April 14, 2008 / 1:05 PM / 12 years ago

Soaring food prices raise investment risk

LONDON (Reuters) - Soaring global food prices are sparking riots and political discontent, raising investment risk in a string of emerging markets and taking the shine off otherwise successful economies that escaped the credit crunch.

Egyptian women shop at a vegetable market in Cairo March 25, 2008. REUTERS/Nasser Nuri

Higher food prices have been fuelled by dry weather in key growing areas, competition from biofuels, rising oil prices boosting production and delivery costs and growing demand from emerging Asia.

While the developed world, particularly the United States, is seen facing a downturn in part fuelled by a credit crunch stemming from problems in the U.S. mortgage market, emerging economies are expected to continue to grow.

But those economies least exposed to the credit crunch are those most affected by the higher food prices — which the United Nations says rose 35 percent in the year to the end of January but have since risen another 65 percent.

“Food prices are the big problem,” said Commerzbank emerging markets research head Michael Ganske.

“For poor people it is maybe 50-60 percent of their spending. Particularly anywhere you have huge divisions of wealth you could have problems.”

Food riots led to the fall of Haiti’s prime minister over the weekend, with violence also seen in Cameroon, Ivory Coast, Senegal, Burkina Faso, Ethiopia and Madagascar as well as the more developed economies of the Philippines and Indonesia.

Many poorer countries are aid dependent and have always been seen as risky investments, but there are signs of growing trouble in previously more appealing destinations.

Shares in the Philippines and Indonesia are off 19 and 17 percent this year as they battle inflation and other worries.

Some other markets have yet to be heavily affected. Egypt’s stock market has been hitting record highs and with its growing trade links to Asia the government says it is at least part insulated from Western economic woes.

But last week thousands of youth and workers clashed with Egyptian police over rising prices.

Further problems, experts say, range from spiraling inflation and wage pressures to protectionism, growing budget deficits, higher taxes and charges on foreign direct investment.


But angry urban populations who have been used to progressively rising living standards in recent years often blame local governments, prompting them to raise food subsidies or cap prices.

Analysts warn any disasters such as floods or cyclones hitting crops could leave them unable to cope, sparking further instability — making climate change a greater worry than usual.

At the same time, states may risk denting growth further through raising interest rates to slow galloping inflation.

Analysts say some emerging economies such as China have more flexibility to handle inflation than Western economies, as they can afford to shave a couple of percent off their high growth rates without demolishing them altogether.

In contrast, Western central banks are cutting rates despite inflation, desperate to preserve what growth they have.

But rising food price rises will still hurt poorer countries more, potentially denting consumer demands for less essential products — purchases of which have helped support growth in cheap consumer goods production in Asia.

Many countries are raising food subsidies, putting them at risk of unbalancing their budgets and pushing themselves into the red. That might be affordable although for those reaping the benefits of high commodity prices, but it raises the risk of debt defaults and higher taxes hitting growth.

Again, richer emerging economies such as China or resource-producers with large sovereign wealth funds are likely to be best placed to afford such subsidies.

In countries such as Mozambique, which has already seen some violence, analysts say governments may drastically up taxes or attempt to increase stakes in foreign-funded mines and projects.


Farmers should benefit, but by blocking exports in an attempt to keep local prices low, major producers including India effectively prevent their farmers from benefiting from high global prices — reducing the incentive to boost production.

Consultancy Control Risks says price controls in Pakistan before recent elections meant flour mills actually cut back production, further exacerbating the problem.

“There is a lot of ham-fisted policy making out there,” said Control Risks analyst Jonathan Wood. “If farmers can’t get at least some access to the higher world price rather than a low local price they won’t grow more.”

Particularly in countries like Mozambique with a few high-profile international mining and commodity projects, governments may raise the tax burden or even potentially demand greater stakes. In countries seen as corrupt, risks rise more.

“Nigeria should be benefiting from higher energy prices but because the wealth only goes to a few people there is much more risk of trouble,” said Commerzbank’s Ganske.

But despite the global gloom, higher global food prices are ultimately seen benefiting producers in Latin America, Australia, New Zealand and North America in particular.

Eclectica Asset Management has put $300 million into agricultural equities with shares in firms from seed companies to tractor makers, 35 to 40 percent of it in the United States.

They see global food prices rising another two to three times as part of a global cycle that last saw prices peak in the 1970s, although they stop short of predicting total disaster.

“Overall, I think we’ll muddle through,” said Eclectica fund manager George Lee. “It’s a good time to be in U.S. agriculture. But farming alone isn’t going to be enough to turn around the U.S.. The mortgage market is just so much bigger than agriculture. Overall, our outlook on U.S. is pretty horrific.”

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