By Iris Boutros
Wheat supply matters for Egypt’s food security. Production is high but demand is higher. Self-sufficiency in wheat is not a realistic goal given limits in water and land, as well as dismal agricultural investment levels. So, imports are high. Risks from both domestic and international wheat markets coupled with reduced purchasing power from the current economic crisis mean that consumers are now more vulnerable than ever. The issues are complicated, and while there are some protections from supply risks, further reducing vulnerability is certainly possible.
With Egypt’s large and growing population, even with past reductions in fertility levels, demand has and will continue to grow. As a water-poor nation with less than 4% of arable land, domestic production to fully meet wheat consumption has been infeasible for some time. Significant increases in domestic wheat production have occurred. Crop yield efficiency, the amount of wheat produced per feddan of land, has increased by about 75% since 1980 when noticeable improvements first began. A decade later, the area under harvest began to increase and the amount of wheat produced has increased four-fold since the start of efficiency improvements.
Despite these gains, Egypt faces a “quantity risk” in the short-term, and quantity risk will continue to rise in the medium and long-term. This means that the quantity of wheat needed to fulfil demand may not be available, even if there are sufficient funds for purchase. Meeting demand with imports will remain a challenge if foreign currency reserves drop even further. And domestic farmers have increasingly less incentive to grow wheat as profits have declined, squeezed between rising input costs and fixed government pricing. In the medium to long-term, water scarcity, climate change and population growth will raise quantity risk.
Quantity risk could be reduced though not eliminated through domestic production, but not with the current supply chain and system of government intervention. For example, the government, the largest purchaser of wheat, announces the purchase price some time after the planting decision is made. To keep farmers interested in growing wheat in future seasons, announcing the wheat price before planting begins would reduce uncertainty of profits. So would a clearer understanding of costs and availability of major inputs, many of which are government provided, such as water, seeds, fertilisers, extension services, and rented farm equipment powered by diesel. In the current supply chain, many of these inputs are unavailable at government subsidised prices at the right time, and farmers have no choice but to seek black market inputs where hefty margins are easily collected because of the critical timing when inputs are needed in cultivation.
Reducing quantity risks would also benefit from reducing risks of post-harvest losses, estimated at 15% to 20% of domestic production. For instance, wheat grown domestically is often stored in open storage spaces, susceptible to rodents and bacteria because appropriate facilities are unavailable. In fact, Egypt has less storage capacity, measured in months of consumption, than any other Middle Eastern country. This is true despite the fact that it is reasonably well understood that as storage capacity increases, wheat prices decrease, because countries can strategically draw down on reserves or purchase more wheat depending on market prices.
Wheat imports easily reduce quantity risk, but the bigger issue is really “price risk”. Price risk is the risk that wheat prices will be prohibitively high, making purchase difficult even though quantity is available on world markets. Since the food crisis of 2008, when food prices rose on the back of high energy prices, wheat and other food prices continue to be high. Food prices hit a new historic all-time high, higher than 2008 levels, in August 2012. Wheat prices decreased by 11% in the ensuing two quarters, October 2012 to February 2012, after the southern hemisphere harvest, but were overall 15% higher than a year before, from February 2012 to February 2013. Most experts globally agree that food prices will not return to pre-2008 prices and that high and rising food prices and volatility around these high prices are the new norm countries must strategise around. Given that wheat imports will remain essential for food security, a strategy to deal with this new norm is needed.
There are a number of ways to reduce price risk, chiefly by reducing exposure to market volatility and by ensuring macroeconomic stability. Ample foreign currency reserves and exchange rate stability are important. However, the more critical issue is reducing exposure to market volatility directly. Because even if Egypt could successfully reduce demand and increase domestic productivity, the country will still remain a net importer or wheat and will therefore be exposed to international price risks. Egypt imports more wheat than almost any country in the world.
Egypt has chiefly sought to reduce external price risk through land acquisition abroad. Land deals in the Sudan, for instance, are meant to meet domestic demand using resources in a country with more arable land and less water scarcity. Unfortunately, this strategy to reduce price risk has other risks. As an owner of land, this assumes risks from bad weather and political disruptions in the host country. It might be difficult to export a harvest to Egypt from a country that struggles with its own food security. This strategy also ignores that markets offer more flexibility than capital locked up in land, forfeiting the choice of which country to procure wheat from depending on harvest and price.
A number of other strategies would reduce price risk, some with great potential for cost reductions. If Egypt used certain financial instruments to protect against price risk, for instance, up to 20% of the costs of international wheat purchases during the height of the food crisis could have been saved. Between November 2007 and October 2008, when wheat prices were at a then historic all-time high, Egypt imported an estimated seven million metric tonnes of wheat. Actual prices are unavailable but estimates put the wheat import bill at about $2.75bn.
A hedging strategy based on futures or options contracts would have saved somewhere between $150m to $600m of that $2.75bn, depending on the strategy. Options contracts allow for the purchase of wheat at an agreed price by a specified date with no purchase obligation. A futures contract allows for the purchase of wheat of a standardised quantity and quality and for an agreed price with payment and delivery at a specified future date.
The degree to which these financial instruments are utilized dictates the amount of savings. Contracting 25% of purchases in this manner would have saved closer to $150m. Purchasing 100% of wheat this way would have saved close to $600m, according to a 2009 report co-published by the World Bank, the FAO and IFAD. Utilising these contracts requires skilled personnel but they are very feasible and are essential to food security strategies for a number of countries. Given how much wheat Egypt imports, it is puzzling why these types of contracts or any of the other more modern price risk management mechanisms available are not already in use. The cost reductions are needed, particularly given the high budget deficit.
International wheat prices continue to be high and volatile. Since self-sufficiency is not a realistic goal, Egypt will remain vulnerable as a major wheat importer. Price risk and reduced purchasing power from the current economic crisis are most relevant today, but quantity risk will also continue to rise. The government does utilise a variety of mechanisms to reduce supply risk, such as land acquisition and price controls, but there is room for significant improvement. Risk management strategies reducing exposure to market volatility and increasing domestic production levels need to be constructed with consideration of all available options, not just those used in the past. Attention to the supply chain, affecting both domestically cultivated and imported wheat, and the incorporation of modern price risk management mechanisms are critical components of that strategy. The challenges are complicated, more so than this analysis suggests, but these risks are real and increasing. Vulnerability can be reduced.