Explaining Food Price Inflation

Type Working Paper
Title Explaining Food Price Inflation
Publication (Day/Month/Year) 2007
URL http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2012/09/26/000356161_20120926​014313/Original/728980ESW0whit0lation0Report0jan025.doc
Since 2004/5, high inflation has become a significant concern in Ethiopia, and shows no signs of abating in 2007. In the latest official inflation figures for October 2007, the 12-month annualized national rate has reached almost 18 percent, with price increases continuing to be broad-based--food increasing by 18 percent and non-food items by 16 percent. This appears puzzling, because national crop output has also increased significantly over the same period. More recently, international commodity prices have also taken off.
At the request of the Ethiopian authorities, analysis was undertaken by Bank staff in collaboration with EDRI and local researchers to study the nature and causes of rises in grain prices, focusing on structural factors. Our methodological approach uses changes in real prices, that is, the prices of teff, wheat and maize, relative to changes in overall prices. We found that medium-term trends in real prices of wheat, maize and teff are broadly consistent with official figures on supply, and estimated increases in demand due to population and per capita income growth. The exception is the large increase in teff prices in 2006-07 (in both nominal and real terms), which remains a puzzle given that at observed market prices; officially reported supply exceeds estimated demand. It is possible that increases in private/cooperative stocks (made more attractive by negative real interest rates on credit) may have played a major role in price seasonality and overall price movements in 2006-07. It is nonetheless the case that these real price increases in teff, while visible to the population, represent only a small part (about 5 percent) of overall food price inflation.
We investigate several hypotheses, and find:
• The partial shift from food aid to cash transfers as part of the PSNP has had positive, but not large, effects on market prices for farmers. However, even together with food transfers, the total size of the program in 2006-07 is only about 1 percent of GDP. Assuming about two-thirds of transfers in-kind is imported food; the net effect of increased supply of cereals plus increased demand because of higher household incomes is an insignificant increase in food prices (less than 0.5 percent).
• The activities of cooperatives may be affecting the structure of the market and improving the bargaining power of farmers (especially in the teff market).
• Global factors are unlikely to directly affect domestic prices in the short to medium run, since Ethiopian prices are below import parity, and based on international forecasts through 2015 for wheat and maize, are likely to remain so.
• The domestic supply is likely to run behind demand in a high growth context, especially since production increases have been driven by area expansion, and trends in yields remain disappointing, further increases in relative prices are likely.
We found evidence of increased marketing of grain production. However agriculture markets in Ethiopia are generally underdeveloped and competition is limited. The private sector is not currently in a position to take the risks involved in purchasing, storing and marketing grain, particularly if food aid purchases and deliveries are unpredictable. The newly introduced commodity exchange is intended to help address these issues.
We also examine the welfare impacts of grain inflation. This is complex, especially for rural households, given the simultaneous production and consumption decisions inherent in their livelihood systems, and the responsiveness of consumption decisions to price and incomes. Nevertheless the micro analysis based on the HICES and urban panel data, suggests several important findings.
• Overall, rises in the relative price of food tends to benefit rural households, though the exact magnitude needs to be investigated further.
• Changes in the prices of teff, wheat and maize tend to affect more the people at the higher income quintile in rural areas, while in urban areas they tend to affect those at the lower income quintiles.
• The recent hike in relative prices has increased the urban cost of living by 8-12 percent in urban areas.
• Inflation could worsen urban income inequality significantly.
• Demand for teff, maize and wheat tends to be elastic, with evidence of substitutability, especially between teff and wheat. In urban areas, all three types of cereals tended to be necessities, with inelastic price responses.

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