Inflation and Fiscal Consequences The Food Price Shock and the Caribbean: Analysis and Response Seminar sponsored by the Caribbean Development Bank and the Inter-American Development Bank 16 June 2008 Kelvin Dalrymple Chief Research Economist
Background Some countries around the world, particularly oil and mineral producers, are experiencing boom conditions in their economies The Caribbean has been under severe pressure and is on the other end of the spectrum a commodity price bust Given that Caribbean countries are high commodity importers, especially of food, high food prices have been affecting both consumers as well as producers Food prices crisis compounds a number of challenges the Region is already facing including loss of preferences, natural disasters, poverty etc
Objective of the presentation To provide a broad overview of the The nature of food price crisis The likely impact of food price crisis Main responses to the food price crisis Recommendations, particularly fiscal, on how to deal with the food price crisis
How did we get here?
Introduction Commodity price boom can be divided into two categories Fuel Non-fuel The price of oil has been increasing very rapidly Almost all of the countries of the Region are net energy importers Trinidad & Tobago is the Region s only significant oil producer Some countries have serious fiscal space problems manifested in high fiscal deficits and huge debt overhang Food is a large proportion of imports both for domestic consumption as well as for use in the tourism industry
Inflation and fiscal policy Most countries within the Caribbean - the main policy instrument is fiscal policy Limited or no monetary policy (largely accommodating) Exchange rate policy mainly fixed exchange rate regimes three (3) of the largest economies in the region - Guyana, Jamaica and T&T use floating exchange rate systems - albeit based on the USD
The nature of the crisis: oil prices The price of oil has more than doubled in the last year (from USD65 a barrel and continued to climb daily; some pundits indicate that the price will reach USD200 by the end of 2008) Increases due to: geopolitical uncertainty (Iraq war) supply constraints (OPEC) global demand (particularly in China and India) Impact felt in many areas Transport (both domestic as well as international) Food prices
The nature of the crisis: food prices Food prices have risen by approximately 45% globally over the last nine (9) months These price have impacted on food staples Wheat and corn prices have increased Which have impacted on the price of bread and associated food products
The nature of the crisis: financial sector nexus Rising food prices have a financial sector component commodity trading has contributed significantly to both increased prices and the volatility of prices hence significantly increasing risks
The nature of the crisis: food prices (2) There is a global shortage of rice Decline in production by major rice countries- Bangladesh, Thailand, Vietnam Some speculate that significant weather changes even climate change may be responsible for destruction of crops due to unseasonable weather Shortage of grain Countries focussing on domestic demand Supplies being used to produce bio-fuels
Some likely impacts of the food prices crisis
Likely impact on poverty High food prices have adverse effects particularly on the poor Food accounts for a disproportionate amount of expenditure (40%) Prior to the high food prices crisis, the incidence of poverty within the Region has been high, and has been exacerbated by the current situation More people are becoming working poor
Likely impact on wages and salaries As a result of high prices, trade unions are agitating for significant increases in wages and salaries (of the order of double digits) to compensate for loss of spending power by workers This could result in an increase in the government wage bill, which will increase the fiscal deficit or lead to further fiscal deterioration and reduce the already limited fiscal space available for governments to manoeuvre
Likely impact on wages and salaries (2) The private sector will also be asked to follow the lead of government and also increase wages and salaries If they follow: the effects will be felt in increased cost of goods and services If they do not follow: they could be a contraction of business leading to possible reduction of scale of operations; and reduction in hours of work for employees, or layoffs
Impact of the crisis: inflation and relative prices Caribbean countries such as the OECS, Barbados, the Bahamas and Belize are fixed exchange rate countries and inflation was largely imported US inflation Recently high prices have been compounded by other factors high demand for basic commodities such as rice, wheat etc
Impact of the crisis: debt Debt levels are very high (most countries have debt stock to GDP of greater than 60%) and some in excess of 100% Six Caribbean countries rank among the most indebted countries in the world Higher prices add to fiscal expenditure and to the debt stock
Main responses to the crisis
Political economy questions How will governments respond and with what instruments? What are the temporal issues? Is the crisis (a) short-term (b) medium term (c) long term Early indications suggest that as different aspects of the crisis have elements of all of the above (certainly lasting solutions will be medium and long term)
Main approaches to the food prices crisis Tax cuts removal of consumption tax, customs services tax, import duty, expanding the zero-rated basket of food items (VAT) Consumption subsidies across the board subsidies on food and fuel Price controls Trade policy - including derogations from the Common External Tariff (CET) and other CARICOM obligations Encouragement to grow more food Social safety nets well-targeted policies to reduce the incidence of the crisis on the poor Other wage increases
Caribbean responses to the food price crisis Tax cuts Consumption subsidies Price controls Trade policy Grow more food Social safety nets Other (wage increases) A&B, DOM, GUY, SKN, BZE, GND, JAM, T&T SKN, SLU, BAR, DOM, SKN, SVG,T&T GUY, T&T GND, JAM, T&T, SKN
Constraints to response The ability to respond is largely determined by: The extent of fiscal space a country possesses Loss of revenue, through subsidisation by the state creates stress with the budget The extent to which such subsidisation may cause distortions The extent to which socio-economic stability may be threatened Failure to respond with a credible policy for alleviating the suffering of citizens, there is the likelihood of civil disorder, riots e.g. Haiti Policy reactions have ranged from interventionist to allowing the market to act These are based on experiences in country: interventionist (subsidies) or market solutions (passing on costs to consumers)
Food prices and fiscal policy Lower tax scenario Increase in food prices leads to a response by government (usually relief), could result in lower taxation on high priced food items, weaker tax base, less revenue to government Particularly in the current environment when revenue from border taxes are already on the decline
Food prices and fiscal policy (2) Subsidised food via price controls Increased food prices results in a government response [subsidised food (maybe through price controls)] government absorbs the additional costs, this is an expenditure item which increases current expenditure and widens the deficit
Food prices and fiscal policy (3) No adjustment in taxes Some countries are almost entirely dependent on trade taxes and cannot afford to give relief If relief is given, a massive decline in revenue would result
Recommendations
Recommendations Focus on local production of food To enhance food security To offset the rising costs of food Create new relationships and business linkages Local Intra CARICOM e.g. Agriculture & Jagdeo Initiative Focus on alternative sourcing of imported food Latin America especially Brazil and Colombia are important new sources for the Caribbean Pushed by private sector consumers are being encouraged to alter taste and lose their brand loyalty
Recommendations (2) Instead of subsidies, targeted relief to the poor A clear definition of the poor is needed for this exercise and means test or some similar mechanism needs to be used Country Poverty Assessments (CPA) and similar detailed analysis, contain the necessary information to deal with these methodological issues
Recommendations (3) Minimise the extent to which short-term policy responses such as subsidies are required since such policies are unsustainable costly to all taxpayers regressive
Recommendations (4) Conservation plans have been devised by countries to conserve energy at the household level using energy conserving appliances using energy conserving bulbs using energy conserving vehicles e.g. diesel vehicles Effective fiscal policy including tax incentives, reducing duties/taxes, use of alternative sources of energy etc., can used by governments to induce a change in behaviour in relation to energy conservation
Recommendations (5) Alternative sources of oil from Venezuela under the PetroCaribe agreement This is designed to cushion the impact of high oil prices by reducing the cost of oil to countries and the difference between the market rate and the buyer s rate reflected as a soft loan Facilitating storage of oil Some countries absorb a significant amount of increase in the price of oil by reducing taxes Others pass on the increases directly to consumers
Recommendations (6) Alternative energy use is on the agenda again Solar Wind Geo-thermal Hydroelectric Bio-energy (from sugar cane) Though the cost of production of alternative energy is high, it is declining rapidly The Region has to move on this agenda to build on the gains of the past and to use sustainable energy sources to reduce dependence on fossil fuels Barbados is self-sufficient in solar water heating Barbados is now exporting technology to St. Lucia, Jamaica and Nigeria
Concluding Remarks Policy prescriptions need to be appropriate to circumstance Traditional macroeconomic policies constrained due to fiscal space monetary and exchange rate policy have limited applicability Short-term policies: focus on conservation of energy; saving money on food Long-term policies: change in attitude and structural behaviour: growing more food; alternative energy