Wheat and inflation

The writer heads the Sustainable Development Policy Institute.

Food inflation is once again irking both the people as well as the government. People are finding food beyond their economic access, whereas the government is trying its best to avoid criticism that it cannot manage the food prices.

There are many factors contributing to food inflation. Imported food commodities (edible oil, pulses) get dearer when international prices increase and/or the value of rupee depreciates. Lack of adequate storage facilities is the primary reason behind the price hike of most perishable commodities such as tomatoes and chilies. It is not possible to store their stocks during peak season for off season consumption. Yet another reason for food inflation is increase in energy prices which not only increases cost of production but also cost of transportation.

These reasons for food price inflation make sense. However, people and the government of Pakistan are in a fix about wheat price inflation. Let us try to analyze what went wrong with wheat prices.

Wheat is the staple cereal in Pakistan, contributing to 37 percent of total food energy intake and grown on 40 percent of the country’s total cultivated land. Punjab contributes about 75 percent of wheat production. Pakistan, a net importer of wheat during the 1980s and 1990s, turned self-sufficient in wheat from 2000 (24 million to 26 million ton production) till the recent arrival of first shipment of imported wheat at Port Qasim.

The government tries to maintain strategic reserves of wheat to ensure smooth supply of wheat flour at a stable price. For this purpose, provincial food departments and the Pakistan Agricultural Storage & Services Corporation (PASSCO, a federal agency) procure wheat on a preannounced minimum support price (MSP). This procurement ranges between 25 and 30 percent of total wheat production. Private sector players including flour mills also buy wheat for their consumption. The government releases its stocks to flour mills, when open market stocks deplete, at a price marginally higher than MSP. The mills getting this wheat are bound to produce flour at a pre-agreed extraction ratio (of flour, bran and other byproducts) and sell at a government-controlled price.

The MSP has often been above the international prices, compelling the government to provide subsidies of $90-120/ton (shared equally by the federal and provincial governments) to export surplus wheat.

In the second half of last year, there was an abnormal increase in wheat prices. Prices of wheat flour shot up to Rs70 a kilo in some areas (almost double than MSP). An FIA enquiry report (April 2020) on wheat price escalation highlighted that the Sindh food department did not procure any wheat in 2019, while the Punjab food department and PASSCO were unable to meet their respective procurement targets, leading to low carryover stocks. The report also pointed out that despite the ban on wheat export imposed in July 2019, the government allowed exports of 48,000 tons, which fueled the price hike in the country.

It was expected that the situation would improve with the arrival of the new wheat crop in May. However, before the harvesting of the new crop was over, it was officially announced that Pakistan missed its wheat production target by 1.6 million to 1.8 million tons. The announcement of wheat shortage not only sent signals to speculative buyers in Pakistan to hoard wheat, but also alerted international wheat suppliers that Pakistan would be a captive buyer, resulting in an increase of international wheat prices.

On the other hand, the Punjab government, to achieve its procurement targets, banned the private sector from buying wheat from the farmers. This, in certain areas, went to the extent of harassment where raids were conducted under the anti-hoarding law and wheat was ‘recovered’ from farmer’s houses. The ban on private buyers to buy wheat was lifted once the four million tons procurement was made by the Punjab food department. However, it was too late then. Wheat was already hoarded by investors and due to limited supply, its price in the open market was way higher than the MSP.

The private sector, had it been allowed to buy wheat in time, could have met the requirements of flour mills at a reasonable price from June till the start of official releases from the food department at subsidized (issue) price in October. In the changing circumstances, the price of wheat in the open market had shot up so flour mills in Punjab put pressure on the government for early releases of wheat. The Punjab food department started these releases in July at the rate of Rs36.80 per kg and fixed the official sale price of flour at Rs43 per kg.

Millers also negotiated a lower extraction ratio. Earlier they were bound to produce 80 percent wheat flour and 20 percent byproducts from the wheat they were getting from the food department. This year the government, in order to compensate for higher wheat price in the open market, agreed that they could produce only 65 percent flour and 35 percent byproducts from the wheat that they would get from the government at subsidized rates (15 percent reduced quantity of flour from subsidized wheat).

Despite all these steps to keep the flour prices under control, it is being sold up to Rs20/kg higher than the controlled rate of Rs43/kg.

Pakistan’s daily requirement of wheat is around 73,333 tons. Punjab’s daily requirement is around 36,000 tons. The food department in Punjab has been releasing around 16000 to 17000 tons wheat per day to flour mills at a price of Rs38.60 kg since July 2020. But these releases are not enough to meet Punjab’s daily requirements. To meet the shortfall, millers have to buy an additional 20,000 tons wheat per day from the open market, at a price much higher than the government-issued price of wheat. In other words, more than half of the flour produced per day in Punjab is bound to be sold at a price much higher than the controlled price.

There is no mechanism to distinct and track the flour prepared from subsidized wheat from that of open market wheat along the complex wheat supply chain (flour mills, dealers, sub dealers, big retailers, small retailers etc). This implies that higher flour prices would prevail, rendering the subsidy mechanism ineffective.

We should also keep in mind that Punjab not only supplies wheat to other confederating units, but also to Afghanistan (and at times to Central Asian States as well). The MSP of wheat in dollar terms plays an important role in determining how much wheat will get smuggled from Pakistan. From 2013 to 2017, the MSP was Rs1300 per 40 kg ($315 per ton), reasonably higher than international prices. In 2018-19 it was fixed at Rs1400 per 40 kg but the rupee had depreciated so it came to $ 223 per ton, almost at par with international prices. Today, with further depreciation in the value of the rupee the MRP equals $212 per ton, whereas international prices have shot up to $ 280 per ton – creating a huge incentive for hoarders to smuggle wheat to Afghanistan and beyond, resulting in the shortage of domestic supplies.

To meet the wheat shortfall, the government plans to import 1.5 million tons of wheat, while the private sector will import another 1.2 million tons. This would improve the supply situation and to an extent the prices too. Imported wheat will cost around Rs50-52 per kg, add grinding, packing cost etc, and the price of one kg flour will exceed Rs55. The government can subsidize to match the issue price, but the private sector cannot and that will keep on distorting the market prices.

A not-popular way of reducing market distortion would be to increase the government issue price (increasing subsidized flour price) to bridge the gap between government price and open market wheat price.

A medium-term approach would be to do away with the MSP that had created a wheat circular debt of Rs757 billion against total stocks of Rs320 billion till December 2019. Abolishing the MSP would also save Rs38 billion annual cost of buying, storing, and releasing 4-million-ton wheat in Punjab only. The 450 billion to 500 billion rupees saved may be diverted to targeted subsidies for food security under BISP/EHSAAS.

The third scenario is to stick to the status quo, which is neither resulting in reduction of rural poverty nor reduction of prices for urban consumers. The government would be reluctant to take any radical measures amidst the current rallies of the united opposition, so expect the status quo –which in the long run will keep on equally pinching the rural poor, urban consumers and the government.

Twitter: @abidsuleri