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Cablegate: Response: Impact of Rising Food/Commodity Prices -- China

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OO RUEHCN RUEHGH RUEHVC
DE RUEHBJ #1690/01 1210914
ZNR UUUUU ZZH
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FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 7007
INFO RUEHOO/CHINA POSTS COLLECTIVE
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UNCLAS SECTION 01 OF 07 BEIJING 001690

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TAGS: ECON EFIN PGOV EAGR SOCI CH

SUBJECT: RESPONSE: IMPACT OF RISING FOOD/COMMODITY PRICES -- CHINA

REF: STATE 39410

INTRODUCTION/SUMMARY
--------------------

1. (U) INTRODUCTION: This report is Mission China's response to
reftel, which requested input on the impact of food and commodity
price increases. It is a composite of analysis and data compiled by
Embassy Beijing as well as by Econoffs in Consulates General
Guangzhou, Shanghai, Chengdu, and Shenyang. The first part of this
message is our formal response within the space limits prescribed by
Dept. Given China's large population, size, and significant role in
global food demand and production, however, we have additionally
included an addendum with more on-the-ground views, largely from the
Consulates General. At the end of this report is a list of relevant
reftels from this post, sent over the last year. END INTRODUCTION

2. (SBU) SUMMARY: China is not a significant importer or exporter of
grains, and the country's recent food price/supply shocks are
largely domestic in nature. China is, however, the world's top
importer of oilseeds and edible oils, and this has bearing on the
prices of these items in other markets. China is also a huge
contributor to the world's rising demand for oil; this impacts the
global price of petroleum- and natural gas-derived agricultural
inputs and increases the economic attractiveness of biofuel crops
and production in other countries. China is not a major source of
globally traded grain supplies, but it is a significant exporter of
some types of produce. The mainland consumer price index (CPI) food
basket rose 21% during the first quarter of this year, while overall
CPI inflation was 8%; both figures were 11-year highs. Food
inflation is expected to moderate over the coming months. Higher
prices have adversely affected lower-income consumers who spend a
higher proportion of their income on food. Apart from isolated
incidents, there is no sign of widespread or sustained instability.
Major factors in recent food inflation are domestic pork supply and
disease problems, winter storms, and the aforementioned costly
imports of edible oils. The Chinese Government has imposed a range
of measures to address food inflation, including export tariffs on
fertilizer and grains as well as price controls on staple food
items. There are also new investment restrictions on some areas of
commodity processing and distribution. Key longer-term drivers of
China's influence on global food markets include rising incomes
raising the caloric intake, limited arable land, and widespread
environmental degradation. These factors are expected to increase
imports over time, but this trend will likely play out gradually.
END INTRODUCTION/SUMMARY

DEMAND
------

3. (U) China's population growth has slowed dramatically; the
current population of 1.3 billion is expected to reach 1.46 billion
by 2030. However, continued economic expansion and rising living
standards have driven up food consumption from approximately 2,000
cal/day in the 1970's to 3,000 cal/day today. Over the past 20
years, there has been a major shift in the composition of caloric
intake, with the grains proportion falling from 70% to 45% and
meat/dairy rising from 6% to 25%. China's average GDP growth has
been above 9% for a generation and is only gradually expected to
slow over the coming years. As living standards further shift
intake away from grains and boost overall calorie consumption, a
fixed arable land supply with limited potential for increased yields
suggests the likelihood of greater imports, perhaps on the order of
15% growth annually in the medium term, according to a report
prepared by UBS, with even higher rates for grains.

4. (U) The mainland consumer price index (CPI) food basket rose 21%
during the first quarter of this year, while overall CPI inflation
was 8%; both figures were 11-year highs. Pork prices alone rose 69%
yoy as of February 2008, with beef and lamb not far behind. Food
prices account for approximately 87% of the overall CPI increase.
Income disparities are very high in China -- the Gini Coefficent is
estimated to approach 0.50. Consequently, those in the bottom half
of the income distribution -- who spend more of their budget on food
than suggested by the 33% CPI weighting -- are adversely affected.

5. (SBU) There is some evidence of product substitution under way.
For example, Consulate General Guangzhou reports that low-income
consumers in the provinces of Fujian, Hainan, and Guangxi are
increasingly substituting cheaper foods, e.g., soy milk for fresh
milk. To date, the effect of such substitution has not been obvious
in demand growth, and it is most likely only moderating the

BEIJING 00001690 002 OF 007


spectacular growth rates we are seeing in milk and meat
consumption.

6. (SBU) No discussion of China's impact on the world's rising food
and commodity prices is complete without reference to energy demand,
which affects fertilizer prices, transport costs, and the incentives
for biofuel crop cultivation and production in other countries.
China does not produce enough crude oil or natural gas to meet its
needs. The International Energy Agency estimates that China's oil
imports will grow from 3.5 million bbl/day in 2006 (half of current
consumption) to 7.1 million bbl/day in 2015 to 13.1 million bbl/day
in 2030, implying that China will account for approximately 40% of
the global increase in demand for traded oil over this period.

SUPPLY
------

7. (U) China is the world's largest producer of agricultural goods
and is number one in cotton (27% of world production), rice (31%),
apples (52%), peanuts (43%), pears (71%), and pork (51%). It is
second in poultry (17%), corn (19%), wheat (16%), citrus (19%), and
rapeseed (27%). China is fairly isolated from global markets and
prices for grain because it neither exports nor imports a
significant percentage of any grain product. This reflects high
transportation costs, poor logistics to export terminals, high and
increasing domestic demand, and government incentives for local use.
China does export seafood, fruits, vegetables, and animal products.
It is the world's top importer of oilseeds and edible oils,
particularly soybeans, where its high level of imports means that
China influences the international market, although it is a price
taker.

8. (U) Recent food price inflation primarily reflects domestic
supply shocks in both livestock and perishables. Some food
inflation is imported, and this is most notably reflected in prices
for cooking (soybean) oil. A swine viral infection has sharply
reduced pork production over the past two years, and
January/February 2008 brought the worst winter weather in 40 years,
killing 63 million poultry birds, 4 million pigs, 393,000 cattle,
and 1.38 million sheep and goats. The storms damaged the spring
2008 fruit and vegetable crops, and will reduce the harvested
rapeseed area from 7.1 million hectares to 6.7 million. Citrus
production is expected to decrease by 10-15%. Overall economic
losses from the storms are estimated at $21 billion. In 2007, a
drought cut corn production by 6%. Livestock growth has also
pressured the corn supply, lowering increases in corn exports to
other markets such as South Korea and Japan.

9. (U) China faces significant longer-term supply constraints. Only
14% of land in China is cultivated, and the country is poorly
endowed with water resources. Although there is much excess rural
labor, there is a significant exodus under way from agricultural
areas: approximately 150 million of China's 700 million rural
residents have migrated to jobs created by China's manufacturing
boom, primarily in coastal areas. The rising cost of inputs such as
fertilizers, pesticides, and feed products for livestock means that
increased prices are not always translating into expanded margins
for farmers. Consequently, supply increases in response to prices
are uneven, depending on specific conditions. Agricultural
productivity and yields have already increased with economic
liberalization and the expanded use of fertilizer. Further gains
will not come easily in an environment of small-scale household
plots and amidst environmental degradation. Food prices do not yet
seem to be a factor in causing an increase in land used in food
production or a shift in production from non-food commodities to
grains. There appears to have been some response by farmers to high
pork prices, but this also is a longer-term trend based on upward
demand for pork in China.

10. (SBU) A think tank contact in Sichuan Province, an important pig
raising center, described supply challenges to us. Many farmers
there no longer raise pigs now because of blue-ear disease. Prices
of baby pigs are so high that farmers cannot afford them. (Note:
We have also heard reference to higher input prices (feed,
electricity, transportation), and the inability to find higher
paying work in urban centers. End Note.) The contact described a
similar situation with rice: many farmers do not store as much grain
as before, since family members have left home to go to other
provinces as migrant workers; they think they can buy grain if they
need it. The contact expressed alarm that stockpiles of grain in
government storehouses are the lowest since the 1980s.


BEIJING 00001690 003 OF 007


ECONOMIC AND POLITICAL IMPACT
-----------------------------

11. (SBU) The mainland consumer price index (CPI) food basket rose
21% during the first quarter of this year, while overall CPI
inflation was 8%; both figures were 11-year highs. Pork prices
alone rose 69% yoy as of February 2008, with beef and lamb not far
behind. Food prices account for approximately 87% of the overall
CPI increase. Curbing inflation has on numerous recent occasions
been declared the government's top economic priority for 2008. This
is the strongest bout of agricultural inflation since the early
1990s and the first time in the past 30 years that rising food
prices are not part of a more general inflation trend. To date,
inflation has not been a major factor in balance of payments or in
fiscal spending, nor is it seen as a factor that will alter
medium-term growth prospects.

12. (SBU) There is no sign to date that food inflation has caused or
is about to cause widespread unrest. There have, however, been
sporadic incidents of note, such as an occasion when supermarket
shoppers stampeded a cooking oil sale (see addendum). Commenting on
inflationary trends in their respective localities, government
officials and citizens in two provinces outside Beijing recently
expressed optimism that prices are stabilizing and said their
regions have not so far experienced widespread social unrest or
hoarding.

13. (SBU) Food inflation has drawn very extensive attention from the
top leadership. Over the past eight months, China has been
undergoing a change in government and Communist Party leadership;
the October 2007 17th Party Congress and March 2008 National
People's Congress were key events in this regard, and on both
occasions, discussion of managing inflation was prominent. As
statistics have been released, top leaders have gone to great
lengths to make themselves visibly responsive, either by announcing
new government measures or by visiting with local residents affected
by high prices. We are unaware of recent food inflation broadly
affecting public attitudes towards biofuels or that it is generating
friction between classes. However, contacts in Hebei and Hunan
Provinces recently asked Econoff if the United States would
reconsider its policy on biofuels because of the recent surge in
world food prices.

ENVIRONMENTAL IMPACT
--------------------

14. (SBU) China is profoundly challenged by long-term environmental
degradation. Recent food inflation has neither mitigated nor
exacerbated this trend in a measurable way. In the longer term
however, China may face serious food production problems, especially
given that per capita water resources are 25% of the global average,
with much of the endowment concentrated in the south. Agriculture
accounts for 70% of water consumption, and water quality is
deteriorating rapidly. Declining water availability for agriculture
in general is a concern of the government. However, favorable
weather conditions are a more important factor than the amount of
available surface/ground water for irrigation for grain production.
expected to negatively impact grain production over the coming
decades. The government is spending tens of billions of dollars to
build infrastructure to transport water to the north. Although
China's water shortages are alredy acute, it is the long term
prospects that look especially daunting, especially with water
pricing policies encourages overuse and waste.


GOVERNMENT POLICY RESPONSE
--------------------------

15. (SBU) Over the past 30 years, China has been transforming from a
command economy to one primarily guided by market signals.
Agricultural prices and volumes were formerly determined by the
Central Government but are now relatively free and open. A notable
exception is grains, where a persistent desire for self-sufficiency
has led to the continuation of price supports, subsidies, and trade
quotas. The prices of produce and meat are by contrast set without
state intervention. China's 2001 WTO accession has reduced tariffs
on "non-essential" goods but left in place a TRQ system whereby
imports of major grains and commodities are subject to prohibitive
tariffs once an import ceiling is reached.

16. (SBU) There have been a number of measures taken by the Chinese
Government to address food inflation as well as broader inflationary

BEIJING 00001690 004 OF 007


trends in the economy:

o In April, the Ministry of Finance announced a 100% special export
duty on fertilizer and related exports for the period April 20 to
September 30. This expanded duties already imposed in February.

o In January, the government imposed price controls on a number of
staple products including cooking oil, pork, eggs, instant noodles,
milk, and grains.

o In December 2007, the government removed the export rebate
(generally 13%) on wheat, rice, corn, other cereals, soybeans and
their derived flour byproducts.

o In December 2007, a new investment catalogue showed continued
concern about foreign participation in the food sector and its
perceived impact on food security. The catalogue included
restrictions on the seed industry, soybean processing, and
distribution services.

o In January 2008, the government announced provisional export taxes
on grains and their flour products as well as an export license
regime on flour products to discourage exports.

o China's ethanol exports rose 500% from 2005-06, leading to
concerns that export oriented ethanol plants might lead to domestic
grain shortages. The government responded by eliminating VAT
rebates and halted approval of new corn biofuel processing plants;
ethanol exports fell 87% in 2007.

o The urban poor have been hit hardest by rising food prices, and
the Central Government is providing subsidies to poor urban
residents so that they can purchase pork and eggs.

o More broadly, the government has adopted a "tightening" policy in
response to inflationary trends, including six increases in interest
rates since January 2007 and a rise in bank reserve requirements
from 10% to 16% over the same period; real deposit rates, however,
remain negative.

ADDENDUM
--------

17. (U) The following material includes spot reports from Econoffs
in our Consulates General as well as Embassy Beijing's Economic
Section:

18. (SBU) SUPPLY AND DEMAND:

** (Chengdu)

o Rising incomes in southwest China have led to increasing demand
for meat (especially pork) as well as vegetable oil. At the same
time, consumers are facing both rising prices and declining quality,
especially for pork. From March 2007 to March 2008, prices for
important commodities rose dramatically in southwest China's two
most important urban areas, Chengdu and Chongqing. A breakdown
(information comes from local Price Bureau data, not always reliable
but indicative of trends at least):

-- Vegetable oil: Chengdu 79%, Chongqing 71%

-- Cabbage: Chengdu up 183%, Chongqing 260%

-- Pork: Chengdu up 88%, Chongqing 67%

-- Eggs: Chengdu down 4%, Chongqing 17%

-- Rice: Chengdu info unavailable, Chongqing 59%

o Rural areas are also feeling the impact of urbanization,
industrialization, and migration of farmers to work in other areas.
Villages are being emptied out, farmers (staying at home) are
getting older, and agricultural production has become a sideline
activity. Farmers' enthusiasm for grain production has been hurt
because of the high costs they have to cover for grain production.
Now some farmers are changing grain farmland into cash-crop land.


** (Guangzhou)

o Despite data showing increased food prices, averaging 9 percent

BEIJING 00001690 005 OF 007


across all food categories in Guangdong, and double-digit percentage
increases for household food expenditures throughout Guangzhou's
consular district (Guangdong, Fujian, Guangxi and Hainan), the
locally-produced supply has not correspondingly increased. Less
than half of all food products in Guangdong province are produced
locally, and total production levels are between one-half and
two-thirds of food supplies in the other three provinces. Food
production only increased marginally in 2007, growing by an average
of 2-3 percent for most products.

o Fujian, Hainan, and Guangxi Provinces produce higher percentages
of their own food, but demand exceeds supply, and 2007 statistics
show that low-income consumers are substituting less nutritious,
cheaper foods for more expensive ingredients because of rising food
prices. One example is a trend towards consumption of soy milk
instead of fresh milk in low income households.

o An important reason for slower supply-side growth is major
increases in production input costs -- especially chemical
fertilizers and pesticides (mostly based on petroleum-related
inputs) as well as feed products for livestock. May producers have
seen profit margins remain te same or decline as the cost of some
inputs ave risen more quickly than food prices.

o Aother reason for slow supply-side growth is wait-and-see
approach among South China farmes, especially pig farmers. This
group remains risk-averse after sustaining major losses in 2006 when
pork prices were very low; feed and vaccination costs have increased
faster than profits; and risks to livestock from disease remain
high.

19. (SBU) ECONOMIC/POLITICAL IMPACT

** (Chengdu)

o Stories of food-related unrest are hard to come by here, but one
example took place in Chongqing in November 2007, when three people
were killed and 31 people injured in an incident at a Carrefour
Store. In order the celebrate the 10th anniversary of its store
opening, Carrefour had a big sale on vegetable oil, in which the
price of a bottle of vegetable oil was reduced by 11 RMB ($1.50) to
from 51 RMB to 39.9 RMB ($5.32). Early on the morning of the sale,
thousands of people were waiting in front of the main gate of
Carrefour. Most of them were 60 or older. When the gate was
opened, people rushed into the store, and many people fell down in
the stampede. Three people were trampled to death, and 31 were
injured, seven of them seriously. According to a report released
by the Chongqing Statistics Bureau, Chongqing's CPI in Oct.
increased by 6.5%, but the price of food in Chongqing including
vegetable oil increased by 34%. "The fast increases in food prices
and the low income of poor people as well as poor management of
Carrefour are the major reasons for the incident," said Mr. Pu
Qijun, Director of the Sociology Research Institution of Chongqing
Academy of Social Sciences.

o Rising food prices have relatively little impact on high-income
families. A contact who is a college professor married to a doctor
tells us, "Food prices, especially pork and vegetables, are going up
very fast, but our quality of life is not affected." Middle-level
income earners face more pressure. Some of them tell us they eat
less pork than before, sometimes substituting fish, the price of
which is increasing less rapidly. As for low-income families, their
living quality has been affected most obviously. A migrant farmer
said his wife and he moved to Chengdu last year. Both of them hold
temporary jobs and they only earn about 1,200 RMB ($171) a month.
They have to pay the house rent, tuition for their son, and other
expense. Previously, they only needed about 300 RMB ($42) for food
per month. But now they said they need at least 500 RMB ($71). He
said they only eat pork on Sunday, and sometimes, they eat some
fish.

** Guangzhou

o News reports have surfaced about occasional boycotts and other
signs of consumer dissatisfaction, particularly among
price-sensitive groups like students. An example was a one-day
boycott of a Guangdong university canteen in September 2007, with
almost 20,000 students participating, after the government increased
campus cafeteria prices 33-50 percent.

o Statistics from each of the four provinces show that among
low-income households, those that earn 50 percent or less of the

BEIJING 00001690 006 OF 007


local average income, food expenditures .

** Shanghai

o Official data show food price increases in Shanghai roughly on par
with the national level (18% yoy in March compared to 21%
nationally, although official numbers are widely considered to
underestimate actual inflation). Food price inflation has been
largely driven by meat/pork prices, which increased by 40% yoy in
Shanghai in March. Prices may have started to stabilize, although
it remains unclear how much of this is due to ongoing government
intervention. Local media reported the Shanghai Development and
Reform Committee implemented temporary price freezes for rice and
wheat, vegetable oil, meat, milk and eggs on January 26. Anecdotal
evidence from wet markets in Shanghai indicates pork prices have
been flat in April (pork increased 67% yoy in March, nationally).
In terms of grains, local supermarkets have not raised rice prices
materially in the last few months, which is consistent with national
level data and also reports that the government has sold some of its
stock of reserves.

o Analysts note that there has been no evidence of a significant
move by the government to increase imports of pork or other meat
products to ease supply constraints, leading some to conclude that
the government is comfortable with its policy response. In terms of
policy measures, a pork vendor in Shanghai explained that financial
incentives to shift farmers to pig production in Zhejiang have not
yet had much success because farmers believe the intermediate food
distributors have pricing power. On the demand side, subsidies from
the Shanghai Municipal Government have allowed local universities to
keep prices at school cafeterias fixed.

20. (SBU) ENVIRONMENTAL IMPACT

** Guangzhou

o Guangxi Province suffered crop and farmland damage as a result of
severe winter storms and a drought last summer. However, despite
the losses last summer, Guangxi was able to increase total crop
production in 2007 due to subsidies and better technology. Hainan,
Guangdong and Fujian Provinces regularly suffer typhoon-related
agricultural losses, and this year's typhoon season has started no
differently with an early storm that damaged farms in Hainan and
Guangdong.

21. (SBU) POLICY RESPONSE

** Chengdu

o Comments from a think-tank contact: Local governments offer
agricultural subsidies to farmers in Sichuan. On average, each farm
household can get 280 RMB per year. The Central Government's
purpose in providing such subsidies is to encourage farmers to
engage in agriculture production. However, the policy still has
problems. Subsidies are offered according to how much land a
household has. As a result, many farmers receive the subsidy even
if they no longer farm. The policy should be changed, that is, only
those who do farm production should get the subsidy. It is good
that the agriculture tax and other fees have been abolished. But
more and more farmland is going out of cultivation since many
migrant farmers on't care about it. In the past, they had to think
more about the taxes they must pay, and would keep their farmland in
production.

** Guangzhou

o Fujian and Guangxi both announced major government programs to
increase agricultural production including more funding for
subsidies, farmer training and relief programs. South China's
provincial and local governments have implemented stronger price
controls on certain basic food products and agriculture inputs like
fertilizer.

REFERENCE TELEGRAMS
-------------------

Beijing 1671: Prices Still High but Provinces Remain Calm

Beijing 870: NPC: Food Inflation Rural Sector's Main Concern

Beijing 823: NDRC Chairman: Slowing Investment Growth, Fighting
Inflation Key Challenges in 2008

BEIJING 00001690 007 OF 007

Beijing 809: Premier's NPC Report Pledges More Reform, Tackles
Tough Social, Economic Problems

Beijing 750: More Attention to the Rural Sector: Will It Be
Enough?

Beijing 573: Inflation, Exacerbated by Snow Storms, Hits a New
11-Year High

07 Beijing 7554: China: Moderate Inflation Here to Stay, Experts
Say

07 Beijing 7233: October Price Surge Attracts Attention in Beijing
and Provinces

07 Beijing 7052: China/Energy: Fuel Shortages Tied to Independent
Firms

07 Beijing 6859: Rising Prices, Rapid Growth Remain Economic Focus
During Party Congress

07 Beijing 6857: Economic Policy Implications of the 17th Party
Congress

07 Beijing 6720: Party Buoyed by Good Social Stability but
Inflation, Bubble Economy Worrisome

07 Beijing 6609: China Inflation: Asset and Consumer Price
Pressure In Focus During Golden Week

07 Beijing 6365: Migrants, Microfinance, and Meat-Shanxi's Rural
Development Challenges

07 Beijing 6286: Party Congress: Economic Policy Impact Seen as
Limited, But Inflation Remains...

07 Beijing 5627: Inflation/Currency: Contrasting Perspectives...

07 Beijing 5578: Inflation Spike Getting Attention from Leadership,
Media, and Public

07 Beijing 3895: Contacts Cite Leadership Concerns Over Future
Stock Market Downturn

07 Shanghai 679: Stock Exchange Up 300% in Two Years

07 Shanghai 553: Inflation Watch Up in Shanghai

07 Hong Kong 2598: Inflation, Overinvestment Key Chinese Risks

PICCUTA

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