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China Political Memo: May 6, 2011

7 MINS READMay 6, 2011 | 08:52 GMT
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Summary
While China's urban consumers have felt the pinch of rising food prices, farmers have suffered from extremely low prices in rural areas. Price fluctuations are being exacerbated by weather-related and seasonal factors, pushing the Chinese government to take relief measures, but authorities need to address the structural challenges of rising prices and supply shortages.
As China's economy continues to struggle with inflationary pressures, seasonal and weather-related factors have exacerbated price rises, posing challenges for agriculture, logistics and ultimately social order. Inflation's effects on food prices have been felt sharply in rural areas recently, but not in predictable ways. Since March, a contradictory trend has taken hold: Continued high food prices in urban areas have added to consumers' inflation woes, while extremely low prices in rural areas have negatively impacted farmers. On the rural producers' side, the sudden drop in prices does not seem to align with China's increasing worries over inflation. Vegetable prices plummeted about 10 percent in mid-to-late April, according to the ministries of commerce and agriculture. The price drops have occurred in scattered locations — mostly in Fujian, Guangdong, Jiangxi, Henan, Shandong and Shanghai — but have not yet spread throughout the country. The problem of rural food prices seized national attention on April 16 when a farmer in Jinan, Shandong, committed suicide in despair over the massive loss he incurred selling his cabbages at extremely low prices. The basic cause for price drops in rural areas is oversupply. While vegetable prices typically fall during this time of the year because of seasonal factors, like new produce hitting markets, this year several circumstances combined to make the price drop come earlier and hit harder:
  • Rising prices in 2010 led the government to impose policies that encouraged farmers to increase production, leading to a 2011 supply boost.
  • Wholesalers and other companies, speculating on rising prices, hoarded supplies, which they then had to dump on markets before the goods rotted, adding to this spring's supply.
  • Weather variations meant that vegetable produce ripened earlier than normal in some regions. Northern and southern supplies therefore hit markets simultaneously, further contributing to the oversupply.
At the same time, prices have remained stubbornly high for China's mostly urban consumers. This is in large part because of rising fuel prices that have heightened logistical costs and disruptions. Logistical costs typically compose between 60 and 70 percent of vegetable retail prices. Each link in the distribution chain brings an estimated 10 to 15 percent price increase because of the costs of procurement, transportation, retail and labor, according to the Shandong Academy of Social Sciences. In addition, excessive road tolls amount to more than half of total logistical costs, according to Chinese researchers. Price caps imposed on retailers, in order to protect urban consumers from the sharpest price increases, have removed incentives for distributors, whose discontent was highlighted recently by the truckers strike at Shanghai's port terminals. Cost pressures on distributors also exacerbate problems for farmers. Distributors have enormous power over setting prices, and farmers cannot organize or bargain collectively with the far larger and more powerful dealers. Governments at both the central and local levels are attempting to head off tensions that could lead to further incidents of unrest by farmers, truckers and others. The Ministry of Commerce issued 13 provisions aimed at cutting logistical costs and reducing the power of intermediaries in the supply chain by encouraging retailers to buy more produce and farmers to sell their goods directly to retailers. The government also claims it will insure farmers against price fluctuations, after hoarding and destruction of excess supply caused prices to rise in recent weeks in some of the areas hit hardest by price drops just weeks earlier. Additionally, the Ministry of Agriculture claims to be pushing local governments to more diligently help farmers find markets and stabilize prices. While government measures may offer some relief, they do not address the structural causes of rising prices and supply shortages. Inflation remains at more than 5 percent, and the government's attempts to manage inflation expectations continue to be restrained (though some STRATFOR sources say anti-inflation measures are starting to have an effect). Farmers will recalculate production to avoid oversupply next year, which may result in sharper drops in output. Large distribution and wholesale companies maintain their powerful position over farmers. Local governments remain reluctant to lower revenue-generating tolls and fees, and while weather patterns are uncontrollable, the problem of water shortages promises to worsen in the coming years. The fluctuation of vegetable prices is by no means the only difficulty inflation causes. As the National Development and Reform Commission attempts to suppress retail prices and shield consumers from high international prices on commodities, it forces companies to swallow higher costs, resulting in supply shortages, lack of investment in solutions and increasingly corrupt behavior. Examples abound. Power companies are suffering such low profits that industrial leaders have warned of bankruptcies resulting from high coal prices and government suppression of retail prices — electricity is being rationed across 20 provinces because of short supply. Steel companies have seen profit margins sink from 7 percent in 2007 to 3 percent in 2011 because of rising iron ore costs and are reportedly investing more into different business sectors (such as real estate and luxury food products) as they find their core business increasingly unprofitable. The central government continues to delay implementation of reforms that would enable fuel prices to rise in keeping with international oil prices, causing trouble among energy companies that try to drive prices up and also demand subsidies to offset losses. PetroChina and China Petroleum & Chemical Corp., in order to register their complaints and drive up prices, have reportedly stopped supplying oil to private depots. And the Ministry of Commerce has warned that some unscrupulous companies are stretching oil supplies by diluting them with ethanol and methanol. Reports indicate that drought conditions continue to affect the Chinese economy, exacerbating agricultural and logistical disruptions that will lead to higher prices in the future. Henan and Jiangxi provinces say rainfall was about 50 percent lower in April 2011 than in the same period last year, while a May 5 People's Daily report said 1 million people have suffered shortages of drinking water. Hydropower output has dropped because of low water levels, exacerbating electricity shortages. Moreover, record-low water levels in some central stretches of the Yangtze River caused extensive shipping-traffic jams in late April that emergency teams are attempting to clear by May 6. Low rainfall has affected 1.3 million hectares of cropland in major grain-producing provinces like Guangdong, Hunan, Hubei and Jiangxi, according to Chinese media. While wheat production is not expected to fall to dangerously low levels, the drop in output is expected to prompt speculators to hoard wheat in anticipation of future price rises, tightening supplies further and likely driving prices up. Chinese economic experts continue to point at uncertainties in global growth, as well as the government's attempts to tighten controls and cool off the domestic economy, in suggesting that inflationary pressures will abate in the second half of the year. Authorities continue to stress that dampening inflation is their chief goal. However, this outcome is by no means guaranteed and depends on their willingness to tighten credit controls, something they have been reluctant to do thus far, for fear of triggering a sharp slowdown. There is little doubt that further supply kinks as well as strikes, protests and other incidents will follow as a result of high prices and the government's attempts to counteract them without undertaking deep reform.

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