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China’s policymakers routinely use the consumer price index (CPI) as an important reference for deciding the country’s monetary policy, but how the index actually works is not readily transparent as the calculation behind the index has never been made public.
Given food’s heavy weighting in household expenditure and in particular the high per capita meat consumption in China, the nation’s CPI index is a “meaty pie”, estimated Rabobank International after analysing public data on food purchases.
It’s no secret that food prices take up a large portion of the CPI basket in China. During the past decade, food costs for urban households have accounted for an overwhelming 62% of inflation on average, according to data from Rabobank.
The food CPI comprises 16 major categories and 262 products, data from the National Bureau of Statistics show. Although the weightings of products in the food CPI are not disclosed to the public, the food expenditure within these categories are published annually.
Based on the official data on food purchase, Rabobank estimated that meat consumption accounts for 19% of China’s CPI basket, second only to dining out, which has the largest share of 21%, followed by fruit and vegetables, which take up 18%. Pork, in turn, accounts for 63% of meat consumption, followed by chicken, which stands at 20%.
Pork’s significant contribution to China’s CPI is no surprise. In July 2011, when Chinese inflation reached an alarming level of 6.5%, the Chinese government responded by releasing stocks from its pork reserve and putting price caps on some edible oils.
Despite the Chinese government’s efforts to control prices, Chinese consumers are constantly worried about runaway food inflation, largely due to the volatility of pork prices.
Behind the price volatility
“Despite chronic soaring prices, pork remains the staple meat for Chinese consumers,” said Jean-Yves Chow, an analyst at Rabobank. “The pork price is not only a significant item in China’s CPI, it is also the most volatile one.”
The instability of pork prices is mainly caused by the mismatch between supply and demand — driven more by fluctuations in supply than by changes from the demand side, Chow reckoned.
Chinese authorities have given subsidies for well-established pig farms and promoted large, standardised pig farming. Even so, so-called backyard farms represented 37% of China’s pork production in 2010, which is down sharply from 57% in 2005, but the production base still remains highly fragmented.
The sector is currently at the mercy of supply, which is often interrupted by diseases and low replenishment. Such unpredictable and disrupted supply translates into greater price volatility, Chow said.
Similarly, the second biggest item in China’s CPI basket, fruit and vegetables, suffers the same supply constraints. According to Rabobank, China’s pork and vegetables supply both account for about half of the world’s production, although the industries are among the most fragmented in the world.
The lack of dynamic production bases in both sectors exposes smaller farmers to significant downside risks. Given the roller-coaster profit levels, many farmers go into the business in the hope of selling their production during periods of rising prices and do not invest (or even exit the business) when the market outlook is pessimistic, and even long-term players adjust the replenishment of piglets based on their price outlook. Such behaviour has left the level of supply quite unpredictable.
China’s pig-farming industry appears to be so profitable that both domestic and foreign non-food and agribusiness players have placed their bets on it. Goldman Sachs had spent around $300 million to buy more than 10 pig farms in China. Deutsche Bank also invested around $120 million in two pig farms in the country. China’s trading giant, Cofco, and a leading steel plant, Wuhan Iron & Steel, have also announced ambitious investment plans in pig breeding businesses.
