2000. Income growth is even more significant, as tastes change vastly when per capita spending power increases — which has been happening in many emerging economies. Put simply, higher per capita income generates more demand for additional food and for different types of food. For example, meat consumption in China was 20 kilos per capita in 1980, but had increased by 150 percent by 2007. Since it takes about 700 calories of animal feed to produce 100 calories of beef, this automatically increases the overall demand for various grains.
Saudi Arabia’s population continues to rise at a rapid rate and is expected to reach around 53 million by 2050. Today, however, the rising demand for food is also attributable to large influx of expatriate workers who, as in the 1970s boom, are again in great demand for the country’s many development projects.
Urbanization and Biofuels
The rise of urban living in emerging markets has altered tastes and increased demand for meat and dairy products, which in turn has led to pressure on cereal production to feed the animals that provide diary products and meat. In most cases, urban populations consume more meat than rural populations and, in most developing countries, consumption per person of meat, fruit and vegetables has increased at a faster rate in urban centers than in rural areas.
In addition, record high oil prices are providing price incentives for biofuel production, at a time when demand for food is on the increase. The rise of biofuels, especially ethanol, has added to the scarcity of land available for the production of other agricultural crops. In Brazil, the area of land used for the cultivation of raw material for ethanol (sugar cane) has increased over the past few years, with the unintended consequence of reducing land availability for food production.
The Effects of Speculation
But the boom in agricultural commodities is due not only to simple supply and demand dynamics. Speculation, which has become the main factor keeping crude oil prices above $100 per barrel at a time of recession in the United States, has also contributed to the boom in agricultural commodities. With the proliferation of mutual funds and exchange-traded funds tied to commodities (including crude oil), speculative buying has witnessed new highs over the recent past, as a way of spreading risk and receiving greater returns during highly volatile times in the financial markets.
Over the past two years, food and other commodities have acquired a quite irrational glamor for speculators, fueled by limited supply and rising demand.
On the positive side, agricultural commodities have been advantaged by exchange-rate swings. As most agricultural commodities are priced in US dollars, the weakening of the dollar against all other major currencies has reduced the impact of the rise in world agricultural prices. In the case of Saudi Arabia, it has been the dollar-pricing of commodities, rather than the currency regime itself, which has lessened the impact of high agricultural prices.
Food Inflation as a Force for Change
Although, in many ways, the economy of Saudi Arabia has escaped the impact of the current global slowdown, it has not avoided the effects of worldwide food-price rises. Food inflation in Saudi Arabia is due mainly to the high import volumes. We believe that greater effort is required to promote market forces in such sectors as the red meat and vegetables, especially in locally produced items.
For the immediate future, Saudi Arabia will remain vulnerable to global food-price fluctuations — and will have to make some tough decisions about its agriculture sector. Given the high population growth rate, food self-sufficiency is not possible — with water availability falling, as long as the current water policy remains static. The Kingdom’s agriculture policy in its current form is no longer sustainable.
New technologies, such as advanced greenhouses, may be introduced — but cannot meet the demands of a growing population. While Saudi Arabia today has the money to invest in domestic agriculture, it simply does not have the water. Looking further afield to develop much-needed food supplies for Saudi Arabia is a viable option.
As the security of crude oil supply is the principal role of Saudi Arabia, so the Kingdom should also safeguard, with the support of key strategic partners, its food security future.
As food prices rise around the world, the Kingdom has to better allocate its subsidies. Targeted subsidies are more valuable than all-encompassing ones. And, if state resources for administering targeted subsidies are currently limited, then the unfolding food situation worldwide should become a force of change.
Although the Saudi foodstuffs sector is more competitive than is widely believed, we take the view that other beneficial measures could be adopted, including:
(a) The establishment of a food price index for all regions of the Kingdom;
(b) Price labeling on all packaged products;
(c) Mandatory disclosure of discounts which wholesalers and food producers give retailers, so as to safeguard transparency in profit margins;
(d) Added transparency in the agreements reached between local farmers and wholesalers, and in those between meat wholesalers and retailers;
(e) Fully documented production and transportation of locally made food products, for checking by the authorities;
(f) Enhanced competition under the auspices of the competition committee;
(g) A legally enforceable definition of “illegal profiteering” common in many countries.
(h) When economic conditions permit, food producers, wholesalers and retailers should — as a matter of social responsibility — make a concerted effort to reduce prices. Historically, it has been rare for food prices to be lowered, even when production costs fall.
(Dr. John Sfakianakis is chief economist at SABB [Saudi British Bank], Riyadh.)
