Economy

Executive Summary Increase In Chinese Ag Prices Has Been Much More Muted Than Globally China’s food price inflation accelerated in April. The rising cost of global agricultural goods and domestic COVID-related disruptions in the supply-chain contributed to a sharp bump in food prices last month. China is not overly reliant on food imports. The country is also well stocked with grain reserves and should weather ongoing global food supply shortages, particularly wheat, better than most emerging economies.  However, China will still be impacted by escalating prices of global agricultural products and energy. Some imported goods (e.g. soybeans and related products) that China relies on, coupled with higher energy costs and a bottoming in China’s pork prices, will continue to push up food prices and headline inflation. Higher reading in headline inflation will not change the direction of the PBoC’s monetary policy. However, more expensive food will dampen Chinese households’ spending power on non-food consumer goods, especially as income growth slows. The food and beverage sector in China’s onshore stocks will benefit from higher food costs. We are initiating a new trade: long domestic consumer staples/broad A-share market. CYCLICAL RECOMMENDATIONS (6 - 18 MONTHS) INITIATION DATE RETURN SINCE INCEPTION (%) COMMENT LONG DOMESTIC CONSUMER STAPLES/BROAD A-SHARE MARKET 05/18/2022     Bottom Line: Despite China’s solid self-sufficiency in food supplies, its food price inflation is not immune from the mounting prices of global agricultural products.   Is China’s Food Price Inflation Transitory? The food component of China’s consumer price index (CPI) increased by 0.9% in April compared with the previous month, a sharp reversal from a 1.2% month-over-month decline in March. Higher food and energy prices pushed headline CPI to 2.1% in April, the fastest year-on-year growth since August 2020. China is not overly reliant on food imports and has abundant grain reserves.  The country is in a better position to weather ongoing global supply shortages in grain compared with other emerging economies, such as the Middle East and North Africa. Moreover, agricultural product prices in China have been structurally higher than those traded in the global commodity market. Large margins in China’s bulk agricultural pricing provide a cushion from escalating global food prices. Nonetheless, China remains at risk for higher food prices this year. Elevated oil prices and the war in Ukraine will further lift the price of fertilizers, adding to input costs for agricultural products. A strong USD will add to the price of USD-denominated commodity imports, particularly soybeans. In addition, China’s domestic pork price may have reached its hog cycle bottom and will pick up in the second half of this year. Food Prices Are Driving Up Inflation China’s headline CPI accelerated to 2.1% in April, on a year-on-year basis, from 1.5% in the previous month. Even though pork prices plunged by 33% in April from a year ago, food prices grew by 1.9% and have been boosted by a jump in the cost of fresh food, such as vegetables (+24% year-on-year), fruit (+14%) and eggs (+12%). Prices in other food categories, such as grains and edible oil, also rose, albeit more modestly (Chart 1A and 1B). Chart 1ALarge Jump In Fresh Food Prices In April Chart 1BOther Food Prices Also Picked Up, But More Modestly China’s strict COVID-19 containment measures have had a broad-based impact on food supplies. Mobility restrictions, roadblocks and risk-averse truck drivers introduced significant challenges in food supplies and transportation. Lockdowns in some large urban areas also led to panic buying and stockpiling among consumers, pushing up demand. Chart 2Increase In Chinese Ag Prices Has Been Much More Muted Than Globally Meanwhile, higher global food and energy prices have likely both directly and indirectly contributed to food price inflation in China. The UN Food and Agriculture Organization (FAO) Food Price Index in April this year leapt to its highest level since its inception in 1990; it is 30% higher than last year and nearly double from its trough in mid-2020. Although price increases in China’s domestic agricultural products have been more moderate, the country’s agricultural wholesale prices have jumped by 10% from a year ago (Chart 2). Bottom Line: Food accounts for about 20% of China’s CPI basket (Chart 3).  Climbing food, along with energy, prices are driving up China’s headline inflation. Chart 3Food Accounts For 20% Of Chinese Household Budgets China Is In A Good Position To Weather Global Food Supply Shocks … Chart 4Ex-China Food Inventories Haven’t Been Built China is well stocked with food reserves and does not rely on imports for most of its agricultural supplies. Thus, the country should weather ongoing global shortages in the food supply better than most emerging economies (Chart 4).  China’s food inventories are significantly higher than levels in the 2006-2008 and 2010-2012 global food price hikes (Chart 5). The nation’s inventories have been steadily building up in the past decade to avert potential food supply shortages. Corn and rice stocks are sufficient to cover consumption for nearly three quarters of a year and wheat stocks are at nearly a year’s worth of consumption. Chart 5China Has Been Building Up Inventories To Buffer Against Supply Shortfalls Chart 6China Is Not Overly Dependent On Ag Imports Furthermore, with the exception of soybeans, China is not overly dependent on imports for agricultural supplies (Chart 6). The country is self-sufficient in supplying rice, wheat, and corn, three major staples in China’s grain consumption basket. Less than 5% of China’s total consumption of the three staple grains comes from imports. Bottom Line:  China is well stocked with agriculture products and is not overly dependent on imports for its food supplies. … But Not Immune To Food Price Hikes Worldwide Chart 7Ag Products Are Traded At Higher Prices In China Than In The Global Market Rising global agricultural and energy prices could still push up the country’s food price inflation. In USD terms, prices of China’s domestic agricultural products have been structurally higher than those traded on global commodity markets (Chart 7). The government heavily regulates and subsidizes its agricultural procurement prices as an encouragement to domestic farmers.  When global food supply shocks sharply pushed up agricultural prices worldwide, China’s domestic agricultural prices, with their large buffer versus global food prices, rose more moderately.  Nonetheless, China’s domestic food prices are not insulated from worldwide price hikes. China is facing higher inflation in food prices this year for the following reasons: Pork prices, which account for 13% of China’s CPI food basket, have likely bottomed. Although pork prices remain in a deep contraction year-over-year, they rebounded sharply in April on a month-on-month basis (Chart 8). The number of sows peaked in mid-2021 and has been declining for the past 10 consecutive months. Falling sow numbers have historically led to rising pork prices (Chart 9).   Chart 8Pork Prices May Have Bottomed Chart 9Pork Prices Will Likely Increase In 2H22 Nearly 90% of China’s soybean consumption relies on imports, making the country vulnerable to external price fluctuations. Soybean prices have jumped sharply this year. A stronger USD will also add to the price of USD-denominated commodity imports. About 80% of Chinese soybeans are crushed to produce meal to feed China’s massive pork industry, which means higher soybean prices will indirectly lead to rising pork prices by boosting input costs. Given that pig output is approaching its cyclical bottom, an increase in pig livestock would mean more demand for soybeans.  Chart 10Edible Oil Prices Reached Their Highest In Decades Growing prices in soybeans and corn will lift the cost of cooking oil, which represents about 8% of China’s food CPI basket (Chart 10). Ukraine supplies 30% of China’s corn imports, and Russia and Ukraine together account for nearly 20% of China’s soybean oil imports. China ramped up corn imports from Ukraine through March despite the war and snapped up large volumes of US corn in April after supplies from Ukraine were cut off. Nonetheless, prices of soybeans and corn will likely remain elevated with no end in sight to the Russia-Ukraine war and supply shortages globally. In addition, as global travel becomes more popular and oil prices remain elevated, the demand for corn-based ethanol, which is blended with gasoline, will also expand. Wheat prices will continue to experience upward pressure in the global market, mainly due to reduced production and exports from Ukraine and Russia (these countries account for 30% of world’s wheat exports). The World Bank forecasts that wheat will be 40% more expensive this year, reaching an all-time high in nominal terms.1 Although China is about 96% self-sufficient in wheat, the upsurge in global prices has boosted China’s domestic cost for wheat; it climbed by 15% in May from a year ago (Chart 11). Higher shipping and input costs, especially for fertilizers, will exacerbate the upside price pressures on agricultural goods. China is the world’s largest exporter of phosphate fertilizer, but its domestic fertilizer prices are heavily subsidized and much cheaper than exported ones (Chart 12). However, the domestic cost of fertilizer will likely follow the lead of rising global prices for fertilizers and agricultural products. Chart 11Chinese Wheat Prices Jumped Against The Backdrop Of Global Supply Shortages Chart 12China's Domestic Fertilizer Prices Will Likely Trend Up The relationship between agricultural prices and the dollar broke down early last year (Chart 13). Historically, a strong USD would weigh down agricultural prices by encouraging ex-US producers to raise exports and boost global supplies. However, the COVID pandemic and war in Ukraine have triggered a global surge in government controls on food exports. Such broad enforcement of protectionist measures will continue to exacerbate worldwide inflationary pressures on food. Chart 13The Inverse Relationship Between Global Ag Prices And The Dollar Has Broken Down Bottom Line: China’s food prices face upward pressure. Strengthening global prices in a wide range of agricultural products, coupled with higher energy costs and a bottoming in China’s pork prices, will all contribute to higher food price inflation in the country. Investment Conclusions Chart 14Core CPI Remains Subdued Food price inflation should not constrain the PBoC from further easing monetary policy. As mentioned in previous reports, China’s monetary policy framework has shifted away from headline CPI and has been anchored in core CPI, which has remained subdued  (Chart 14). However, China’s accelerating food and energy prices, as household income growth is slowing, will lower households’ purchasing power and curb their demand for non-food consumer goods and services.  While China’s overall consumption and economy will suffer from higher food price inflation, soaring food prices will help to widen the profit margins among food processing firms (Chart 15).  Furthermore, food and beverage companies in China’s onshore equity market have one of the highest ROAs and the lowest financial leverages (Chart 16). We are initiating a new trade: long Chinese onshore consumer staples/short broad A-share market. Chart 15Long Chinese Onshore Consumer Staples... Chart 16...As The Sector Will Benefit From Rising Food Prices   Jing Sima China Strategist jings@bcaresearch.com   Footnotes 1     The World Bank’s Commodity Markets Outlook Report, April 2022.     Strategic Themes Cyclical Recommendations