Look Beyond Production and Yields: Business Standard 7th February 2008

The bull run in commodities means different things to different people. Investors are, for obvious reasons, joyous when prices move up, while consumers are disappointed at the marketplace which is followed by an expression of umbrage. Governments then try to fix the blame on someone — bad weather, low yield, insufficient investment, futures trading, private players and now exporters (for maize). But, have we missed something very important in the process which can provide a vital clue?

Globalisation has sort of flattened the world economy in many respects, starting from technology and then to world agreements culminating in the Euro — while still haggling and stuttering on the WTO. And now it has actually spread to commodities too and while such developments make sense in the industrial field, it has permeated the agricultural sector where prices in India are influenced significantly by movements in the rest of the world.

The contemporary corn/maize case is best illustrative of this phenomenon. India’s production has been good in 2007 and so was it last year. India is a small global player, but once there is shortage elsewhere in the world, the global price moves up, and with it the incentive to export. Domestic producers or procurers can buy in the local market and export the same overseas at a higher price. The farmer gains, so does the intermediate, while the user ends up complaining of higher prices and the search is on for the usual suspects. This has been witnessed in the case of pepper, chillies and cumin earlier. But there is a legitimate foreign hand here which needs to be understood.

Increases in crude oil and gold prices are now legendary as crude crossed $100, while gold scaled new heights during 2007 and so have domestic prices of the same. The bull run in gold in India and the constant mounting of losses of the oil companies bear testimony to the strong correlation in prices here, where, however, price discovery takes place on foreign soil. But the same was witnessed across agricultural commodities in particular, as prices rose quite remarkably across all segments. The table illustrates this point.

The table reveals some interesting observations. Firstly, nine of the top 11 commodities which have witnessed increase in price of over 10 per cent during 2007 are agro-based products. This has been caused by declines in production or stocks in some countries. However, there have been no crisis-like situations in any of these products, and a minor disruption has caused upheaval in prices.

Secondly, the price rise witnessed in agro-products was lower in India relative to the world in nine of the 10 commodities, with cotton being the only exception. Cotton prices were higher, more due to the export factor as production in domestic markets has been vibrant. This is indicative of a partial insulation of our markets, which are still regulated today. As a corollary, with progressive integration with world markets, we should be prepared for a higher intensity of this effect in future. Thirdly, the world prices of five of the seven metals increased by less than 10 per cent this year, with nickel and lead being the exceptions. The lower demand for them could be the slowing down of growth in some countries, with the China-factor playing its part. The global slowdown on account of the sub-prime crisis and the decrease in growth in liquidity has played its role too.

Lastly, in four of the metals, the price rise in India was higher than that in the world, reflecting greater elasticity in iron, steel, copper and aluminium, while it was almost on par in case of nickel.

The interesting takeaway here is that Indian commodity prices, particularly of agriculture products, are progressively getting integrated with the global scenarios and while the changes are less significant, there will tend to be convergence in future. Most of these products are becoming global with India being a large producer or consumer of virtually all commodities due to the sheer size of its population. In wheat, it was observed that a mere fall in global stocks, though not production, can cause an upward swing in prices. In case of non-agri metal products, prices have been more elastic given the demand-supply imbalances.

Given this movement towards globalisation of agri-prices, it would be essential for the government to do two things. The first is to closely monitor what is happening globally in terms of output, stocks and prices and be prepared for similar trends domestically. Secondly, a policy regarding foreign trade needs to be in place to meet these contingencies. Imports need to be allowed to ensure supplies; while the call on exports needs to be weighed carefully with market reality to ensure that the final prices are in alignment with the fundamentals.

More importantly, we need to look beyond just our own production and yields