World Perspective

Overview presented by David King, IFAP Secretary General

31st North American - European Union Agricultural Conference

Orlando, USA, 21023 September 2005

 

WORLD - STRONG GROWTH

 

The world economy was strong in 2004 with growth of 5.1 per cent, the highest level for 30 years. Prosperous consumers mean a healthy demand for farm products.

This good global economic performance is not spread over all regions. In fact it is the USA and China that is pulling the rest of the world along. Consumption in the USA is remarkably resilient in spite of a large financial deficit. Growth in China is particularly significant since it is generating huge market demand for primary products such as oil, minerals, metals and also agricultural products. China represents only 4 per cent of world GDP, compared with about 17 per cent for each of the USA and EU, so its contribution to world economic growth is impressive.

What are the prospects for the current year 2005, and the next?

Oil prices have risen by more than 50 per cent from last year, and this alone will knock about 1 per cent of global economic growth. Oil revenues go mainly to the countries of the Middle East and Central Asia, which have a low capacity to consume them. World economic growth is expected to slow somewhat in 2005 and 2006 to about 4.3 per cent

 

USA – ECONOMY STILL PERFORMING WELL

The US economy is remarkably resilient, and just keeps on growing. Economic growth is expected 3.5 per cent, which is lower than last year’s level of 4.4 per cent but still higher than any of the other G-7 countries. Unemployment is low at 5 per cent of the population, and consumer spending continues at a high level; savings ratios are almost zero. As a result, the USA has accumulated a massive balance of payments deficit with the rest of the world, equivalent to over 6 per cent of GDP, as its strong economy sucks in imports and capital. This deficit is being financed by surpluses in other countries, mainly oil exporters like Russia and the countries of the Middle East for 30% of the total, Japan and Latin America for another 14% each, China 7% and most of the rest from emerging Asian economies (24%).

For years, observers have been warning that these imbalances are unsustainable, and that one day investors could take their money out of the USA, the dollar would collapse and the world economy brought to a standstill. Since everyone gains when the US economy is performing well, there is little incentive for external investors from Asian or the oil producing countries to precipitate such a crisis, so a ‘soft landing’ looks more likely. The Federal reserve has been slowly increasing interest rates since February this year, reaching a level of 2.5 per cent (and there should be another increase this week), to cool off demand. Retail sales have been falling, and the devastation of hurricane Katrina will push growth down further. The US dollar has depreciated by about 6 per cent compared with last year (12% over the last 3 years) but is holding up pretty well. The US economy continues to lead the global expansion, albeit at a lower rate. Farmers seem to be benefiting from this, enjoying strong meat prices and strong export performance in 2004 and record net farm income of $82 billion in 2004.

Things will not be so good this year. Damage to US farmers of Hurricane Katrina is estimated to be $2 billion. Transport and input costs have risen and grain prices have fallen. Weather-related disaster losses have impacted over half the counties in the US, and earlier this year Congress voted to cut $3 billion from agricultural programs.

 

EU – SLOW GROWTH AND HIGH UNEMPLOYMENT

 

The EU economy is still stuck in a situation of slow growth and high unemployment. Economic growth in the Euro area is expected to be about 1.3 per cent in 2005, maybe reaching 2.0 per cent in 2006. Unemployment in the Euro area is almost 9 per cent (20 million people). Public discontent with this poor economic situation was deemed responsible for the rejection of the EU Constitution by French and Dutch voters and the regional election defeats of Chancellor Schröder in Germany. In Italy, the Finance Minister has recently been very critical of the Euro.

The European Central Bank has been holding interest rates at 2.0 per cent in order to keep average inflation in the Euro zone under 2 per cent, and it has done so successfully. However, the ECB has been criticised for not reducing interest rates in order to stimulate the EU economy and reduce unemployment, which are in fact outside its narrow mandate. Any reduction in Euro zone interest rates looks unlikely at the present time given the inflationary effects of higher oil prices, and the fact that the Euro has stopped appreciating. Outside the Euro zone, the UK has a much higher interest rate of 4.75 per cent. There is pressure on the Bank of England to reduce this in order to shore up consumption which is flagging (falling retail sales). Any cut in interest rates would be good news for farmers.

National governments can use fiscal measures to try to boost their respective economies, but there is little coordination of economic policy among the countries of the Euro zone. Many have already increased government spending to beyond the limits imposed by the Growth and Stability Pact, i.e. they have run up budget deficits of more than 3 per cent of GDP. Other advanced economies have larger deficits, e.g. Japan has a budget deficit of 6.9 per cent of GDP and the USA a fiscal deficit of 4.4 per cent of GDP.

On top of a difficult economic situation of weak internal demand, in export markets most EU farmers have had to live with a strong Euro that rose consistently against the dollar from October 2000 until early last year when it fell slightly. In addition, another reform of the EU Common Agricultural Policy has led to substantial cuts in farm prices that were only partially compensated by direct payments. Part of the CAP reform includes a shift away from intensive farming and as a result intensive beef production is declining, offering opportunities to farmers in Brazil, Argentina and Uruguay to fill demand in under utilised meat processing plants in Europe.

 

JAPAN – ECONOMIC RECOVERY

 

The Japanese economy surprised investors by growing an annualised rate of 3.3 per cent in the second quarter of this year.  This is the highest level for 15 years, and unusually it was due to domestic demand growth not exports. Japan has been battling with deflation (falling prices) for nearly a decade as consumers save their income and do not spend generating domestic economic activity; this is changing as bank lending in Japan has risen this year for the first time in 7 years. Interest rates are around zero per cent.

Japan’s long-awaited upturn in its economy was boosted by the landslide election victory of Prime Minister Koizumi earlier this month and his reform agenda. The stock market in Japan rose to a 4-year high. Economic growth in Japan is expected to average around 2 per cent in 2005.

Mr. Koizumi ran his election campaign on privatisation of the post office, whose savings and life insurance system makes it the world’s biggest financial institution. Japan has a huge public debt, equivalent to 160 per cent of GDP, and Mr. Koizumi is seeking to give the private sector a much larger role in the Japanese economy. With a large fiscal deficit of 6.9 per cent of GDP, the Koizumi administration may also seek to increase taxation while trying not to choke off the economic recovery.

The yen has remained broadly stable relatively to the US dollar over the last year, and competitiveness is not a problem. Unemployment is at a 6-year low of 4.5 per cent.

 

CHINA – GROWING STRONGLY BUT SLOWING IMPORTS

 

China continues to grow at 9 per cent per year and has a current account surplus of 6 per cent of GDP. China is adding about $200 billion to reserves every year and now has over $700 billion. Inflation is 3 per cent and falling. The abolition of textile quotas on 1 January 2005 gave a boost to Chinese (and Indian and Pakistani) exports of clothing.

An annual growth rate of 7-9 per cent will allow China to create 15 million new jobs every year.

China’s economic development has been based on investment in manufacturing capacity for export. This has caused some problems in international trade, e.g. the dispute over textile imports this year. Quotas were imposed on China on June 10 after only six months of open access. It resulted in 77 million garments being impounded in the EU. On September 7 the dispute was resolved and the garments released, with half the excess being attributed to next year’s quota and the other half waved through.

Investment-led growth for export has also led to some unequal distribution of the benefits of growth. The main beneficiaries of rapid growth are the large coastal towns and not the rural areas. China is shifting emphasis away from investment for export to more spending on social programs such as health and education, and development of domestic import substitutes.

In July 2005, China revalued its currency, the Renminbi by 2.1 percent and introduced a new managed float linked to a basket of currencies and not only the US dollar as in the past. This still leaves the Renminbi about 3 per cent over valued.  Revaluation raised the cost of exports of Chinese exports, including for agricultural products such as fruits and vegetables, processed fish and seafood, prepared meats, textile and timber products. However the revaluation helped agricultural exporters to China, such as the USA, Brazil, Argentina, Malaysia and Australia. China is a large importer of agricultural products like soybeans (from the USA, Argentina and Brazil), wool (China imports most of the quality merino wool of Australia), natural rubber (from Malaysia; natural rubber prices are at a 10 year high), dairy products and lamb (from Australia and New Zealand).

Since the beginning of 2005, China decided to try to slow its unsustainably high growth level by introducing measure that in effect restricted lending by the three largest state-owned banks, and this has reduced the growth of imports – a blow to exporters to China. Since China joined the WTO, it has lowered tariffs on imports, and these now average about 10 per cent overall. Exports remain strong.

Interest rates are 2.25 per cent, and there is pressure to increase them to mop up the high level of liquidity in the Chinese economy.

It should be noted that China has 21 per cent of the world’s population but only 10 per cent of the world’s arable land. In 2004, China was a net importer of $7 billion of agricultural and food products – mainly cereal and oilseeds. This is a concern to China which would like to remain self sufficient in basic food grains. Farms in China are small, typically being under 1 ha. Agriculture still employs 40 per cent of the population and this is the poorest sector.

 

INDIA – BOOMING BUT NEEDS PRIVATE SECTOR INVESTMENT

India’s economy is growing by 6.7%; the Mumbai stock market has risen by 80 per cent since May 2004. In spite of the tragedy of the Tsunami in December 2004, this has not significantly altered the good growth prospects for India.

After China, India is becoming a major player in the global economy. The Indian economy is still largely government driven, like other Asian economies. The Indian government is making use of increased revenues to develop basic economic infrastructure and social services. However, Indian already has a very high fiscal deficit of 10 per cent of GDP, and, like Japan, needs to encourage more privatisation of the economy. India still has constraints on foreign investment and is seeking to encourage more development of the private business sector.

India does not account for a large part of world agricultural trade, since it has a large internal market (1 billion population) and a good productive resource base.  Nevertheless, India has a positive balance in agricultural trade, mainly due to exports of tea, rice, wheat, sugar, and spices. The main markets for its exports are the USA, Bangladesh and Japan. India imports vegetable oils, cotton, fruits and vegetables.

 

AMERICAS – STRONG POTENTIAL

 

Latin America is growing at 4.1%, a pleasant surprise for most observers, and the high levels of inflation experienced in the 1980’s seem to have been brought permanently under control; it is around 6 per cent.

Substantial fiscal surpluses in Brazil of 4.6 per cent of GDP and in Argentina of 5.1 percent of GDP have allowed these countries to pay back some of their debt and so try to be less vulnerable to foreigners pulling their money out of the country when times are difficult. Brazil is even expected to float its first global bond issue this week in local currency (the Real), which is a sign of growing confidence.

As well as having vulnerable financial systems, many countries in Latin America have heavy administrative structures and weak regulatory environments. Foreign direct investment in Latin America fell sharply after the Argentine default of late 2001, and has not yet recovered owing to a weak business environment, e.g. for enforcement of contracts. The region is also not as open to foreign trade as other parts of the world, except for Chile whose average tariff is around 2.5 per cent. External trade constitutes under a quarter of GDP of Latin America, compared with over a third in Asia and 60 per cent in the EU.

 

Brazil relies on agriculture for 40 per cent of its export earnings. Traditionally, Brazil’s agricultural exports have been mainly coffee and orange juice. Today the export boom is being led by soybeans, sugar and pig and poultry meats. The main market for these exports is the EU with 40 per cent of the total. However, the fastest growing markets for Brazilian agricultural exports are China and Russia.

 

In Central America, the opening of US textile markets to China and India has resulted in losses for their textile industries. These countries are hoping to recover some of their market losses in the USA resulting from the removal of textile quotas by increased market access under the recently-passed USA- CAFTA-DR free trade agreement.

 

The Canadian economy has the fastest growth rate and strongest budget position of the G-7 nations. Seven consecutive budget surpluses have allowed for a significant reduction in public debt and a substantial tax cut. The interest rate is low at 2.5 per cent (same as in the USA) and inflation is under 2 per cent.

Good net export performance has led to a 13 per cent real appreciation of the Canadian dollar in 2004. This will slow down consumer spending and export performance in 2005. GDP growth is expected to be 2.8 per cent.

 

In Mexico, one third of revenues are from oil exports. Given the increase in oil prices the government has proposed a budget with a surplus for the first time in a decade. This has created a fight in Congress with legislators who want to see increased government revenues spent on education health and general infrastructure.

Economic growth in 2005 is expected to be 3.7 per cent, the same as Brazil, following 4.4 per cent growth in 2004. This is a good result after the weak years of 2001-2003. Inflation is under control at 4.6 per cent.

 

RUSSIA – PLENTY OF MONEY BUT POOR INVESTMENT

 

Russia’s economic growth in 2005 is forecast at 5.8% (down from 7.1% in 2004), boosted by increasing oil revenues. Oil money has allowed Russia to reduce its debt by $15 billion and also constitute a Stabilisation Fund (from taxing oil prices above $20 per barrel); it also has a high level of foreign currency reserves and a budget surplus. However, the politically-motivated break up of the private Yukos oil company has damaged the investment climate in Russia. Foreign direct investment is negligible and domestic investment is down by 10 per cent over last year. Taxation and transport tariffs are high, also discouraging domestic investment.

President Putin is spending much of the country’s oil wealth on increasing public sector salaries and pensions. The country is therefore consuming its oil wealth rather than using it for public sector investment in the economy. Strong consumption growth has mostly been met by higher imports and inflationary pressures. Inflation is running at over 10 per cent. Growth in oil revenues and real wages should also lead to a rise in imports in 2005.

 

 

AFRICA

 

Growth in Africa is 5%, the highest for 8 years. Inflation is down to 9%, the lowest in more than 25 years. This is good news for Africa. The IMF says that this is a result of reforms - increased macroeconomic stability (control of government spending and the growth of the money supply) followed by domestic economic reforms (market-friendly policies). The recovery of agriculture in Ethiopia and the Gambia from drought also contributed significantly, as did higher oil prices for African oils producers.

A favourable world economy and the debt relief for the Highly Indebted Poor Countries (HIPC) that was decided by the G-8 are certainly positive factors for Africa. However, on the other side of the equation it should be remembered that ACP countries in Africa will be hit by the erosion of trade preferences under the Anything but Arms agreement with the EU and trade liberalisation in the WTO. Cotton prices are very depressed and this is hurting farmers in West Africa. Textile producers in Northern and Southern Africa were also hit by the opening of EU textile quotas to China.

Africa’s main problem is still political instability which discourages the needed investment that is necessary to put Africa on a sustainable path of high growth like the Asian economies.

 

AUSTRALIA AND NEW ZEALAND – BENEFITTING FROM EXPORTS TO CHINA

 

Soaring Chinese demand for raw materials, including agricultural products, is boosting the economies of Australia and New Zealand and companies are posting high profit levels. In Australia, there is a huge amount of investment in the mining sector driven by demand from China. Economic growth will be around 2.7 per cent in 2005 in both countries.

Both countries have budget surpluses above 1 per cent of GDP and low unemployment (5% in Australia, 3.8% in New Zealand). Both the Australian and New Zealand dollars are strong relative to the US dollar. The Australian dollar has appreciated by 16 per cent relative to its level in1990, and the New Zealand dollar has appreciated by 29 per cent over the same period. Retail sales keep growing, and in March 2005 interest rates were raised to cool the economies. At 6.75 per cent, interest rates in New Zealand are already the highest of any advanced industrialised country, and no decreases are in sight. In Australia the interest rate is 5.5 per cent. The inflation trend is 3% in Australia in 2005 falling to 2.0% in 2006, and stable at 2.0% in New Zealand.

All is not well in the farm sector however, as drought hit Australia, creating a shortage of crops and livestock feed, with distress slaughtering of animals. The net value of farm production in Australia fell by 10.6 per cent in 2004-05 and is forecast to fall by another 23.1 per cent in 2005-06.

 

COMMODITY PRICES

 

Strong demand in the USA and China has also been responsible for a commodity price boom that started in mid-2002, mainly pushed by increases in oil prices. Demand from China has been pushing up the prices of metals and minerals. Demand from Indian for gold jewellery has pushed gold prices to a 17-year high (helped by some governments also increasing their gold reserves). Food and agricultural raw material prices also increased significantly (over 30%), especially for coffee, sugar, rice, meat, and timber.

Oil price increases have been sustained, rising from about $20 per barrel in 2002 reaching $40 a barrel in 2004 and $65 a barrel currently in 2005. With oil production capacity reaching its limit and China increasing its oil consumption by 15.6 per cent in 2004 (1), oil prices are unlikely to fall significantly. In the short term, this is bad news for farmers, who are subjected to cost inflation for fuel, fertiliser and other oil-based inputs. At the same time, plentiful harvests have depressed the prices of many farm products, with significant drops for cotton (-34% since 2003) and soybeans (-21% since 2003).  Cereals prices are well below last years levels. Thus, while the world economy is still strong, farmers are generally not doing well this year.

(1) China is facing electricity shortages as its economic boom reaches certain capacity limits. There is now increasing use of diesel engine generators and hence an increased demand for oil.

 

Bio-fuels

In the longer term, the sustained rise in oil prices will open opportunities for farmers to develop programs for renewable energy. Brazil, for example is giving a significant boost to its sugar cane bio-ethanol program. Sales of “flexible-fuel” vehicles that can run on either gasoline or alcohol in any proportion account for 50 per cent of total vehicle sales in 2005 and this is expected to rise to 75 per cent in 2006. Demand for bio-ethanol in Brazil has doubled sugar prices over the past two years.

In the USA, mandatory use of bio-fuels for environmental reasons will increase the demand for corn for ethanol by 5 per cent per year over the next 8 years. In the EU, bio-fuels will be part of the solution to reducing emissions of greenhouse gases by 8 per cent by 2012.

 

Avian influenza

The outbreaks of avian influenza (strain H5N1) in Indonesia, Vietnam, Thailand, Laos, Cambodia, and China are becoming a global problem. Already 60 persons have died from the disease and 140 million birds have died or been slaughtered to contain outbreaks in South-Eats Asia. Following the avian flu outbreaks, Brazil has been able to increase exports of poultry meat to fill markets that were previously supplied by Thai and Chinese producers.

In June and July this year, migrating water birds have brought avian influenza from South-East Asia to Mongolia, Russia and Kazakhstan.  This migration caused concern in Europe where the Netherlands for example ordered that all domestic poultry must be kept indoors. Over the other side of the Atlantic, President Bush announced last week the creation of an international partnership to share information on avian and pandemic influenza that will include Canada, Cambodia, Japan, Nigeria, Thailand and Vietnam.

 

 

CONCLUSION

 

Overall, the world economy is in good shape, but this does not mean that farmers are in good shape. For most farmers of the world, incomes are under pressure from rising input costs due to oil price increases, and from falling government support for agriculture and falling prices for farm products. For the future, agriculture has to be able to exploit new market opportunities to increase value-added e.g. for bio-fuels, and it also has to become a higher priority on government agendas, if it is to receive its fair share of the increasing wealth generated by the world economy.