Since the 2007-2008 food price crisis, food price volatility has been front and center in the international development conversation. The period of the crisis saw a dramatic rise in the international price of grains and other important commodities, while the years immediately following the crisis saw increasing grain price fluctuations on the international market. Rising global prices and increasing global price volatility are of particular concern to developing countries because if these trends are transmitted to domestic markets, they can have serious negative impacts on farmers and poor consumers.
In a new paper published in World Development, IFPRI researchers examine the extent to which global grain prices and grain price volatility are actually transmitted to local markets in developing countries. As the paper states, the extent of this transmission has implications for what types of policies – whether global/regional or domestic – can best help developing countries address the issue of price volatility in their local food markets.
While many studies have looked at whether price (in levels) is transmitted from global to domestic markets, this is the first study to estimate the transmission of food price volatility from global to local markets across multiple developing countries and regions.
This is an important distinction to make because it is not necessarily true that cases with high price transmission will also have high price volatility transmission. For instance, if prices were indeed transmitted from global to domestic markets but only after a few months’ lag, this may protect local markets from shorter-term international volatility. Alternatively, even in the absence of direct price transmission, high price volatility in global markets may induce uncertainty among local traders, resulting in higher local price volatility.
The paper focuses on the short-term effect of global maize, rice, wheat, and sorghum prices on 41 domestic price returns in 27 countries across Latin America, Asia, and Africa. The price data used are monthly and span January 2000 to December 2013. The study is carried out using a multivariate generalized auto-regressive conditional heteroscedasticity (MGARCH) model. Domestic price data is taken from FEWS Net (Famine Early Warning Network, a USAID-funded project) and FAO GIEWS (FAO’s Global Information and Early Warning System), while international price comes from the FAO International Commodity Prices database. For each commodity, prices were generally taken from the main local market (which is typically the capital city).
Overall, domestic grain prices appear to move in line with international prices in only a few of the studied markets. For maize, only one of the sixteen maize markets studied (Honduras) saw significant price transmission from global markets. For rice prices, only six of the fifteen markets appear to be significantly affected by global prices: one in Mali, two in the Philippines, two in Thailand, and one in Ecuador. In the case of wheat, three of the seven markets (Mumbai, India; New Delhi, India; Lima, Peru) saw statistically significant levels of price transmission from world markets, while for sorghum, none of the three studied markets was found to have statistically significant links to global markets.
In terms of price volatility, however, the study found more linkages between domestic and global markets. Volatility transmission seems to be more common when trade (imports or exports) are large relative to a country’s domestic requirements. In several cases, grain price volatility is transmitted from international to domestic markets when the ratio of traded volume to domestic requirements is above a certain threshold – around 40 percent.
Maize markets seem to be the least susceptible to international price volatility. Only four out of the sixteen studied maize markets (Benin, Ethiopia, Nigeria, and Colombia) experience price volatility transmission from global markets. Rice markets are slightly more sensitive to international volatility, with eight out of the 15 studied markets showing significant transmission. It is domestic wheat markets that appear to see the most impact from international price volatility. All seven of the studied wheat markets showed a statistically significant link between global and domestic price volatility.
Generally speaking, these findings support the idea that trade plays an important role in determining price volatility transmission. Most of the countries in the study sample are somewhat self-sufficient in maize, with net trade in maize accounting for only 16 percent of domestic use. The studied countries are more dependent on trade in rice (around 38 percent on average) and wheat (around 78 percent on average) to meet their domestic needs.
“However, while trade seems to play an important role in explaining price volatility transmission from global to local markets,” says Manuel Hernandez, Research Fellow at IFPRI’s Markets, Trade and Institutions Division and one of the paper’s co-authors, “there are also some exemptions to this general trend, which highlight the need to better understand food price volatility in developing countries to ensure adequate policymaking.”
For example, the study found that wheat markets in India experience a significant level of price volatility transmission, despite the fact that India is generally self-sufficient in wheat. Similar results were found for maize in Ethiopia, rice in Peru, and sorghum in Burundi – in all of these cases, trade in the commodity in question is relatively low (less than 40 percent of domestic requirements), but price volatility transmission was found to be statistically significant.
One hypothesis for this finding, according to the authors, is that local traders are prompted by international volatility to respond in ways that contribute to local volatility even in the absence of direct trade effects. Alternatively, it could be that price volatility is actually being transmitted through closely related grain markets for which there is trade, such as wheat.
Understanding the extent to which domestic markets are impacted by global food prices and food price volatility can help policymakers craft better strategies to address that volatility. If volatility in global grain markets is in fact transmitted to developing countries on a significant scale, policies enacted through global and regional partnerships, such as the WTO, may be more effective ways to reduce volatility around the world. However, if a country’s food price volatility stems not from global trends but from its own domestic situation, national policymakers should focus on domestic efforts such as stabilizing food production, reducing grain storage and transportation costs, and strengthening social safety nets to protect both poor producers and consumers from the its negative effects.
By: Sara Gustafson, IFPRI