A brewing commodity crisis and developing countries

The United Nations has warned that Russia’s invasion of Ukraine could trigger a global famine as Moscow’s Black Sea blockade delays crucial grain exports, and stoked fears of a deepening hunger crisis in countries such as Yemen and Ethiopia. The UN’s special rapporteur on the right to food, Michael Fakhri, warned on Friday of a global famine as the result of Russia’s invasion.

“For the last three years, global rates of hunger and famine have been on the rise. With the Russian invasion, we are now facing the risk of imminent famine and starvation in more places around the world,” said Fakhri. — An excerpt from a recent Guardian published article ‘UN warns Russian blockade of Ukraine’s grain exports may trigger global famine’

What should poor developing countries, including Pakistan, are supposed to do in terms of dealing with high import bills at the back of global commodity supply shock and reduced supply-related oil price shock. More recently, from the war in Ukraine by Russia significantly is adding to already high oil, wheat, fertiliser and steel prices, among others.

According to Food and Agriculture Organization (FAO) Food Price Index (FFPI), with latest data as of February, and therefore does not include the full impact of war in Ukraine on prices of commodities, prices increased at an all-time high of 3.9 per cent (with previous high in February 2011 at 3.1 per cent) in February 2022.

An early February New York Times (NYT) article ‘Food prices approach record highs, threatening the world’s poorest’ pointed out in this regard: ‘Food prices have skyrocketed globally because of disruptions in the global supply chain, adverse weather and rising energy prices, increases that are imposing a heavy burden on poorer people around the world and threatening to stoke social unrest.’ Indeed, developing countries in particular are unfortunately required to walk a very thin rope in terms of managing inflation, and boosting growth, especially that which increases inclusivity to diminish high level of income inequality and poverty. It also reduces much-needed influence of demos over public policy.

While the pandemic-led recession had already impacted supply chains, and with it, commodity prices, the war in Ukraine is likely to turn commodity shortages into a full-blown commodity crisis. With developing countries facing an imminent debt crisis, and have little financial support in terms of a significant level of allocation of special drawing rights (SDRs), adequate release of climate finance, or meaningful debt restructuring/relief, higher import bills on account of very high commodity prices, not to mention longer time lags in obtaining supplies, are likely to seriously pinch the poor in particular in terms of little hedging in relation to food storage with them, and high food and transportation costs they face. This is a sure recipe for acute political instability, even more than the Arab Spring, given it did not come at the back of any pandemic.

On the other hand, higher inflation would mean greater rise in interest rates globally, which would act as a double edged sword for developing countries like Pakistan, which will be facing higher debt repayment levels and taller interest payments in case they wish to accumulate portfolio investment, and build greater level of reserves to manage difficult balance of payments situation, and also reduce the level of imported inflation through stronger local currency at the back of reserves’ buildup.

Moreover, a tighter monetary policy at home, at the back of inflation, which is likely to build up much further in the wake of the pandemic, and given that recent dip in oil prices may likely remain a short-term phenomenon – before rising up and continuing their march to previous highs in recent months of crossing $130 per barrel, and even closing in on the $200 per barrel mark if one looked at how future contracts were being locked into just before this dip in oil prices – in the wake of recently imposed lockdowns in China, and greater release of oil supply from some developed countries as a makeshift in the wake of sanctions on oil import from Russia.

Moreover, there are also fiscal implications in terms of higher subsidies, especially in developing countries like Pakistan already struggling to manage budget deficit and development/stimulus expenditures, which are, traditionally speaking, entering higher expenditure mode on account of the election year. These need to create cushion of commodity inflation for the lower income groups in the wake of the pandemic. While the government may fund short-term subsidy requirements with higher import taxes, nonetheless subsidy provision will take away taxes from needed health and overall development expenditures.

With regard to the economic consequence of war in Ukraine, a recent Financial Times (FT) article ‘Economic impact of war in Ukraine could go from bad to worse’ pointed out: ‘Policymakers are beginning to trace out the possible repercussions of the Ukraine war around the world. The most obvious link is food prices, which are already soaring, and will no doubt rise further if the Ukrainian sowing season is not salvaged soon. Just one example in an IMF round-up of global repercussions should make us feel very nervous: Egypt imports 80 per cent of its wheat from Russia and Ukraine.’

Moreover, regarding higher prices of wheat, and its likely impact on developing countries, an early March published FT article ‘Wheat prices hit record highs as war halts exports from Ukraine and Russia’ indicated: ‘Wheat prices have hit record highs on intensifying concerns of a supply shortage because of the war in Ukraine, raising the spectre of soaring global food inflation. Ukraine and Russia account for about 30 per cent of the world’s traded wheat and still have crops from last year to ship. …Wheat traded in Chicago, the international benchmark, has jumped more than 50 per cent since Russia invaded Ukraine. …Food and agricultural experts have warned of increasing food insecurity in poorer countries, many of which are already suffering from high hunger levels because of the coronavirus pandemic.’

In addition to rising prices and supply time-lags for commodities like wheat and fertilizer – both of which are essential for developing countries like Pakistan, which are likely to have sufficient wheat for this year’s domestic consumption at the back of strong output of wheat crop. But these countries have lower strategic reserves of wheat, and with a big agriculture sector having therefore a strong fertilizer demand an additional important worry is in the shape of steel. With regard to high fertilizer prices, a recent Guardian published article ‘Fertiliser prices hit new highs as multiple problems affect global supplies’ indicated: ‘Fertiliser prices have broken new records as global supplies are hit by multiple factors including reduced supplies from Russia and Belarus, disruptions to the supply chain, a China export ban and a Canadian rail strike. …Prices for raw materials that make up the crop nutrient commodity market – ammonia, nitrogen, potash, urea, phosphates, sulphates and nitrates – have risen 30% since the start of the year, and are now higher than the levels reached during the food and energy crisis when prices jumped in 2008, according to CRU, a UK-based commodity consultancy.’

Pakistan is already in the midst of pursuing a large-scale housing construction activity, and imports a significant amount of steel – for instance it reportedly imported $3.2 billion worth of iron, steel in 2020, which made up 6.9 per cent of its total imports that year – will likely face the sting of war in Ukraine in terms of steel import, since according to a recent Bloomberg article ‘Steel is the other big commodity shock from the war in Ukraine’ Russia and Ukraine combined are the second largest exporter of steel, after China, whereby in 2020 while China exported 51.4 million metric tons of steel, the two countries combined exported 43.8 million metric tons of this commodity.

In addition to experiencing likely delays in receiving steel for the housing projects in particular, higher prices of steel would mean greater fiscal pressures on government in Pakistan in terms of providing subsidy on interest payments on houses both due to higher steel costs and also higher interest payments requiring greater subsidy levels to continue with the cap on mortgage rates. This increases risk for banking sector as well. In case government dwindles on interest subsidy, putting under stress people’s capacity to pay mortgages over the housing completion cycle. This will add to the incidence of non-performing loans (NPLs) or bad loans. The situation, therefore, requires strong policy focus by government to manage macroeconomic risks. Unfortunately, however, current political instability can distracts the government from such a focus. Added to this, rich advanced countries and multilateral organizations have not provided a needed financial support programme to developing countries, nor the Bretton Woods institutions, including, International Monetary Fund (IMF), have overall shifted away from their emphasis on pro-cyclical conditionalities/prescription.

Indeed, the current commodity crisis needs to be given utmost importance because this may lead to food riots as pointed out by the chief of World Trade Organization (WTO), as highlighted in a recent Guardian published article ‘War in Ukraine could lead to food riots in poor countries, warns WTO boss’ as follows: ‘Rocketing global food prices as a result of the war in Ukraine could trigger riots from those going hungry in poor countries, the head of the World Trade Organization has said. Ngozi Okonjo-Iweala warned food-producing countries against hoarding supplies and said it was vital to avoid a repeat of the Covid pandemic, when rich countries were able to secure for themselves the bulk of vaccines.’ Such riots could become the main factor for regime changes in developing countries in general, lessening of capacity of developing countries in managing a difficult balance of payments and debt sustainability situation, and would require urgent and deep financial support and understanding by rich, advanced countries, and multilateral organizations.

(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund)

He tweets@omerjaved7

Copyright Business Recorder, 2022