Intrinsic Value

Recent increase in soft commodity price across the board will be felt across the world. China reported 4.5% y/y inflation in food in February, India earlier this week reported 9.52% inflation for February and 13.86% at annualized levels. Recent Central bank rate rises in the example of South Korea is a real risk going forward for the emerging market growth story.

The higher risks from increase in food prices on interest rate in emerging markets is due to the fact that they spend more portion of their income on basic necessities than developed nations. In developed nations, the percentage of income spent on food is a fraction in contrast to the emerging markets. So which countries would the price increase be felt relatively more harshly than others?

I did a scan across the major regions and created a sample which captures some really interesting regional segments.

Household Percentage of Income Spent on Food 

Data Source: See End of Post

United States in 2009 spent 8.9% of its income on food at home and away from home. The trend among developed nations on percentage income spent on food is around 10%. The standout in the first group I included is the Turkish, which spends almost 30% percent of their income on food. While EU members generally have a higher distribution range of income spent on food, from low teens to twenties. The contrast of Turkey as an aspiring EU member shows the level of difference in economic development.

 If you look at the PIGS segment which constitute the poorer EU countries which are also under sovereign stress. With the exception of the Irish, they spend around 16% to almost 20%. Therefore, higher food prices on top of government budget austerity would be an additional pressure on GDP discretionary spending in the region.

Interestingly, the BRIC countries proportion of income spent on food is increasing alphabetically, from almost 25% in Brazil to 35% in China. Prolong high food prices could pose a serious risk to the BRIC growth story in the near future, which is the most likely reason contributing to its markets underperformance in the recent months. The respective central banks are responding to this problem in its own way. Brazil’s central bank is raised interest rates to 11.75% in its fight with inflation, similarly with Reserve Bank of India which just started its rate hike cycle. These two countries have the sweet end of higher exchange rates, which could offset some of the price increases.

China in contrast is doing the exact opposite on the exchange rate and interest rate fronts. Apprehensive in devaluating the Yuan in response to higher import price of commodities, it only exacerbated the problem domestically. Furthermore, it is slow in raising rates. As a matter of fact, it did everything from increasing reverse requirements to nearly 20% to lending restrictions to slow the down inflation pressures. Increasing interest rates is the lasting resort (Red Capitalism: examines the level of financial leverage in the system which could be the reason in the Central Banks reluctance to raise rates).

Since the data is quite detailed from the Chinese statistics bureau, we can further disseminate the data and the implication of food inflation in China. While the above graph shows the average portion of income spent on food, the breakdown shows that the percentage spent on food across the income spectrum is really wide. This ranges from 48.14% in low income households to as much as 29.18%.

The problem is that a far larger portion of the population would be classified as low to middle income than the high and highest income brackets. For the fourth estate, their spend on food is almost half to 40% of income. Hence, from this data we judge that food prices going forward is a real problem for the Communist Party. While the issues in the Middle East could be a reason for them to raise domestic security expense to record high, out of control food prices could also lead the peasants to cause a problem for the Party’s control on power.

Breakdown of Chinese Income Groups Portion Spend on Food 

The interesting fact from the data above is that the absolute amount spent on food per household increases with income. The highest income bracket consumes double in meat and triple in milk and process goods in contrast to the lowest income bracket. This trend could be exploited as play on the next stage of China’s growth, especially with the focus away from industrial to consumption based growth.

Since large portions of the BRIC’s income are spent on food, how long before would they have a similar consumption pattern to the developed markets? The obvious answer is, when they have a higher income (duh).

United States Food Spend as Proportion of Income History 

The above chart shows the consumption pattern of United States over the last 80 years. As it can be seen it was only in 1928 it spent almost 25% of its income on food. This is a stage which matches the highest income group in China. Overtime, assuming no major global conflicts, it would take a good 30 years if they grow at the rate of United States during the period. This period was characterized by the post war boom and the nifty fifty years. It is interesting to note that even after 2000, the portion of income spend on is still declining. However this is before the recession which results in a sharp increase in food stamps. This is issue will be another post.

The Intrinsic Value

 Data Source:

The most comprehensive source is the US department of Agriculture with most recent data for 2009. European data is sourced from EuroStat and US Dept of Ag. Chinese data is from Chinese National Statistics Bureau (2008). Japanese has monthly outputs; annual data is an average of 2009 and 2010. Asterixed countries are using 2007 data.