JINHUA, China (Reuters) - The Jiahua pig farm in eastern Zhejiang province is on the frontline of China’s battle with food inflation, a prime example of how a shift in farming practices may someday stabilize the price of the nation’s favorite meat - and soothe a perennial headache for Beijing.
Pork prices are so volatile and have such an influence on inflation in the world’s second-largest economy that many Chinese joke that CPI stands for the “China Pork Index”.
Annual inflation ticked up slightly to 2 percent in August from a 30-month low in July, reflecting in part a turnaround in pork prices, which climbed after a summer dip, returning to levels last seen in May.
For the moment, pork supplies are ample. Record profit margins for pork last year meant that people of all stripes, from peasants to coal millionaires, invested in pigs.
That’s good news for the Communist Party, which is sensitive to any potential for public unrest ahead of a once-in-a-decade leadership transition later this year. The Party blames inflation for demonstrations in Tiananmen Square over 20 years ago, and keeps a lid on prices by fiat if necessary.
But while headline inflation has trended unusually low in China this summer, pork prices and food inflation risk exploding higher in coming quarters, testing the government’s resolve to keep a lid on prices even as it faces a cooling economy.
In the long run, China’s move from small backyard pig pens to industrial mega-farms could help calm volatile boom-bust pork cycles and help bring inflation more under control.
With their economies of scale and more stable production plans, bigger farms such as the Jiahua Pig Breeding Co are expected to help curb sharp moves in pork prices.
“The faster the trend to scale-up and the faster that backyard breeding is phased out, the more volatility will be dampened,” Hua Jianqing, Jiahua’s president and principle investor, told Reuters from his headquarters in rural Zhejiang.
“It won’t be a year or two. My analysis is that it will take three to five years to reach the balancing point.”
Jiahua keeps 5,000 breeding sows at a time, and raises 100,000 pigs a year.
Squirming and oinking, young sows are lined up daily for buyers peering through a glass window. Those that are picked are shipped hundreds of miles to help seed yet another mega-farm.
Large-scale operations with more than 3,000 pigs now account for about 20 percent of China’s herd, but huge, North American-style farms of Jiahua’s size account for only about 2 percent.
Record-high margins last summer created a classic boom in investment in pigs, but now a drought in the U.S. is pushing up the price of grain used for feed, prompting small farmers to slaughter their animals and setting the stage for a possible supply shortage in months to come.
Small farmers still raise enough hogs - about one-third of the national herd - that their decisions to buy more piglets or sit out a season can make a big difference in prices.
“If fewer choose to raise, in the third quarter of 2013 we see a shortage of pork and a run-up in prices,” said Andy Rothman, China strategist for CLSA in Shanghai.
The latent risk of a spike in food inflation is one of the concerns keeping Beijing from loosening policy too much, even as the vast manufacturing sector shows signs of contracting.
Although a dramatic, 18.5 percent drop in pork prices in the year to August helped bring food inflation to 3.4 percent last month, food prices are still up 5.9 percent so far this year, running above Beijing’s overall inflation target of 4 percent.
The huge investment necessary to create a large commercial operation means the larger farms will stay in business even during a downturn, unlike many smallholders.
“If the price is not good, we can sell off some piglets. But we wouldn’t sell them all,” said Manager Xu at a cooperative farm with a few hundred pigs in Luohe in Henan Province.
Jiahua, for example, cost 110 million yuan ($17.4 million) to set up in its 73-hectare site, which includes 32 long brick pens. The farm employs 200 people.
Hua is investing 300 million yuan in a newer farm three times the size under construction north of Shanghai.
“We think of pig raising as supplementing farm household income but nowadays you need to be rich to raise pigs,” said Shi Tao, analyst for eFeedlink in Shanghai.
Still, while larger farms are, in theory, better able to weather rising costs, few have gotten to the scale where they can hedge grain prices on China’s notoriously volatile futures markets. Jiahua sources grain from a regular supplier in the north, buying more when it looks like prices are rising. To cut costs, the farm has its own feed mill.
“This year prices have not been too stable, but we buy in scale to hold down costs. We buy corn by the container and buy medicines wholesale,” said Zhong Dongshan, a manager of a farm with 3,000 pigs in Jiangsu Province, north of Shanghai.
But while the march to scale may benefit Chinese consumers and Beijing by capping pork prices, investors may find it takes longer than expected to turn a profit.
What is currently a short, sharp cycle in pork prices will lengthen as farms get larger, with each downturn in the future becoming longer and more severe as low-cost producers tough it out, said Shi Tao, analyst with eFeedlink in Shanghai.
In the past, “peasants reacted immediately to price drops by selling the pigs they had and not raising more,” he said.
“Now the larger-scale farms won’t cull sows, they can absorb losses longer while smaller producers drop out.” ($1 = 6.3407 Chinese yuan)
Additional reporting by Shaoyi Xiao in Beijing and Anita Li in Jinhua; Editing by Kim Coghill