China: The Economics of the Pork Biz
Pork occupies a special place in Chinese traditions and cuisine. Suckling pigs, served with their crispy hides, head, and eyes intact, are common at festival holidays, office openings, and other events to ensure good luck. The Chinese have hundreds of ways to serve pork, from sizzling strips fried with chili and green peppers in Sichuan, to minced pork with garlic and tofu. Pork accounts for 70% of protein consumed by Chinese.
So it comes as no surprise that the government is concerned about skyrocketing pork prices that contributed to a 15.4% year-on-year increase in the cost of food, and a 5.6% year-on-year increase in the consumer price index in July, the most dramatic in 10 years.
Soaring pig prices reflect a large contraction in stockbreeding last year due to an epidemic of "blue ear" disease, a form of swine flu that does not spread to humans. The impact even hit demand for animal feed from international suppliers. "The disease in the pork industry cut into our production and profitability" in the fiscal year that ended in May of this year, said Norwell Coquillard, president of Cargill Investments (China), in an e-mail response. He adds, however, that "volumes are recovering now."
Because of the highly fragmented nature of pig farming in China, there is no reliable data on the number of pig deaths, though official estimates of 1 million to 2 million out of a total of 500 million animals slaughtered annually are probably too low.
Inflation vs. Runaway Growth
The government has reacted with a variety of measures to contain prices, from attempts to centralize purchases to smooth fluctuations, to subsidized insurance for farmers against diseased hogs, reflecting the prevailing perception that much of the inflation is supply-led.
Pig farmers are trying to enlarge their stocks. However, it may be a while before such measures have a meaningful impact. "Though farmers are now responding to higher prices by increasing stocks, it takes about 18 months from the time a piglet is conceived until it is ready for slaughter, so prices may not peak until mid-fall," says Andy Rothman, China economist for CLSA Asia Pacific Markets.
So far, the pork-inspired runup in inflation probably isn't a threat to the larger economy. Several observers have pointed out that after stripping out food from the consumer price index, core inflation was just 0.9% in July year-over-year, hardly an alarming level for an economy that is chugging along at more than 11% growth.
The far bigger battle, some economists argue, isn't inflation but the economy overheating from excess lending and stock market bubbles. Professor Xu Xiaonian, an economist at China Europe International Business School, believes the government should stop trying to micro-manage the pork industry and stick to macroeconomic measures. "I believe the economy is overheating and the government has done too little in terms of interest rates and exchange rate adjustment," he says.
Rural Incomes Benefit
Others concur. "From a monetary point of view, I don't think we are at the stage of widespread inflation," says Standard Chartered (STAN.L) China economist Stephen Green. "But given other indicators of growth picking up, the best approach would be monetary tightening with two more interest rate hikes." At current rates of inflation, real interest rates are negative for savings accounts at banks, which pay just 3.3% for one-year term deposits.
As a result, individuals are pouring their money into real estate and the white-hot stock markets, instead of keeping it in banks. Credit Suisse (CS) regional economist Dong Tao says China needs to hike interest rates by at least 200 basis points to induce people to hold bank deposits.
Also, there is at least one upside to soaring food prices. Real rural income increased 13.3% in the first half, helping close the yawning urban-rural income divide. This has been a major boost for individual pig farmers, as backyard farms account for 70% of pork production.
However, the small size of most pig-raising operations, usually no more than a handful of hogs at a time, makes these households most vulnerable to disease. That is why Beijing in mid-August instructed the country's biggest five insurers to offer government-subsidized policies enabling farmers to insure pigs for about $1.60 each, thus encouraging an increase in production.
Animal Feed's Price Pressure
Of course, while insurance protects farmers, it won't address supply interruptions should another outbreak occur. Credit Suisse's Dong Tao points out that blue ear disease currently accounts for 40% of all non-slaughter-related deaths of pigs.
The movement for alternative fuels could also put upward pressure on Chinese food prices. Global prices of corn, for example, have increased dramatically due to the increase in ethanol production.
Corn prices in China, though different from global prices, are correlated with them, and upward pressure on animal feed is likely to continue. One sure sign that pigs will remain central to China is the pending launch of pork futures, expected to start trading on the Dalian Futures Exchange later this year. Liu Yugang, researcher at the information department of the Dalian exchange, says futures should "help decrease price differentials between different regions, one of the causes of current price volatility."