Extreme Weather to Fuel Food Inflation: Analyst

Extreme weather conditions can push food prices, already on a high in Asia, further north. In 2011 regional inflation could be close to 5 percent, provided there is no sudden spike in the year. If there is a sudden spurt say of 10 percent, then the overall figure forregional inflation could touch 5.5 percent in 2011. This compares with 4.5 percent in 2010.

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Already, reports of higher fruit and vegetable prices are emerging from China, especially in provinces hit hardest by the drought. Higher electricity prices are likely to pass into prepared food prices, which have been rising strongly in the past few months.

Prepared food has a large weightage in most Asian CPI baskets. On average, we estimate that prepared food accounts for more than 40 percent of food inflation in emerging Asia.

The share of prepared food is especially high in Singapore, South Korea and Hong Kong, reflecting their “eating out” culture. This means the pass-through from higher raw food prices into prepared food in these economies is usually rapid, especially in an environment of elevated energy costs.

Extreme weather conditions in Asia are already affecting productivity. In China, the Yangtze River Basin is currently in the grip of its worst drought in four decades, while the eastern Shandong province faces an unprecedented shortage of water. Shandong has received just 12 mm of rain since September 2010, with some reports indicating that around 40 percent of the province’s wheat crop has been lost.

In an attempt to relieve the impact of the drought, officials started releasing water from the Three Gorges Dam on May 16, discharging 9,500 cubic meters of water per second. Release of dam water for irrigation has reduced electricity production in China and resulted in power shortages.

Since hydroelectric power accounts for one-fifth of Chinese electricity production, this action could raise the risk of an energy crisis ahead in the summer. Already, the government has hiked electricity prices in order to reduce demand. Higher utility costs are likely to pass through overall costs, including prepared food.

Marine transport is also feeling the negative impact. On May 12, AFP reported that the authorities had closed a 228-km stretch of the 6,300-km Yangtze River (Asia’s longest river) to prevent containerships from running aground, which could also potentially disrupt food supply chains.

The key implication of these developments is that the upside risks to food inflation are rising rapidly, contrary to the more benign outlook that is currently priced in, largely on the back of the recent decline in rice and vegetable prices. However, the sharp swing from the extreme La Niña pattern (“big wet”) to El Niño (“big dry”) combined with drought-like conditions in China may lower food production and push prices higher.

Rahul Bajoria is Barclays’ regional economist covering Malaysia and Thailand. He is also a regular guest on CNBC TV.