Over the past 2 weeks, national average flour price has increased by nearly 5 percent, sending jitters in a market that had previously shown signs of calm. Per kg flour price has in fact touched a new high of Rs 60 per kg, Rs 9 higher than an earlier peak in last October, when imports by TCP had helped stabilize supply in local market.

Interestingly, the recent restlessness in flour market has not been accompanied by a similar rise in wheat prices. Grain prices are still trailing well below peak levels witnessed between Oct 2020 to March 2021. Back then, price of 40kg wheat bag had climbed to Rs 2,400 in some wholesale markets, before crashing by almost Rs 300 during peak harvest months (May – June). Grain prices have since stayed in that territory, as claims of highest-ever wheat output along with plans to import additional 3-4 million tons helped calm down speculative activity.

With domestic market ‘seemingly’ inundated with grain stocks, the recent reversal in price trend appears to be an aberration. Several theories are making rounds as to why prices are exhibiting restlessness – especially now. In what follows, BR Research will restrict its analysis to the three most likely explanations.

According to news reports and estimates by BR Research, federal government’s commodity reserves agency PASSCO and provincial food departments procured nearly 5.5 million tons of wheat during the latest harvest season (May 2021). This estimate is based on the incremental rise of Rs 203 billion in public sector commodity debt between March and June 2021. Although volume of wheat procured is lower than last year, plan to import additional 3 million tons through TCP suggests that public sector reserve stocks shall remain adequate.

What’s different this year, however, is in-season participation in wheat purchase by private sector players. Last year, steep public sector procurement target of 8.25 million tons – along with lower-than-expected output – had resulted in an administrative ban on private wheat holding. The ban led to widespread panic, causing speculative activity to run wild.

In contrast, private sector activity seems to have returned in its full glory during the latest harvest season, in part motivated by lower public sector procurement target, and higher output. As per SBP figures, credit to private sector wheat processors rose by 2.5 times between March and June 2021, equivalent to procurement of at least 0.5 million tons of wheat at prevailing market prices. It is worth emphasizing that this procurement only reflects formal sector purchases using bank credit, and excludes all buying on cash or market credit, both by formal and informal sector operators.

Moreover, by May 2021, wholesale wheat prices fell and reached parity with Sindh Food department’s notified rate. This indicates that the market was adequately supplied, as greater participation by both public and private sector players did not lead to panic buying. Why then are [flour] prices reversing gears now?

It is usually understood that demand for domestic consumption during post-harvest months - May to August - is fulfilled through private sector buying. Once seasonal output has been mopped up by mills and stockists, public sector begins releasing its stocks - beginning September - to stabilize supply and prices. Last year, due to severe shortfall, provincial food departments had begun releasing stocks much earlier (in July 2020). Flour prices are expected to stabilize this year as well once public sector stocks start trickling into the market. But will they?

That is too early to say. Until March 2021, city-wise retail prices in Punjab as recorded by PBS had shown remarkable resilience. This was partly explained by the fact that PBS was still recording city-wise prices at the DC notified rate of Rs 1,720 per 40kg. This was at the time when 40kg flour bag was already trading above Rs 2,000 in wholesale markets. Yet, subsidy on wheat release price by Punjab Food department – and practice by PBS to record flour prices at DC rates – ensured that national average flour prices as reflected in CPI remained stable.

Ever since the Food department in Punjab has run out of previous year’s carryover inventory, flour prices in various regions of the province are gradually adjusting upwards. Whether they will remain at the current level (Rs 2,200 per 40kg) or reach at par with flour prices prevailing in rest of the country (Rs 2,500+) depends on release price for 2021-22, which is yet to be announced by the provincial government.

If the release price set by Punjab Food department witnesses significant upward revision to recover full cost and minimize loss to provincial kitty, national average flour price may undergo yet more correction. Remember, 36 out of total 76 markets in the CPI basket are located in Punjab and thus have a significant impact on national average prices.

Punjab Flour Mills Association is lobbying for wheat release price to be set at Rs 1,875 per 40kg, which is significantly lower than current market rate. If the provincial government yields, it will in turn demand that flour price be fixed at a proportionately lower rate. However, due to much higher prices in Sindh and elsewhere, Punjab’s steeply subsidize grain could make its way to other provinces, rendering the subsidy ineffective. Whether that throws a spanner in the works for national average flour rate depends on how PBS records flour prices for Punjab: at DC notified rates or at prevailing market prices.

But that’s not the only theory doing rounds in the market. Recent adjustment in currency and fuel prices is said to be pushing the accelerator on local commodity market prices. Moreover, wheat price in the international market has continued to persist at its highest-level in at least six years ($275 - $325 per ton). Since wheat is a winter crop in most regions, there is little chance that its price shall return to pre-pandemic territory ($200 - $250 per ton) any time before next year’s harvest that begins in February, unless of course the global market crashes sooner.

Meanwhile, currency depreciation has once again narrowed the gap between international and local wheat prices in recent weeks to under 1.15 times. Back in March 2021, the same had climbed up to 1.35 times. Remember, when international prices are trading at a discount to local prices, it bodes well for domestic price stability. Readers nostalgic for the ‘great flour price stability of 2014 – 2018 may be surprised to find that local prices traded at 1.65 times premium over international price during that period! Why? Because weak global prices (or higher local prices) reduce the incentive for outward smuggling, ensuring that local market remains adequately supplied despite output shocks.

Is that the case today? It is hard to comment with certainty. Each time there is a spike in local wheat demand, it is conveniently chalked up to “smuggling to Afghanistan” without any evidence. Now that Afghanistan is actually witnessing turmoil due to suspension of international trade – and freefall in its exchange rate - the possibility of smuggling actually warrants attention.

However, considering that Afghanistan has always depended on Pakistan for its wheat and flour demand, any change of political regime or financial crisis should not cause a spike in its overall demand. That said, it is possible that stockists in Afghanistan may have increased the size of their purchase orders (volumes procured from Pakistan) as some may foresee turmoil and food shortages in their country. Nevertheless, such panic buying should only lead to a temporary surge in prices, and not result in an overall increase in consumption in that country.

In addition, suspension of trade with central Asian countries indicates that any incremental supplies to Afghanistan from Pakistan should not makes its way to other countries, unless of course those countries are also facing shortages. So far, that does not seem to be the case.

Lastly, in June 2021, the ECC approved plans to import 3-4 million tons of wheat. This coincided with claims by GoP that the country had achieved highest-ever domestic output. Thus, the import plan was widely interpreted as buffer stock building to counter any food shortages due to the (then) predicted turmoil in Afghanistan. Now that imports are underway, prices should find stability eventually, even if not immediately.

Which brings us to the last theory: that domestic wheat supply is insufficient to meet annual consumption. While the government did a commendable job in calming market sentiment during peak harvest season, several signals since indicate that supply situation is not all that adequate.

First, despite a 30 percent increase in minimum support price, public sector procurement target was still missed by at least 15 percent on national basis. Moreover, if supply was indeed adequate – based on past consumption trends, plans to import 3 to 4 million tons of wheat at peak international prices simply did not make sense.

Remember, government import plans coincided with peak harvest and procurement season. International prices have increased by at least 10 percent since June. Recent news reports indicate that the government has accepted bids of up to $370 per ton by international suppliers, which will translate into landed cost (at Karachi) upwards of Rs 2,500 per 40kg bag. This is well-above the price at which government had purchased locally.

If Food departments are intent on setting wheat release price under Rs 2,000 per 40kg, imported wheat will cost another Rs 37.5 – 40 billion in subsidy. If domestic market is indeed adequately supplied, why should the government desperately procure from international suppliers at peak international prices, only to rake in additional import bill of $1 billion at a time when it is already distressed by widening trade deficit?

Because the objective for imports is to maintain domestic price stability and build strategic reserves, public sector will have no choice but to release its international buying at less than full cost, incurring a loss. If domestic production was indeed adequate and imports only being made to build buffer, would it not make more sense to let the private sector players make import decisions based purely on market conditions? Remember, out of the 4 million tons import quota announced by ECC in June, 1 million ton was allocated to private sector. So far, there has been no news of private sector buyers showing eagerness to use up import quota.

To borrow from the Finance Minister, it remains “to be seen which way the camel [of wheat prices] sits”. Government social media accounts are often seen blaming the rising international prices for the spiral in domestic prices. If domestic prices indeed are set at parity with landed cost of imports – as seems to be the case right now – what then is the justification of running an expensive Rs 200 billion commodity procurement program and bleed the exchequer dry? If wheat prices in wholesale market exceed the peak levels witnessed during October 2020, the generous MSP paid to farmers will have failed to serve its purpose.

Remember, the public sector ends up paying at least Rs 25 billion in subsidies, markup payment, storage costs, and overheads each year out of the public kitty; cost that is never recovered. Instead of curtailing the bloated public sector footprint, the incumbent government is instead bent on expanding the same to add imported reserves. Good luck!