Friday, May 2, 2008

Food Security and Financial Markets

This post is in continuation to my previous posts on rice trade, and will seek to examine the possible long term solutions to combating foodgrain inflation.

In the period from March 2007 to March 2008, the average world price for corn increased 30%; for rice, it increased 74%; for soybeans, 87%; and for wheat, 130%. In India, the prices of oils and fat have gone over the roof - vanaspathi by 41.15%, mustard oil by 58.2%, groundnut oil by 24.7%, milk by 11.1%, and potato by 12.5% in the March 2007-March 2008 period. The BBC has this on the rising food prices.

Rising food prices hurt net consumers, while benefiting producers. In developing countries, the major share of poor consumers are the urban poor and the landless agriculture labour, who spend upto 70% of their incomes on food. And this category is a major share of the consuming population, and are most vulnerable to price volatility.

The volatility in foodgrain prices highlights the volatility associated with commodity prices in an integrated global economy. It also underlines the importance of adequate measures to cushion atleast the poorest and most under-privileged from such uncertainties. It is in this context that the much derided Public Distribution System (PDS) of India and the role of the Food Corporation of India (FCI) in maintaining adequate buffer stocks of foodgrains, assume significance as vital componenets of a comprehensive food security policy.

What are the policy prescriptions available? The world of financial markets may interestingly enough, have a lot to offer to our food security policies. In the recent years, the financial markets have seen a proliferation of instruments that are aimed at hedging against financial risks, besides enhancing global financial liquidity. Similar interventions aimed at hedging commodity price risks and increasing availability are necessary.

The existing commodities exchanges and trade in commodity derivatives, are more concerned with non-foodgrain commodities, and are populated more by private sector participants. Nation states or their representatives, especially from the developing world, are not participants in these exchanges. Further, the financial instrument dimension of commodities trading is increasingly overtaking its commodity price hedging dimension.

Madan Sabnavis of the National Commodities Exchange (NCDEX) of India argues for the establishment of a World Agricluture Bank (WAB) to address global demand supply mis-matches in agriculture commodities. He proposes that the WAB, build up a buffer stock of foodgrains, by procuring at the prevailing market price, to be used in times of crisis. This global FCI(!) would allow its contributing members to buy a certain multiple of their contribution or quotas, at a predetermined price, which may be announced at the beginning of the year. The members would therefore be hedged against abnormal price rises.

A more effective alternative than a WAB would be to have a global commodities exchange, trading in agriculture commodities, and with national economies or their representatives being the traders. There can be an international commodities trading market in which individual countries or their representatives are the traders. Therefore, a rice consumer like Senegal could enter into a futures contract for purchase of rice from a rice producer like Vietnam. This would ensure that both the producers and consumers get insulated from the vagaries of global commodities market preferences. In fact the numerous private commodities exchanges could get linked to this massive global commodities exchange (GCEX).

Another alternative would be, as Esther Duflo suggests, to create an international market in providing foodgrain price insurance for the poor. She writes, "Countries that are neither net sellers nor net buyers could do this internally, and countries that are either net sellers or net buyers should be able to sell this insurance on the world market."

Prof Robert Shiller had sometime back conceptualized macro-markets, which can be created to trade in macro-securities of various agriculture commodities. These macro-securities, linked to both global market prices and individual national production figures, will insure producers and consumers against agriculture price volatility.

Macros are twin-securities - up and down macros - issued on an index, which move up and down, in response to the movements in the value of the index. The macros give dividends, with the holder of the up macro being rewarded when the index rises, and the holder of down macro when the index falls. Individual nations, (or their food trading agencies, like the FCI in India) can buy the down-macros, while regular investors can buy the up-macros. There can be international macro-securities to hedge against the volatility in rice, wheat, corn and other foodgrain prices.

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