December 13, 2008
China corn defies the free market
While socially laudable, official efforts to keep corn prices high may soon distort China's domestic feed and livestock sectors.
An eFeedLink Exclusive Commentary
by Eric J. BROOKS
Government policy reverses course
Traditionally concerned with keeping its corn prices low and imports out, the last ten years saw China do everything possible to ensure plentiful supplies and stable prices. From 2004 onwards, exports were strictly controlled. To keep corn plentiful and cheap without resorting to importation, approximately 100 million of the 130 million tonnes in emergency corn reserves it had less than 10 years ago were exhausted, leaving only about 30 million tonnes at the beginning of 2008.
What a difference 12 months makes. A modestly good harvest has coincided with slack feed demand, depressed deep processing output and tight new restrictions on conversion to ethanol and crashing CBOT corn prices. Outside of China, a global credit crisis destroyed all the excess money fuelling commodity prices. Chained to the price of oil through bioethanol, corn's price crashed from nearly $8/bushel to barely $3/bushel in just 5 months.
This sudden turn of events is forcing the country's corn policy to steer a radical 180 degree turn. Instead of ensuring plentiful supplies and low corn prices, the government is now concerned that corn farmers will be squeezed between falling corn prices and high costs for fuel, fertiliser and farm labour.
Keeping peace with price supports
Such a situation could drastically cut farm incomes, create social unrest in the countryside and lead to not enough corn being planted next year. To make sure that none of this happens, in October, the National Development and Reform Commission announced that the government planned to buy corn at RMB1,500/tonne ($5.55/bushel).
The first round of purchases amounted to 5 million tonnes and at first, it kept Dalian corn futures comfortably elevated. More recently however, with an unexpectedly large corn surplus and CBOT corn floating around the $3.30/bushel (RMB 890/tonne) range, the government discovered that its purchases might not be enough.
With Dalian futures falling 1.3 percent in just one day and the average corn price threatening to break through the pre-determined RMB1,500/tonne price floor, the government recently announced additional price supporting measures. It now intends to add to national reserves an additional 5 million tonnes of corn over and above the 5 million tonnes it bought previously. To relieve the downward price pressure, the government is also looking at exporting up to 4 million tonnes of corn in 2009. In addition, the government is now also trying to clear excess soy from the market through official purchases, rather than have soy farmers suffer a loss of income.
Imports amid plenty? The price of defying market forces
While these policies and their motives are commendable, their open defiance of market forces is creating several awkward, contradictory circumstances.
First, with China's corn being kept approximately 40 percent higher than CBOT prices, it will be extremely difficult to export corn in the face of much cheaper American corn, especially at a time when long-distance shipping costs have fallen drastically. Exporting China's excess corn might mean that government may have to sell it more cheaply overseas than in China itself. The government subsidy this may imply may itself be very large.
Second, that artificially maintained 40 percent price gap with CBOT corn may lead to a very strange domestic situation: In a free market, China's corn surplus would solve itself by causing its domestic price to drop closer to CBOT levels. The lower price would increase domestic consumption while enabling it to be easily exported. At the very least, market forces would not work to draw in foreign corn at a time when domestic supplies are in excess.
Price floors curtail livestock feed demand
Thirdly, corn demand is low because livestock numbers were decimated by last year's winter storms. That was nearly a year ago but hog, poultry and aquaculture numbers still have not recovered. This is partly due to the fact that meat and livestock prices have crashed. While the cost of livestock inputs such as fuel or transport have fallen, thanks to official price supports, feed costs have not fallen as much as meat prices.
By reducing the profitability of China's livestock sector, corn price reduce the supply of meat, leading to higher long-term meat prices. In the long run, the reduced meat supply could even lead to having to choose between higher pork prices or more imported pork. In all of these ways, the official support of corn's price is undermining China's corn market and affecting its ability to raise sufficient livestock to meet national demand.
Several available policy options
What China needs at this time is a more market-friendly approach to clearing its corn surplus. Towards this end, there are several policy options available. The first, and perhaps the most logical alternative would be to simply allow domestic corn's price to fall. At the very least, allowing China corn to fall to its natural price would discourage imports from further bloating domestic supplies.
In addition, lower corn prices would help to restore livestock rearing's profit margins. By allowing growth in livestock numbers to resume, an overhang of surplus corn could be quickly converted into meat. This in turn, would help tame the food price inflation that China has suffered in recent years.
A second market-friendly means of increasing corn demand would be to re-write the restrictions on ethanol production that China has introduced over the last two years. Instead of today's unqualified restrictions on ethanol output, the proportion of a corn harvest that could be turned into ethanol could be made to depend on its market price. More corn would be turned into ethanol when corn's price is low, less when the price is high. This would ensure that the biofuel sector clears excess corn from the market without threatening domestic supplies when there are shortages.
A third option is to double or triple the announced quantity of government corn purchases. While not as market-friendly as the above-mentioned solutions, this alternative has certain strong advantages. First, while purchasing corn would cost the government money, so does the alternative of providing an export subsidy at a time when China's corn is much more expensive than US or Argentine corn exports. However, such purchases would at least work towards rebuilding China's national corn reserves, which have been badly depleted over the past decade. While the price support this implies would not spread the surplus corn's benefit's to livestock farmers, the national security implications of rebuilding national reserves surely makes this option attractive to policymakers.
Finally, China could get lucky enough for CBOT prices to rise up enough to meet China's domestic price. This on its own could relieve much of the downward price pressure.
Only one thing is for sure: large harvests, low international prices and high domestic price floors make awkward bed fellows. Unless the price gap between China's corn and the rest of the world's closes soon, all sorts of odd market distortions are sure to follow.
All rights reserved. No part of the report may be reproduced without permission from eFeedLink.