China: The economics of the pork biz

Agriculture

A swine flu has decimated pig stocks and contributed to a big runup in food prices, though few see China's overall inflation rate getting too much out of hand

by
Frederik Balfour

Pork occupies a special place in Chinese traditions and cuisine.
Suckling pigs, served with their crispy hides, head, and eyes intact,
are common at festival holidays, office openings, and other events to
ensure good luck. The Chinese have hundreds of ways to serve pork, from
sizzling strips fried with chili and green peppers in Sichuan, to
minced pork with garlic and tofu. Pork accounts for 70% of protein
consumed by Chinese.

So it comes as no surprise that the government is concerned about
skyrocketing pork prices that contributed to a 15.4% year-on-year
increase in the cost of food, and a 5.6% year-on-year increase in the
consumer price index in July, the most dramatic in 10 years.

Soaring pig prices reflect a large contraction in stockbreeding last
year due to an epidemic of "blue ear" disease, a form of swine flu that
does not spread to humans. The impact even hit demand for animal feed
from international suppliers. "The disease in the pork industry cut
into our production and profitability" in the fiscal year that ended in
May of this year, said Norwell Coquillard, president of Cargill
Investments (China), in an e-mail response. He adds, however, that
"volumes are recovering now."

Because of the highly fragmented nature of pig farming in China,
there is no reliable data on the number of pig deaths, though official
estimates of 1 million to 2 million out of a total of 500 million
animals slaughtered annually are probably too low.

Inflation vs. runaway growth

The government has reacted with a variety of measures to contain
prices, from attempts to centralize purchases to smooth fluctuations,
to subsidized insurance for farmers against diseased hogs, reflecting
the prevailing perception that much of the inflation is supply-led.

Pig farmers are trying to enlarge their stocks. However, it may be a
while before such measures have a meaningful impact. "Though farmers
are now responding to higher prices by increasing stocks, it takes
about 18 months from the time a piglet is conceived until it is ready
for slaughter, so prices may not peak until mid-fall," says Andy
Rothman, China economist for CLSA Asia Pacific Markets.

So far, the pork-inspired runup in inflation probably isn't a threat to
the larger economy. Several observers have pointed out that after
stripping out food from the consumer price index, core inflation was
just 0.9% in July year-over-year, hardly an alarming level for an
economy that is chugging along at more than 11% growth.

The far bigger battle, some economists argue, isn't inflation but
the economy overheating from excess lending and stock market bubbles.
Professor Xu Xiaonian, an economist at China Europe International Business School,
believes the government should stop trying to micro-manage the pork
industry and stick to macroeconomic measures. "I believe the economy is
overheating and the government has done too little in terms of interest
rates and exchange rate adjustment," he says.

Rural incomes benefit

Others concur. "From a monetary point of view, I don't think we are
at the stage of widespread inflation," says Standard Chartered (STAN.L)
China economist Stephen Green. "But given other indicators of growth
picking up, the best approach would be monetary tightening with two
more interest rate hikes." At current rates of inflation, real interest
rates are negative for savings accounts at banks, which pay just 3.3%
for one-year term deposits.

As a result, individuals are pouring their money into real estate
and the white-hot stock markets, instead of keeping it in banks. Credit
Suisse (CS)
regional economist Dong Tao says China needs to hike interest rates by
at least 200 basis points to induce people to hold bank deposits.

Also, there is at least one upside to soaring food prices. Real
rural income increased 13.3% in the first half, helping close the
yawning urban-rural income divide. This has been a major boost for
individual pig farmers, as backyard farms account for 70% of pork
production.

However, the small size of most pig-raising operations, usually no
more than a handful of hogs at a time, makes these households most
vulnerable to disease. That is why Beijing in mid-August instructed the
country's biggest five insurers to offer government-subsidized policies
enabling farmers to insure pigs for about $1.60 each, thus encouraging
an increase in production.

Animal feed's price pressure

Of course, while insurance protects farmers, it won't address supply
interruptions should another outbreak occur. Credit Suisse's Dong Tao
points out that blue ear disease currently accounts for 40% of all
non-slaughter-related deaths of pigs.

The movement for alternative fuels could also put upward pressure on
Chinese food prices. Global prices of corn, for example, have increased
dramatically due to the increase in ethanol production.

Corn prices in China, though different from global prices, are
correlated with them, and upward pressure on animal feed is likely to
continue. One sure sign that pigs will remain central to China is the
pending launch of pork futures, expected to start trading on the Dalian
Futures Exchange later this year. Liu Yugang, researcher at the
information department of the Dalian exchange, says futures should
"help decrease price differentials between different regions, one of
the causes of current price volatility."