Will Food Inflation Ease?

The World Economic Forum (WEF) Davos 2023 reminded us that one of the 10 global risks that will haunt 2023 until the medium term is the risk of food inflation.

Judging from the food price index issued by Food and Agriculture Organization (FAO), world food prices indeed declined. Prices returned to the levels seen before Russia’s invasion of Ukraine. However, this price level is still above the one before the COVID-19 pandemic. This high price level occurs for all sub-commodities such as tubers (cereals), meat, milk, vegetable oil and sugar.

The global food inflation map released by the International Monetary Fund shows that the majority of countries in the world are still experiencing food inflation of above 5 percent. Only China, India as well as several African countries managed a figure of below 5 percent.

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In Indonesia, food inflation amounted to 5.8 percent in 2022. The volatile food commodity group is also still increasing in price by 5.6 percent and is still the largest contributor to headline inflation, excluding administrative-goods inflation related to fuel-price adjustment.

The cause of high food inflation is the relatively low elasticity of demand for food, due to the lack of substitutes for this type of food commodity. Any interruption in production, whether due to illness or natural disaster, will push prices up substantially. This situation is exacerbated by the fact that barriers, especially non-tariffs, are high in almost all countries, so that the supply response to this production shock cannot work effectively.

Food stocks

Will food prices, which are still high, be able to decline following the downward trend throughout the second half of 2022? How is the state of global and national food until the end of 2022? Stock plays a role because the availability of food in the market is not only determined by production but also the condition of the commodity stock. For example, when stocks are high, commodity availability increases because producers release stock to maintain liquidity, so prices fall with certain production.

Conversely, if stocks are low, the demand for a commodity increases, not only to meet direct and current consumption, but also to meet the need to maintain minimum stocks at the consumer or trader level.

United States Department of Agriculture (USDA) data, January 2023, show global stocks for staple-food commodities tend to strengthen because stocks are the same or tend to decrease. Global stocks of rice decreased from 52.5 days of use to 44 days in 2022/2023. Likewise, wheat decreased from 68.8 days (2020/2021) to 57.9 days (2022/2023).

As regards wheat, Ukraine's production will experience a decline as cropping during the (spring) season is down by 40 percent from 2022 levels and the continued war will have a significant impact on winter cropping. If not compensated by increased production in other countries, global wheat stocks will fall again.

In the case of rice in Indonesia, I suspect that the increase in rice prices during the famine season (December-February 2023) will continue. Production during the 2023 harvest season, which is predicted to be slightly better than in 2022, will not reduce and normalize rice prices because stocks at State Logistics Agency (Bulog) and the possibility of it in the community are also low.

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Therefore, the increase in production during the big harvest season in March-April 2023 will be immediately absorbed to meet consumption needs and stock accumulation. The more aggressively Bulog makes purchases, the higher the prices for grain and rice will be. As a result, if we would normally see deflection in food prices during the harvest season, this year it is possible that food inflation will be positive. Other food components that are quite large in the Consumer Price Index (CPI) are wheat flour and instant noodles. The increase in wheat prices will also cause high commodity inflation.

Fertilizer prices have indeed fallen from their peak but are still high, even though gas prices have fallen to near normal prices. Constraints to potash supplies, including a ban on imports from Belarus, have kept fertilizer prices high.

High input (fertilizer) prices will certainly reduce farming profits. The normal response is to lower the intensity of the fertilizer. As a result, productivity (yield), especially rice, wheat and corn, decreased. For rice, the decline in global production in 2022 and the prospect of decreasing stocks have pushed up rice prices in the future market.

In the Indonesian context, farmers' complaints about the scarcity of fertilizers are often heard, although it is not clear whether what the farmers are complaining about is related to the availability of subsidized fertilizers or fertilizers as a whole. Anecdotal evidence shows that due to the very high price of unsubsidized fertilizers and the limited availability of subsidized fertilizers, farmers, especially marginal farmers who do not have working capital, reduce the intensity of fertilizer use. As a result, grain and rice production could be reduced during the big harvest season from March to April 2023, below the BPS forecast. If this happens, food price inflation will remain elevated in 2023.

Weather and climate impacts

Climate change has caused the weather to fluctuate and become more erratic. Weather including rain intensity is a determining factor in food production. Throughout 2022, dry weather hit the western hemisphere and affected food production in Argentina and several countries in Africa.

Meanwhile, the relatively high rain intensity in Australia partially benefits food production, and in several areas in Australia it caused flooding. The decline in global stocks is inextricably linked to the decline in world food production related to climate change.

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This irregular pattern is expected to continue throughout 2023 and beyond, both at the global and domestic levels. In Indonesia, the Meteorology, Climatology and Geophysics Agency (BMKG) predicted there would be major changes in climate conditions throughout 2023/2024. Favorable weather (mild La Nina) throughout 2022 is expected to turn into El Nino in several regions of Indonesia.

Apart from the issue of fertilizer use, this weather change is not expected to affect grain production in the big harvest season March-April 2023 because the rice was planted in late 2022. What might be affected is production after the harvest season, March-April 2023. Therefore, planning production starting from the readiness of the irrigation system and the availability of fertilizers needs to be carefully prepared.

Price asymmetry

The decline in world food prices will not always be immediately translated into a reduction in food prices in the domestic market because empirical experience shows that the pass-through coefficient of world food prices relative to local prices tends to be low. Prices in the local market fell only after global prices fell for a long time. This passthrough coefficient is also asymmetric. When global prices rise, local prices rise rapidly but not when prices fall (Martin and Minott, 2022).

The description above shows world food inflation in 2023 and 2024 is likely to remain high if we do business as usual. Because of this, it is necessary to prepare carefully starting from efforts to maintain food production, adequate food stocks to effective market-intervention mechanisms. We need to learn from the experience of less-effective cooking-oil interventions.

Finally, it is necessary to prepare an adequate budget both to maintain food production and to intervene in the market. The fiscal burden of managing food inflation may increase but the positive effect will be significant.

Mohamad Ikhsan

Professor of the Faculty of Economics and Business, the University of Indonesia

This article was translated by Kurniawan Siswo.