July 4, 2011

A shortage of hogs is set to push China's consumer price index (CPI) to a new high, and means a respite from inflationary pressure may be several months away.

The official data on inflation in June will not be published until July 15. But the early signs are that it will show the CPI popping above 6% on-year. That is way above the government's target of 4%, and earlier forecasts by many investment bank economists, who started the year predicting a peak of around 5%.

The proximate cause is food prices. End-June prices for pork, China's favourite meat, are up 67% on-year. Experts said pork alone will contribute 1.6 percentage points to June's CPI. This is not the first time pork prices have pushed China's inflation index to worrying levels. In February 2008, a similar pork shortage sent prices soaring, the main factor behind inflation jumping to 8.7%.

The government's solution to the 2008 hog crisis-subsidies that encouraged farmers to ramp up pork production-has a lot to do with the causes of the current dearth. The surge in production that followed the subsidies in 2008 led to a collapse in hog prices in summer 2009. That in turn caused farmers to slaughter sows and reduce breeding, leading to the current shortage.

Pork prices are now at record high levels, which should strengthen incentives to increase production. But higher prices for output are only part of the equation for China's farmers. The price of corn-which is the major cost factor in the production of pork-is just as important.

Record high corn prices in China, mainly as a result of growing demand for animal feed, have reduced profit for hog farmers. A ratio of 6:1 in the price of pork to corn is the minimum for farmers to break even. The number has hovered just above that level for much of the last year, and only moved significantly higher in the last month.

A fall in international corn prices-under way since mid-June-should help alleviate cost pressures. But even as higher pork and lower corn prices improve incentives for farmers, hogs conceived today will not come to market until the first quarter of 2012. That means China's high inflation could be more persistent than investors expect.