Puneet Vatsa: Unpacking high food and fertilizer prices

2023-04-26

Food and fertilizer prices have risen sharply since mid-2020. Energy prices have risen still more steeply. If there were doubts regarding the strength of the association between these prices, the last two-and-a-half years are sure to allay, if not eliminate them. Puneet Vatsa, a Senior Lecturer of Economics at Lincoln University in New Zealand, shared his insights on unpacking the reasons behind the high food and fertilizer prices.

 

China Daily: What is the association between energy and food and fertilizer prices?

 

Vatsa: Agriculture is energy-intensive: as energy becomes expensive, so does growing food. Producing fertilizers also requires energy: natural gas is a critical feedstock for producing nitrogen fertilizers globally; in China, however, coal is the primary feedstock. Rising natural gas and coal prices increase the cost of producing nitrogen fertilizers; this higher production cost is transferred to farmers and agricultural businesses. In turn, this transfer makes it costlier to produce food and manifests itself in higher food prices. In light of this chain of events, observing high food prices in the wake of rising energy prices should come as no surprise.

 

China Daily: However, what may be surprising is how quickly food prices change to mirror the trajectories of energy and fertilizer prices. It is as if these prices are synchronized. Why is this the case? After all, it is common for farmers to purchase fertilizers only a few times during a growing season. In fact, they may purchase a significant proportion of fertilizers well in advance of harvest time. So, if fertilizer prices rise close to harvest time, much later than when they were purchased, why does the price of food grown using that fertilizer rise? Should higher fertilizer prices not be reflected, at the earliest, in the next harvest, that which is grown using expensive fertilizers?

 

Vatsa: There are several reasons why food prices may change almost contemporaneously with not only fertilizer and energy prices but also with prices of commodities to which they are unrelated.

 

First, commodities are globally traded and are exposed to the same economic shocks that influence the demand for and supply of these commodities. For example, a slowdown in global economic activity reduces the demand for many commodities simultaneously, leading to lower prices. In contrast, disruptions in global supply chains may engender shortfalls in available supply, causing a broad-based rise in prices.

 

Second, institutional investors may view several commodities as one asset class; they may invest in securities linked to commodities, driving up the demand for several of them together.

 

Third, because commodities are generally priced in US dollars, fluctuations in the US dollar exchange rate affect commodity prices. As the US dollar strengthens, US dollar prices of commodities fall and vice versa.

 

Fourth, low interest rates can boost speculative demand for a range of commodities, increasing their prices above levels consistent with the underlying market fundamentals.

 

Fifth, geopolitical turmoil in regions that produce large volumes of specific commodities can halt production activities and cut off vital shipping routes, thus pushing up prices. Even the anticipation of upheaval and unrest can significantly increase prices as people revise their expectations of inventories, supplies, and prices.

 

China Daily: Given the complexity of commodity markets and the global economy, it is challenging to untangle the drivers of commodity prices. That the synchronized movements of commodity prices may reflect factors unrelated to the trade of physical quantities complicates matters further. The above provides a broad framework within which one can ponder potential causes underpinning high food, fertilizer, and energy prices. How do you interpret the unprecedented rise in these prices over the last few years?

 

Vatsa: Food, fertilizer, and energy prices surged during the second half of 2020, a few months after the World Health Organization declared the COVID-19 outbreak a pandemic. The pandemic resulted in clogged supply chains and led to significant shortages globally; higher prices ensued.

 

At the same time, governments enforced lockdowns to curb the pandemic, reducing production, employment, and overall demand for goods and services. In response, central banks worldwide lowered interest rates, and governments rolled out fiscal stimulus packages. These policies may have offered a lifeline to ailing economies but contributed to inflation in 2022.

 

A frigid winter in Europe in 2021 and strong demand in Asia increased energy prices further. Towards the end of 2021, the impending war in Ukraine created uncertainty in global markets regarding food, fertilizer, and energy supplies from Russia, Ukraine, and Belarus. With the Russo-Ukraine war becoming a reality in February 2022 and sanctions on Russia and Belarus, prices spiraled upward—low supplies, even the fear thereof, have kept markets anxious and prices high. Countries have responded by restricting exports of food and fertilizers to meet their domestic needs, making matters worse.

 

To bring inflation under control, central banks of many countries have increased interest rates. To be sure, inflation has declined moderately since mid-2022. However, it continues to be uncomfortably high. Food and fertilizer prices, in particular, are significantly higher than their pre-pandemic levels. This is a grave matter with profound implications for global food security.

 

China Daily: How do higher food and fertilizer prices affect global food security?

 

Vatsa: Soaring food prices have exposed the poor, many of whom live in Asia and Sub-Saharan Africa, to hunger and malnutrition. In 2022, the number of people facing food insecurity increased by 118.7 million, reaching 1.3 billion. Because the poor spend significant proportions of their incomes on food, they are especially vulnerable to sharp increases in food prices. Furthermore, many of the world’s poorest people are smallholder farmers. For them, unusually high fertilizer prices have made it prohibitively expensive to grow food, exacerbating food shortages. Because these farmers rely on what they produce to feed their families, they may be at risk of malnutrition and starvation.

 

Despite concerted efforts from policymakers and central bankers, reducing food and fertilizer prices is proving difficult. Raising interest rates and keeping them high for an extended period may be infeasible, as it may stifle economic growth. And these measures can go only so far in the face of abrupt shortages of critical commodities due to military conflict, geopolitical risks, broken supply chains, and trade restrictions—resolving these is vital to addressing high food and fertilizer prices and global food insecurity. Should they remain unresolved, the world may have to grapple with high prices and their attendant problems for the foreseeable future.