Nicholas Nassim Taleb on Forecasts

"If you ever have to heed a forecast, keep in mind that its accuracy degrades rapidly as you extend it through time." Nassim Nicholas Taleb, 'The Black Swan'

Monday, August 1, 2011

"Amazing Thailand" - new rice policy will damage the market and Thai rice farmers

While the weather still keeps us on our toes in North America, let's take the opportunity to look at the rice industry.  Above all we need to understand the serious downside impact the ridiculous policy proposals of the incoming populist Pheu Thai government]will have on international supplies.

Rice represents 23 percent of the world's supply of major cereals and is the preferred staple food of much of Africa and most of Asia - in other words the regions of the world where the population is growing the fastest (a recurring theme in this Bulletin).  Although many Asian do consume wheat or corn products, in almost all these countries the word "rice" is synonymous with eating - the Thai will say, "gin khao mai?"  - "eaten rice?"when she asks if you've eaten a meal and it is an equally common greeting.  The Japanese word for cooked rice "Gohan" is synonymous with "meal".

Seventy-eight percent of the world's supply of rice is produced in China, the Indian sub-continent, the Mekong Sub-Region and Indonesia, while demand is similarly concentrated - 67 percent is consumed in China, the Indian SC and Indonesia.  Partly because of the deep-seated cultural importance of the crop Asian countries want to be self-sufficient and largely they are. Indonesia has been an exception switching from being an exporter to an importer depending on the harvested volume. The operations of the Indonesian government's procurement agency BULOG are important to watch.

This means that the international trade in rice is very "thin", i.e., the volume is a small proportion of the overall amount of rice in the market.   Exports represent just 7 percent of the total supply, and about half of that comes from just two countries, Thailand and Vietnam (Cambodia and Laos also contribute, but much of their rice is actually taken through the two main Mekong countries).

The small volume of internationally trade rice (relative to the overall supply) means that prices can swing rather dramatically depending on the volume available for export and the fact that there are few sources with a surplus to buy. For example, when BULOG enters the market on the buy side, rice process can jump by $100/ton.  Similarly a reduction of supply will raise prices dramatically.

So what happens in Thailand and Vietnam is critically important to those who DO import rice - many African countries and Europe. Countries like Ghana, Senegal and Tanzania (which actually do grow their own rice) have relied on cheap Thai and Vietnamese to meet growing demand.

Let's review the situation in Vietnam first: there are two main rice growing areas, in the north the Red River Delta (surrounding Hanoi) and in the south, the Mekong (Viet. Cuu Long) Delta are both intensively cultivated.  From being just self-sufficient in the early 1990s, Vietnam has raised production to the extent that it now exports the world's second largest volume of rice (6.4 million tons) and competes equally on quality with Thai white rice.

The issues for Vietnam are (a) paddy land is being lost to industrialisation, (b) industrial pollution is damaging yields that have hitherto been driving the production increase, and (c) the water in the Red River and the Mekong is being limited by dams built upstream by other riparian countries.  Vietnamese experts say they expect that rice exports will peak at around 7 million tons and may well come down.

And now for "Amazing Thailand" (those familiar with Thai tourist advertising will get the allusion).  Thailand has dominated the international rice trade both in terms of volume of exports (up to 10 million tons at the peak) and quality.  Thai "fragrant" or "jasmine" (Th. khao hom dork mali) is a premium product that sells for over $1,200/ton in e.g., Hong Kong.  The issue for this variety is that it grows only on  dry land in the North-east so overall production is limited. But Thai white rice is grown extensively throughout the central areas of the country  supported by an extensive and relatively well-managed irrigation system. Weather, soil, water, experienced and hard-working farmers, available seed, technical expertise and a sophisticated export trade.

What could possibly go wrong?

The answer is (as is often the case in developing countries - Thailand is "emerging"  - but one wonders what it will emerge as?) GOVERNMENT.

Of course all governments interfere in agriculture and the Thai government is no exception.  However the proposal of the incoming (elected by a huge majority) Pheu Thai government to establish a monopolistic farm-gate price for white rice of 15,000 Baht (about $517) per ton and more for fragrant/jasmine rice amounts to sheer unadulterated lunacy.

The current price paid to farmers by hundreds of millers is roughly half that amount; production costs amount to (at a guess) $400/acre, with a yield of, say 2.5 tons/acre and a farm sale price of the current $241/ton, the farmer gets a gross margin of roughly $200/acre.  About 60 percent of farmers have holdings of  less than 10 acres. But even at this level, with three crops a year under irrigation the farmer's gross income is around $6,000/year.  Although not large by western standards this is considerably more than the minimum wage.

So the average Thai rice farmer is not poor (by world standards). But of course he would like to be richer and the rural population voted almost exclusively for the Pheu Thai party and for a government-subsidised farm gate price about double what he or she gets now. Nice if you can get it, but unfortunately one of the basic rules of economics (not a subject well understood in Thailand, at least not in official circles) is "there is no free lunch".

At the subsidised price for paddy rice, millers and exporters estimate (see article in The Nation newspaper) that the F.O.B price would have to rise to over $800/ton - when Vietnam is exporting comfortably at $545.

The Thai government (we should say, the Royal Thai Government - RTG - to be correct) proposes to use its food security warehouses to buy all the paddy. It will become (that lovely word) a monopsonist - the sole buyer of farmer's paddy.  This will be milled on consignment and then packaged and sold ONLY from the government warehouses, it is said on "government-to-government" arrangements.  Official stocks are forecast to rise to well over 6 million tons for the current 3 million.

They could be even higher, because rice will flood into Thailand from, you guessed it, Vietnam, Laos and Cambodia. Hey folks, it's called arbitrage - absent effective border controls (and I can assure you they ARE absent) a commodity will simply follow the money.

So now we have the very real prospect because of this daft politician's promise, made for no other reason than to get elected, that not only will Thai rice - hitherto available competitively for export at a reasonable price relative to other cereals - back up in government warehouses, but export availability will be reduced in Vietnam and other neighboring countries.

One wonders what the WTO will make of this flagrant abuse of anything resembling free trade, and one is SURE that the prospect of "government-to-government" deals without the benefit of the current competition between dealers, will lead to rampant corruption.

In the end who will be the loser?  Unfortunately the very person the policy is intended to benefit, the Thai rice farmer, who will have priced himself out of the market. And the consumer, now without a supply of reasonably-priced rice. With rice removed from the thinly traded export market, prices will sky-rocket.

What could change the situation?  An outbreak of common-sense in Thailand is never a likely prospect. But India is set to lift a ban on rice exports and this may relieve pressure on the international price.  So then the RTG will be the proud owner of millions of tones of rice that it has bought for considerably more than the world price; you can keep  rice, but not forever:)

As we who live in Thailand  say, "TIT" - This is Thailand, and as the Thais say, "mai pen rai" - Never mind!