At the end of May, the Food Price Index of the FAO (Food and Agriculture Organization) has risen 17.72% so far in 2022, compared to May 2021, the increase in one year has been 22.8%. This index measures monthly changes in a global food basket.
The global food system, although it was already weakened by Covid-19 and climate change, has recently suffered strong supply shocks derived from exogenous factors such as the war between Russia and Ukraine that caused disruptions in the market balance of certain grains and foods (of the total international trade, the aggregate of both countries represents 28% of wheat, 29% of barley, 15% of corn and 75% of sunflower seed).
The effects of climate change are becoming more severe. Whether “La Niña” or “El Niño”, both have repercussions on the production chains of certain grains, for example, these phenomena caused rains at the end of last year that forced Chinese wheat producers to postpone winter plantings , in such a way that the expected harvest for this year will be one of the lowest in a long period of time. The USDA (United States Department of Agriculture) recently predicted that the production of red winter wheat, the main crop in the country, would fall by around 21% compared to 2021.
Facing supply constraints on production inputs, lower expected harvest rates, and higher transportation costs, the food market faces a severe imbalance; some nations have begun to take action: India has announced the suspension of wheat exports due to a severe heat wave that has affected its harvests.
The food market faces significant challenges on the supply side, although the effects of climate change have reduced the number of expected harvests, production as a whole faces additional challenges derived from pressures on energy inputs moving to a key element, fertilizers. Of the three main types of industrial fertilizers, Russia is the largest exporter of those based on nitrogen, the second largest exporter of those based on potassium and the third largest exporter of those based on phosphates.
In the short term, the consequences are reflected in higher inflationary pressures, forcing central banks to opt for more restrictive monetary stances and more aggressive increases in interest rates. It is important to remember that monetary policy is ineffective in solving supply disruptions, higher credit costs affect farmers, especially when inputs are expensive; The effect of these actions will be seen in a tightening of financial conditions and lower food production.
The disposable income has seen its purchasing power erode given the high levels of inflation, the absolute level will be lower due to the less lax financial conditions. The most exposed regions are the African countries of the Sahara region, who spend around 40% of their income on food, the emerging countries around 25% and the developed world less than 20%.
In the medium to long term, the potential consequences could be famine, political destabilization and mass migration, as populations seek new sources of livelihood.
Translating these effects into investment portfolio decisions, the transition towards more efficient means of food production will be accelerated, a possible substitution effect will arise (example: consumption of rice instead of wheat) and despite the fact that the environment is highly uncertain, those Food-exporting countries, whose funding cost is relatively lower than other countries, would see a smaller deterioration in their risk premiums. Consequently, they would have a better performance compared to other countries, with respect to one of the most severe risks that the world will face in the coming years.
*Alan Vázquez Alvarado is Asset Allocation | VP Portfolio Manager.