Philip Lowe: World prices and the Australian farm sector
Speech by Mr Philip Lowe, Assistant Governor (Economic) of the Reserve Bank of Australia,
at the Australian Farm Institute Agriculture Roundtable Conference 2011, Melbourne,
10 November 2011.
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I would like to thank Troy Gill, Ewan Rankin and Trent Wiltshire for assistance in the preparation of this talk.
Good morning.
Thank you for the opportunity to speak today about some of the challenges and opportunities
facing the farming sector in Australia.
Perhaps more than any other parts of the Australian economy, farmers understand
uncertainty. They live with uncertainty about rainfall and growing conditions. They live with
uncertainty about the costs of their key inputs. And, of course, they live with uncertainty
about the world prices for their outputs. It is this ability to deal with uncertainty that is one of
the strong and enduring characteristics of the Australian farming sector.
This morning, I would like to begin by talking a little about some of the uncertainties facing
the global economy. I would then like to discuss why it is that, despite these uncertainties,
the medium-term global environment facing the Australian farming sector is quite favourable.
And then finally, I would like to briefly touch on current conditions in the farming sector in
Australia.
Global uncertainties
It is clearly a difficult time for the world economy. Financial markets remain captivated by the
unfolding events in Europe. The authorities there are dealing with a very difficult combination
of excess government debt and weak banking systems. The problems are compounded by
the weak growth prospects in the region and increasing fear of widespread contagion.
This situation is, in part, a legacy of many years in which a number of governments spent
much more than they raised in taxes, with bondholders being more than willing to finance the
difference at low interest rates. It is being compounded by the fact that the policy options
facing the members of a currency union are more restricted than those that would face a
country with its own currency.
In preparing the Reserve Bank's latest forecasts of the world economy, we have assumed
that the European authorities do enough to avert a real disaster but are not able to avoid
periodic bouts of considerable market volatility and uncertainty. There are, of course, a range
of other scenarios, many of which, unfortunately, are on the downside. This inevitably means
that there is likely to be considerable uncertainty about the global economy for some time.
But amongst the gloom emanating from Europe, it is important not to lose sight of what is
going on elsewhere in the world. In the United States, recent economic data have generally
been better than they were earlier in the year. It now seems clearer than it was a few months
ago that temporary factors - including the rise in oil prices and the supply-chain disruptions
from the Japanese earthquake - contributed to the weak US economic outcomes earlier in
the year. As is normal though for a country having experienced a financial crisis, the recovery
in economic activity has been slower than normal. Nonetheless, corporate balance sheets in
the United States remain in good shape and a pick-up in business investment is under way.
And importantly, there are few signs that the recent financial turbulence has led to the
significant deferrals of spending on capital goods that caused so much damage in 2008 and
2009.
In Asia, growth remains firm, although below the pace in 2010. This moderation in growth
partly reflects a general tightening of macroeconomic policy over the past year in response to
a pick-up in inflation. Recently, there have also been some indications that the weakness in
the North Atlantic economies is having an effect in the region, with growth in exports having
slowed. But taking a slightly longer-term perspective, one encouraging development is that
domestic demand in the region appears still to be growing reasonably strongly. This is
important because over the years ahead, Asia will need to rely more on domestic
consumption, rather than exports and investment, to drive its growth. To do this, further
policy reforms in the region will be required, but progress on this front is being made.
So the global environment is a very complex one at the moment. Over the course of this
year, forecasts for world growth in 2012 have been revised down from slightly above-trend
growth to slightly below-trend growth. It is noteworthy that around three-quarters of the
expected increase in global output is expected to come from the emerging and developing
countries, a marked change from the past when the advanced economies accounted for the
bulk of growth in global output. From Australia's perspective, global growth somewhere
around average, or just a little below, would make for a relatively benign international
backdrop. The difficulty for many other advanced economies is that average growth will not
allow them to make inroads into their very high levels of unemployment and excess capacity,
and this is likely to create both economic and social strains in these countries for some time.
The global environment facing farming
I would now like to look beyond these global macroeconomic risks to the medium-term global
outlook facing the farming sector. And here the news is more positive.
In short, farming is benefiting from some of the same underlying forces that have led to an
improvement in the outlook for the mining sector: namely, the development of Asia and the
steady rise in incomes of the many hundreds of millions of people who live on the Asian
continent. As incomes rise, especially from low levels, food consumption tends to increase,
and the increase is concentrated in food with relatively high value added. There is also
growing demand for agricultural products for energy production. And this increase in demand
is occurring at a time when global growth in agricultural productivity has been slow by the
standards of previous decades.
This changing balance in global demand and supply can be seen in the global prices for
agricultural goods, which have increased significantly. As one example, the IMF's global food
price index has almost doubled over the past decade, after trending lower in the 1980s and
1990s (Graph 1). While after adjusting for overall inflation, food prices are still just below their
average over the twentieth century, the downward trend evident over most of the past
100 years appears to have stopped. And looking forward, there are reasonable prospects
that higher prices are not just a temporary development. For example, in its latest review of
world agriculture, the OECD is predicting that prices of a wide range of products over the
next decade will be 20 to 30 per cent higher than their average over the past decade (after
adjusting for inflation).1
The higher prices of agricultural commodities - together with their greater volatility - have
attracted the attention of policymakers around the world. Just last week, the G20 issued a
comprehensive report looking at the reasons for these developments. Its central conclusion
is that "marked shifts in the physical supply-demand balance ... have been the main driver of
the price fluctuations over the past ten years" and that "for many commodities, the expansion
of supply has fallen short of buoyant demand".2
Graph 1
This buoyant demand for agricultural commodities is underpinned by rising food consumption
per capita as incomes rise, particularly in Asia (Graph 2). Since the early 1960s, the number
of kilojoules consumed on average per person across the planet has increased by almost
30 per cent. In China, the rise in average food consumption has been particularly
pronounced, with food consumption per capita more than doubling over the past 50 years.
And in recent times, there has also been a significant increase in average food consumption
in the world's least developed economies, after there had been little growth for many years.
Graph 2
Looking at cross-country data, it is clear that higher-income countries consume much larger
quantities of meat and sugar per person than do lower-income countries (Graph 3). In
contrast, there appears to be little relationship between the average human consumption of
grains and a country's per capita income. However, overall demand for grains does increase
with income, given the use of grains as food for animals. One implication of these findings is
that as average incomes increase over time, there is a tendency to consume more protein,
especially meat. Over the years ahead, this switch in diets is likely to generate strong
underlying growth in demand for a wide range of agricultural commodities.
Graph 3
Another factor adding to global demand has been an increase in the use of agricultural
commodities for non-food purposes, particularly for biofuels. In the United States, for
example, bioethanol production now uses more than one-third of the total corn crop and, in
Brazil, sugarcane is used extensively to produce ethanol. Globally, the OECD estimates that
almost one-quarter of total sugar cane production is now used for non-food purposes, and
this share is expected to increase significantly over the years ahead. Similarly, a substantial
rise is expected in the use of vegetable oil for purposes other than food (Graph 4).
Graph 4
These developments on the global demand side have coincided with relatively modest
expansion on the global supply side. In the years prior to the surge in demand, global
research into improving yields was relatively low, as was investment in expanding the supply
of arable land. This is one of the consequences of the low level of prices in the 1980s and
1990s. The result has been that the rate of growth in yields has slowed and there has been
little growth in the area devoted to agricultural production over recent decades, partly due to
the urbanisation process in Asia (Graph 5). Another factor affecting global supply has been
an increase in the frequency of reported extreme weather events including droughts, floods
and high temperatures.3 Export bans imposed by some countries have also reduced the
supply coming onto world markets.
Graph 5
All up, these fundamental global drivers are reasonably favourable for the Australian farming
sector. No doubt, global prices will continue to fluctuate in a wide range and there will be
problems in individual markets. But the overall external environment is likely to be a relatively
positive one over the medium term. And this external environment is being driven by some of
the same underlying factors that have improved the outlook for the mining sector.
I would now like to turn more specifically to recent developments in Australia.
Developments in Australia
To begin with, it is worth noting that the high prices for agricultural commodities in global
markets have flowed through to higher prices for many commodities in our domestic markets.
However, the higher exchange rate has meant that the increase in Australian dollar prices
has been less than the increase in foreign currency prices. In Australian dollar terms, the
IMF's food price index that I showed earlier has increased by 40 per cent since 2004; this is
substantially less than the increase in foreign currency terms, but significant nevertheless
(Graph 6). The other notable feature of this graph is that the long-run swings in Australian
dollar prices tend to be smaller than those in foreign currency prices. This is another
illustration of the stabilising effects of our floating exchange rate; when commodity prices are
high, the exchange rate tends to be high, and when commodity prices are low the exchange
rate tends to be low, smoothing out the fluctuations in domestic prices. This provides an
important source of stability for the economy as a whole.
Graph 6
At the individual commodity level, there have been substantial increases in the prices of a
number of commodities over recent years (Graph 7). While prices are generally lower than
earlier in the year, partly due to problems in the global economy, most are substantially
higher than they were a decade ago. This is true for the commodities in this graph as it is for
lamb prices and the prices of many dairy products.
Graph 7
This rise in prices is the good news for domestic producers. The bad news is that the same
forces that have driven up global prices have also put upward pressure on the prices of many
inputs used by the farming sector. Obvious examples here are the higher prices of fuel,
fertiliser and seed. For some parts of the industry, these increases in costs have been a
significant constraint on profitability.
It is also important to recognise that there are substantial differences in the current situation
across commodities. In particular, the producers of commodities whose global prices have
not risen have found that the exchange rate appreciation and higher input costs have had a
significant effect on their competitive position in global markets. One clear example is the
wine industry, where the price of grapes internationally has not shown the same pattern as
that for many other commodities, with the Australian dollar price of grapes falling
significantly. As a result, the average Australian dollar export price for wine has declined by
around 40 per cent over the past decade, and production has fallen over recent years. And
according to its latest assessment, ABARES does not expect a reversal of this trend in prices
any time soon (Graph 8).4 A similar, although less dramatic picture, is evident for some
horticultural products.
Graph 8
Turning now to the volume of output, as opposed to the price of output, the recent aggregate
outcomes for the farm sector have also been generally favourable. According to the
Australian Bureau of Statistics (ABS), farm GDP increased by almost 10 per cent in the past
financial year, boosted by higher levels of rainfall. As one example, the winter wheat crop is
expected to be a near-record high of around 40 million tonnes this year and this follows a
good harvest last year. Taking a somewhat longer perspective, farm output has increased by
around 70 per cent since the mid 1990s, although there have been a number of bad years
over this period, particularly due to severe drought.
This combination of generally high prices and high output has provided a substantial boost to
aggregate income of the farming sector over the past financial year, and another favourable
outcome is expected this year (Graph 9). After adjusting for inflation, farm incomes over
these two years are expected to be almost double the average of the previous two decades.
As I mentioned earlier though, the picture is not uniform across the industry and some parts
of the farming sector have experienced very difficult conditions over the past year. But
overall, the current picture is better than it has been for some years.
Graph 9
Of course, agriculture remains an industry whose fortunes can change quickly from year to
year. And it is one in which very significant structural change has occurred over many
decades. Given its importance to the overall Australian economy, it is also an industry that
the Reserve Bank has paid close attention to over the years, and it continues to do so.
Looking forward, no doubt the fortunes of the industry will continue to wax and wane. And
like many other parts of the Australian economy, the farming sector will need to continue the
process of structural change. As I have talked about, this process is being driven, in part, by
a fundamental realignment of global relative prices due to the re-emergence onto the global
stage of the populous countries of Asia. This realignment of relative prices is creating new
opportunities for Australian agriculture. I wish you success in finding those opportunities and
in taking advantage of them over the years ahead.
Thank you.