Grain pricing

Chinese agriculture is hampered by rising production costs, with domestic grain prices surpassing those of the world market since 1994.

For the last three years, domestic prices of major crops such as late rice, corn and soybeans have been 37% higher than after-import duties international prices. China is now trying to curb a looming oversupply crisis through a radical shift in agricultural policy.

What next

Since 2014, China has committed to a more market-oriented approach to agricultural pricing, and is redefining its understanding of food security. However, while policy changes have been enacted recently, some issues still raise controversies and will take several years to bear fruit.

Subsidiary Impacts

In the medium term, grain prices will decline due to abolition of price guarantees, but the government will work to avoid a sharp price drop that could have a dramatic social cost. Longer term, China will reduce its corn production, stabilise its rice and wheat production, and increase its soybean production; it will focus on high added-value products and increasingly rely on market mechanisms.

Analysis

China’s per capita arable land and freshwater are only one-third and onequarter of the world average. Labour-intensive, small-scale production employs 200 million farmers, 30% of Chinese population, for an output of 9% of Chinese GDP. By comparison, US agriculture accounts for 2% of the GDP and 2% of jobs.

In the last decade, rising labour costs and land values have driven up the price of agricultural commodities further.

The opposite trend in international markets, along with a strengthening renminbi until 2014, has created a discrepancy between domestic and international grain prices.

Pricing policy

The 2004 State Council Document Number 17, ‘Guiding Opinions on Further Deepening Reform of the Grain Circulation System’, introduced ‘minimum purchase prices’ and ‘temporary reserve’ purchase prices. Both consisted in the Chinese government committing to buy grain at a fixed price, before and after cultivation respectively.

These policies aimed to raise domestic prices to incentivise farmers to grow crops linked to food security (corn, soy, rice and wheat). The objectives were to:

• ensure food security amid soaring demand for animal feed; and
• ensure social stability in rural areas by giving farmers a decent and growing income.

The system was popular and led to uninterrupted production growth. Farmers' incomes rose for twelve years.

However, it was not sustainable. The fixed purchase prices had to be raised significantly to keep up with production costs that increased at 8-10% per year. Meanwhile, the number of corps covered increased, embracing a growing proportion of agricultural production.

Production costs soared for the grain processing industry, aquaculture and livestock farming, forcing many enterprises out of business.

Oversupply

Even as domestic grain prices rose, international prices dropped, resulting in a large price discrepancy and pushing imports up, as agreements signed at China’s accession to the WTO in 2001 limited its capacity to control grain imports.

Since joining the WTO, China’s agricultural imports have grown more than tenfold. Between 2003 and 2015, rice, wheat and corn went from being net exports to net imports. Overall net grain imports increased 56.4 times.

As Chinese retailing and processing companies preferred imported grains to domestic one, causing massive overproduction. Stored rice, wheat and corn exceeds grain production, causing losses and unprecedented pressure on storage capacity.

Soybean, meanwhile, suffers from underproduction. Demand has risen more than 900% during the last 25 years, while production only grew 11%. Imports have soared and are forecast to hit a record of 86 million tonnes in 2016-17. Most are genetically modified and under Chinese law can only be used for animal feed.

Strategic shift

Faced with these challenges, the government has shifted towards market pricing. Trial reforms began in 2014 and in early 2016 the government declared that agricultural support strategies no longer centred on price controls and central purchasing.

Price support has already been eliminated for sugar and cotton, and will be soon for corn and soybean. Only rice and wheat sill raise controversies, as they are seen as essential crops, with a very high potential social cost of suppressing minimum price. China also intends to reform its subsidies system to better fit WTO rules. Since reforming its pricing system in 2004, China has not taken into account WTO categories when granting categories, leading to excessive ‘amber box’ subsidies while leaving large possibilities for expanding green and blue box subsidies. Chinese government now intends to develop green and blue box subsidies, in particular ecological-oriented subsidies promoting green products.

Corn stockpiles doubled between 2009 and 2016

To replace price support, risk control mechanisms are also encouraged through insurances and futures markets. In 2016, Dalian Commodity Exchange approving 12 ‘Insurances + Futures’ pilots, and 18 ‘Over-the-counter options’ pilots in 2016, and Chinese government is heavily investing in rural finance and insurances.

The strategic shift also targets development of ‘new professional farmers’ and includes training farmers into the national education development plan. Through updated laws and financial incentives, new farming entities—scaled family farms, farmer cooperatives and leading enterprises—considered more innovative and productive, and professional farmers adopting modern farming methods are encouraged to play a leading role.

Food security

An Agricultural Modernisation Plan released last month enacts a shift in the government’s conception of food security from self-sufficiency to ‘sustainable capacity’.

While basic grains sufficiency remains the absolute priority, the government wants to rationalise agricultural development and give full play to comparative advantage. Instead of striving to increase output each year, the government now calls for idling land to restore its fertility, and building agricultural capacity through technology and mechanisation. By stabilising rice and wheat production, reducing corn production, and increasing soybean production the plan aims to address supply and demand imbalance.

As China moves away from national self-sufficiency in grain, Beijing also wants to expand agricultural cooperation with other countries and make use of international markets while developing high-value export products.

Chinese agriculture is seeking strategic trade relations, moderately increasing imports while encouraging its own enterprises to go global. During the 13th five-year plan, COFCO pledged to increase its investment in Belt and Road countries, aiming to increase overall operating volume from today’s 12.2 million to more than 21 million tonnes. In the future, increasing capacity building cooperation and farmland purchases are to be expected, especially with countries along Belt and Road.

Slow changes

Slow-moving pilots, lack of reliable data, and fear of social instability are likely to slow down the reform process. The social cost of the reforms has led the government to water down some of them. The government legitimacy still rests on carrying the banner of the agricultural class, so even as support is decoupled from production, sensitivity to rural tension will remain a priority.

A collapse in corn prices following the abolition of the ‘temporary reserve’ policy (ie, the fixed price post-cultivation) angered farmers. In response, the weekly corn stockpile auctions introduced in mid-2016 were suspended in September. On October 20, the state-owned company Sinograin announced that it would buy 440,000 tonnes of corn from farmers in Heilongjiang, propping up the grain price to temporarily ease pressure on newly harvested corn.

More broadly, one of the most controversial issues is whether to eliminate minimum purchase prices for wheat and rice, as they are considered as essential crops with huge social impact. The price of rice after reform, in particular, is still uncertain, with some experts calling for a price based on cost of production, while others prefer setting the price on cost of imported grain.

This article was first written for the Oxford Analytica Daily Brief, which is the copyright holder.