IMPACT OF RISING FOOD/AGRICULTURAL COMMODITY

UNCLAS SECTION 01 OF 10 ULAANBAATAR 000205 SIPDIS SENSITIVE SIPDIS STATE FOR EAP/EX, A/OPR/ALS, A/HR/OE/CM STATE PASS PEACE CORPS, USTR, OPIC AND EXIMBANK USDA FOR N. SAKHLEH BEIJING FOR AGATT USAID FOR DEIDRA WINSTON BANGKOK AND MANILA FOR USAID TREASURY FOR T.T. YANG COMMERCE FOR ZGCROSS E.O. 12958: N/A TAGS: EAGR PGOV SOCI EAID ETRD ECON PREL MG SUBJECT: IMPACT OF RISING FOOD/AGRICULTURAL COMMODITY PRICES ON MONGOLIA Ref: STATE 39410 SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION ¶1. (SBU) 1. SUMMARY: Prices of Mongolia's chief staples have risen more than 33% over the last year, with flour spiking nearly 45% year-on-year. As most of these staples are imported, Mongolia has suffered from inflation related to rising energy and related transport costs. Other factors exacerbating the situation include severe weather, internal distribution bottlenecks, the dollar's depreciation, and the Chinese Yuan's appreciation. Public discontent, especially from the urban and rural poor, has bubbled to the surface but not turned violent. A recent demonstration drew nearly 4,000 citizens, who demanded that the government take immediate action to lower costs of flour and other staples. The GOM has responded by setting up a Price Council to consider ways to lower prices on key foodstuffs; this may involve subsidies, price fixing and strategic reserves of key commodities. In addition, the GOM has proposed a US$400 million program to rehabilitate farmland and enhance farming methods. However, funds for both schemes are limited, and in the case of the farm program, the results are months, if not years away. END SUMMARY. ¶2. (U) List of past reporting cables on food prices and related topics: -- 2008: Ulaanbaatar 177: IN MONGOLIA, THOUSANDS DEMONSTRATE AGAINST HIGH FOOD PRICES Ulaanbaatar 129: LIVESTOCK FORAGE PREDICTION IN MONGOLIA TRANSFORMED THANKS TO USG ASSISTANCE Ulaanbaatar 116: IMF: 17% INFLATION THREATENS MONGOLIA'S ECONOMIC STABILITY Ulaanbaatar 115: MONGOLIA PLANS AMBITIOUS AGRICULTURAL EXPANSION, AS FOOD PRICES CLIMB -- 2007: Ulaanbaatar 686: MONGOLIA EXPERIENCES HIGHEST INFLATION IN OVER A DECADE Ulaanbaatar 679: MONGOLIANS BELIEVE CLIMATE CHANGE WREAKS HAVOC ON MONGOLIA Ulaanbaatar 475: MONGOLIA'S RAILROAD WOES: CONSTRUCTION, OTHER MATERIALS STACK UP AT CHINESE BORDER FOR LACK OF LOCOMOTIVES, RAIL CARS DEMAND -------------- ¶3. (U) What are the most important, essential foods/agricultural commodities consumed in host country? -- The Ministry of Food and Agriculture of Mongolia (MoFA) considers wheat and flour, dairy products, and meat as strategic food staple items. UN surveys of household incomes and expenditures find that these three product categories make up some 86% of a Mongolian's daily caloric intake. ¶4. (U) How have prices changed with regard to these ULAANBAATA 00000205 002 OF 010 foods/commodities? -- According to GOM (Government of Mongolia) figures, the average price of bread, flour and cereals in March 2008 rose 45.8% year-on-year (y-o-y); meat and meat products (mostly of domestic origin) rose 27.9%; and vegetables (most imported from China) rose 26.3%. Overall, prices for food and non-alcoholic beverages rose 33.3% over the past year (16% since January 1). The price of a 55-pound bag of flour had risen to $21.40 from $7.70 four months earlier. ¶5. (U) Is host country a net importer or exporter of those commodities? -- Mongolia imports 70% of its wheat from Russia, mostly from western Siberia. The quality of these imports is generally poor, often categorized in Russia as unfit for human consumption. 20% comes from Kazakhstan, 9% from China. United States is donating 25,000mt in 2008. -- 98% of Mongolia's imported rice comes from China. Mongolia imported US$1.9 million worth of rice in the first three months of ¶2008. -- Although Mongolia produces 350 to 400 million liters of milk per year, all of which is consumed locally, only 5% of this milk is processed through pasteurization. Milk is produced in Mongolia on a seasonal basis, with most of annual production occurring in June, July and August; production is promptly consumed for lack of refrigeration. Poor infrastructure - including an absence of proper storage facilities, and inefficient distribution networks -- creates milk shortages in big markets (the main cities). These shortages have to be offset by importers, which bring in around 20 million liters of milk and milk products annually (largely in dry-milk form, which is reconstituted in-country, or long-life UHT milk.) -- The country exports 5% of its domestically produced meat (some 90% of it beef) to Russia, Saudi Arabia and Japan. Meat to Russia is in the form of unprocessed carcasses; Saudi Arabia, in the form of lamb; and Japan, in the form of horsemeat and pet food. -- Mongolia is self-sufficient in meat, and therefore imports few meat products, except for some pork, mainly for sausage production; some poultry, fish, eggs (30-40% of total egg market); and some vegetables, principally during the winter months. ¶6. (U) What percentage of domestic consumption is satisfied by domestic production? -- According to GOM estimates for 2007, total demand for wheat reached 298,468mt, of which only 121,200 mt (40%) was met by domestic producers. Mongolia expects to import 91,071.43 mt, mostly from Russia, leaving a supply deficit of 27% or 81,715.32 mt. However, it is important to note that at least half of wheat demand goes for alcohol production (mostly vodka),rather than for direct human consumption. -- Mongolia's meat demand is primarily for beef and mutton and is fully met by domestic producers. Mongolia's poultry meat industry is modest, although it produces between 60-70% of its own egg ULAANBAATA 00000205 003 OF 010 supplies. -- The country mills only about 30% of its flour supply. Although Mongolia is capable of supplying 100% of local flour demand through domestic millers, the shortage of wheat -- and the lack of storage facilities - keep producers from running their mills at full capacity. -- Mongolian producers supply 80% of potato market and 30-40% of vegetables, primarily cabbage, carrots, cucumbers, and onions. ¶7. (U) Have there been shifts in consumption towards alternative commodities? -- The government considers rice and potatoes as alternatives to flour. Potatoes are grown domestically, and Mongolia supplies about 80% of total demand for potatoes locally. But GOM statistics show that imports of potatoes since January are down nearly 50% over figures from the same period last year, mainly because of soaring prices for imported potatoes, suggesting that domestic suppliers are currently filling 90% of local demand. There is no indication, however, that users of flour have turned to potatoes because of rising flour prices. -- The situation with rice may become problematic because nearly 100% of Mongolia's rice imports are from China. MoFA officials expressed concern, based on statements from counterparts at the Chinese Embassy in Ulaanbaatar, that China might act to ban rice exports in the future. (Note: Post has not been able to confirm this statement. End Note.) ¶8. (U) What are the differences in the impact of rising food prices on different groups (e.g., rich vs. poor, urban vs. rural, ethnic groups),on different regions? -- Food price increases are hitting poorer consumers harder, and among these, the rural and urban poor bear most of the shock. World Bank surveys show that poor, rural households devote the highest share of their consumption basket to food (58 percent),while the urban poor dedicate 46 percent of their income to food products. Non-poor households devote 35 percent of incomes to food. -- Since the beginning of the year, price increases for food have been steepest in the southwestern part of the country (Bayankhongor and Ovorkhangai provinces, at 35% and 25%, respectively). Ulaanbaatar's inflation rate for food items hit 16% in January, which is close to the national average. ¶9. How have rising incomes affected consumption patterns? -- There is no information available yet, anecdotal or otherwise, that shows any noteworthy change in consumption patterns. Supply -------------- ¶10. (U) Is there evidence that domestic agricultural production is responding to changes in prices? -- Recent price rises have sensitized the GOM to food security concerns (see Ulaanbaatar 115); and so, it wants to increase wheat and vegetable production to become self-sufficient by 2010. It ULAANBAATA 00000205 004 OF 010 wants to reduce import dependence, especially on Russia and on food donations. It wants to extend loans to farmers for technology, seeds, and equipment, to increase yields. ¶11. (U) Has there been an increase in investment, domestic or foreign, in food production? -- The government is working with commercial banks to support investments in the crop farming sector by subsidizing part of the loan interest. This will allow farmers to receive loans at almost half of the current commercial-loan interest rate. The GOM has strongly encouraged private banks to immediately offer at least US$50 million in loans to the Mongolian farmers. (Note: American managers of two of Mongolia's largest banks have refused to pump cash into a sector that they argue is not economically viable. End Note.) -- In March, the Minister of Food and Agriculture rolled out the GOM's "Crop Rehabilitation Third National Mobilization" (CRTNM) to restore self-sufficiency in wheat/flour and vegetable production by ¶2010. The CRTNM calls for investment of about US$413 million over three years, starting this year. The agricultural sector, long dominated by the state (either directly or indirectly),has attracted little investment from the GOM's budget or the private sector in recent years; the price rises do not seem to have encouraged investment into the current system. ¶12. (U) Is there an increase/decrease in land used in food production? -- In fall 2007, domestic wheat production declined due to drought in the agriculture-intensive provinces of Khentii, Selenge, and Tuv. This reduced supply and put further upward pressure on prices. -- There is no indication that land under recent cultivation has either decreased or increased in response to price fluctuations. However, food price increases have motivated the government to propose the Crop Rehabilitation Campaign (CRC) to increase crop production by restoring and using old, abandoned crop lands. ¶13. (U) Have higher input costs affected food production and prices? -- MoFA believes that higher fuel-driven transport costs for bread and cereal products imported primarily from Russia have contributed to at least 3.3% of the 16% inflation since September 2007. MoFA infers the same general effect for all food imports. -- Costs involved in transporting livestock from the field to the city have contributed at least 3% to cost increases. In particular, the increase in the price of domestically-produced meat accounted for more than 3% of the observed 27% jump from last year. (The rest is attributed to speculators and distribution bottlenecks.) -- Overall, because Mongolia's agricultural sector has been too cash-starved to use many modern inputs in its production, recent price increases have not impacted production or prices. ¶14. (U) Are there changes in food inventories/stocks? -- The GOM has developed a plan to create reserves of 15,000mt of flour and 100,000mt of wheat this year. However, the GOM has not funded the proposal, saying no money is available at this time. ULAANBAATA 00000205 005 OF 010 ¶15. (U) Are shortages of storage or food processing facilities contributing to crop losses? -- MoFA officials state that inadequate storage capacities do not allow efficient use of the crops grown. This year, the government approved building or restoring 190 storage facilities across the country. ¶16. (U) Are there other bottlenecks in supply chains? -- Over the past year, Mongolia has experienced tremendous bottlenecks for goods and supplies coming in on the sole single-track rail line from China. Part of the blame lies with an ambitious housing scheme and construction boom that has reduced tariffs on imported construction materials, spurring sharp increases in imports of these materials (at the expense of other imports). In addition, Mongolia's aging, under-invested railway system cannot keep pace with transport demands. These weaknesses have affected the importation of other products, including food items, contributing, in turn, to price hikes. (Note: Efficiency improvements are the central objective of the $185 million Millennium Challenge Account (MCA) railroad project, but work and the flow of funds will begin only later this year; it will not have much impact on this problem in the near term. The total MCA expenditure will total roughly $285 million. End Note.) -- For meat products, 100% supplied by domestic producers, a gray-market system for transporting meat to market has allowed middle-men, aka "changers," to artificially drive up prices by hording meat or slowing delivery. ¶17. (U) What is the effect on exports and/or capacity to supply food assistance? -- Mongolia is not an exporter of food/agricultural commodities or a supplier of food assistance. ¶18. (U) Has there been a shift in production between food and non-food commodities, or an increase in the use of food crops for non-food purposes (such as fuels)? -- MoFA is looking for possibilities in biofuel production. However, Mongolia completely lacks the technical, legal, regulatory and financial infrastructure to actualize such grandiose ambitions. ¶19. (U) Are there other factors affecting supply, such as weather or government policies? -- Weather remains a limiting factor. Mongolia has long winters and dry springs, while summers -- although relatively wet -- are too short for many crops. Droughts that damage crops and kill livestock are common, as are harsh, livestock-killing winters. In 2007, drought in Khentii, Selenge, and Tuv provinces caused 2007 domestic wheat production to decline, reducing supply and placing further upward pressure on prices. -- Herders' growing preference for raising more profitable cashmere-producing goats exacerbated stress on pasturelands; alleged price-fixing among grey-market meat suppliers; and a rise in demand as net income increases. POLITICAL IMPACT -------------- ULAANBAATA 00000205 006 OF 010 ¶20. (SBU) Have there been public protests or violence? Sharply rising prices for staple foods prompted approximately 4,000 demonstrators to take to the streets April 18 in the heart of Mongolia's capital, Ulaanbaatar. (Note: Press reports of 20,000 demonstrators were inaccurate. End Note.) Protestors demanded price cuts of 40-50% for bread and flour, and threatened a nationwide strike if the government failed to act. Since April 18, no other protests or actions have occurred. ¶21. (SBU) What is the effect on the stability of host government? -- A recent survey found that "inflation on goods" ranked third on a list of voter concerns, behind unemployment and corruption. The issue was not among the top concerns six months ago. So far, there is no indication that current price rises translate into government instability, and it is unclear how they will affect nationwide Parliamentary elections on June 29. (Comment: Populist candidates may attempt to use price increases to attack their opponents in the upcoming election, accusing the ruling coalition of not doing enough to limit price increases for staples and fuel. End Comment.) ¶22. (SBU) Has there been an impact on friction between classes, ethnic groups or urban/rural populations? -- While no ethnic friction has occurred, food price increases will surely hurt the urban and rural poor. As a result, one may see increasing disparities between the poor and non-poor, if food prices continue to rise. Many of those running for office or currently in power come from privileged backgrounds. These elites drive luxury SUVs and wear fancy clothes and jewelry. Even before recent price increases, Mongolians talked about a widening income gap. If current price trends continue, poor voters may grow increasingly resentful of the rich urban and wealthier rural classes, for having so much when they can barely afford staples. ¶23. (SBU) Has there been any impact on public attitudes toward agricultural biotechnology and/or biofuels? -- The Ministry of Food and Agriculture has told us that they support the use of Genetically Modified Organisms (GMO) as a possible solution to increased food costs and concerns over food security, but it says the public is opposed. There are currently no regulations in place, and MOFA does not know how to commercialize products under research. ECONOMIC IMPACT -------------- ¶24. (SBU) How significant has the rise in food prices been in its impact on inflation, balance of payments, trade balance, the fiscal situation or any other important economic indicator? -- According to the GOM, food items constitute 41% of Mongolia's Consumer Price Index (CPI) consumption basket. In 2007, price hikes for food accounted for 70% of total inflation. The 15.1% inflation rate, which Mongolia experienced in 2007, was the highest in a decade, and mostly driven by food items. -- Global inflation and the Tugruk's depreciation against the Chinese Yuan (CNY) have driven prices for all imported foods higher. (Note: The IMF recently classified the Tugruk's de facto peg to the U.S. dollar as the major reason for the depreciation. End Note.) ULAANBAATA 00000205 007 OF 010 Since March 2007, the Tugruk lost 10.5% of its value against the CNY. A continued appreciation of the Chinese Yuan will push Mongolian prices up further. For reference, as of May 1, the USG's official rate was $1=Tugruk 1170. -- However, Mongolia's exports of copper, molybdenum, fluorspar, skins, cashmere, and gold have generated a positive balance of trade, balancing out some the effects of a declining dollar. ¶25. (SBU) How might this affect private-sector development and medium-term economic growth prospects? -- Mongolia's economy grew 9.9% in 2007, thanks to impressive gains in the service, agricultural, banking and construction sectors. This growth has so far managed to outpace the impact of these price hikes. ¶26. (SBU) Approximately how many poor households are net food consumers that would be impoverished by the food price rises, and approximately how many are net producers and could benefit? -- The impact of food price increases is harder on poor consumers, and among them, the urban poor bear most of the brunt. Household surveys undertaken for the World Bank's Poverty Assessment in Mongolia show that 28% of all households in Mongolia are rural agricultural producers, from which one might infer that 62% of the population will be affected by food price increases. However, as urban and most rural dwellers, rich and poor alike, must use imported grains and other imported, processed staples, all will be affected to some degree by price increases. (Note: Embassy Locally Employed Staff have expressed concern about rising food costs, which they note have increased about 20-25% over the past several months, coupled with static incomes in the absence of a salary increase. We have already lost a few key employees recently for these reasons. End Note.) ENVIRONMENTAL IMPACT -------------- ¶27. (SBU) Have rising prices had an impact on issues such as deforestation, water availability and quality, soil conservation, etc.? -- MoFA's "Third Crop Rehabilitation Campaign" national program is confined to rehabilitating old crop fields and currently does not include plowing new lands, which could result in ecological damage to the environment. Environmentalists had threatened to oppose the measure unless this proviso was included. The plan also focuses on re-cultivating abandoned farmland, which could help hold back desertification. -- Besides increasing livestock production, pig and poultry farming is growing and being supported to meet the demands for meat. This could lead to an exacerbation of overgrazing and result in increased water use, which is contributing to desertification. GOVERNMENT POLICY RESPONSE -------------- ¶28. (SBU) Has host government made changes in tariffs, quotas or other import restrictions? ULAANBAATA 00000205 008 OF 010 -- The GOM has proposed a price stabilization program and set up a Price Council. This Council is chaired by the Finance Minister and consists of the Tax office, various line Ministries, Customs Authority, the Bank of Mongolia, the Unfair Competition Agency, Consumer associations, the Minerals and Petroleum Authority, Employer's federation, Federation of Trade unions and Police. The Council is expected to closely monitor inflation and analyze its impact; submit a proposal to exempt wheat imports from VAT and customs taxes; re-negotiate the imported oil price with the Russian oil company as well as seek alternative oil sources in the Middle East; conduct financial audits of petrol importing companies; and continue to subsidize domestic wheat producing farms. So far, however, the Council has not acted on any of the new proposals. -- In connection with the flour price increase and shortage of wheat, the Mongolian Government struck an agreement with Russia on buying 100,000mt wheat with zero Russian export tax, and zero Mongolian import tax and VAT. This measure is expected to reduce flour price from US$0.89 down to US$0.65 per 1 kg. -- On December 30, 2007, Parliament amended the VAT Law, exempting wheat imports and 40,000mt of flour for the period of January 1, 2008 to July 1, 2008 from the tax. The Parliament also exempted imports of wheat and 40,000mt of flour from Customs tax from January 1 until July 1, 2008. ¶29. (SBU) Have there been export restrictions? -- No restrictions are in place, because Mongolia exports little in the way of agricultural food products. Major agricultural exports are cashmere and wool, for which certain export taxes apply (but no export restrictions). ¶30. (SBU) Have there been nationalizations and/or redistributions of private farms or industries? -- No. ¶31. (SBU) Are there changes in policies on food assistance? -- Mongolia is not a food donor country. -- As a recipient of food aid -- for instance, USDA-funded 416B wheat, French wheat, Korean rice, etc. -- Mongolia continues to welcome such aid. ¶32. (SBU) How are Central Banks reacting to food-price-driven inflationary pressures? -- As noted early, the IMF re-classified Mongolia's exchange rate arrangement as a conventional peg, which acknowledges the de facto peg of the Mongolian Tugruk to the US dollar. This has limited the flexibility of the central bank, the Bank of Mongolia (BOM),to combat inflation on imported food goods as the Tugruk depreciates against world currencies in sync with the dollar. Consequently, the Tugruk has lost 10.5% of its value against the CNY since March 2007, making Chinese vegetables, fruit, and rice imports more expensive. ¶33. (U) What about price subsidies, cash transfers and other assistance to the population? -- The government is pushing commercial banks to support investments in the crop farming sector by subsidizing part of the loan interest, a call which the main commercial banks seem to have rejected. -- There has been talk by the GOM of offering life-line subsidies, ULAANBAATA 00000205 009 OF 010 low-cost, or even free flour to populations affected by extreme poverty, especially pensioners on limited incomes, but nothing has been formally presented, let alone approved. ¶34. (U) Are there policy efforts to promote food production? -- The Government designated 2008 as the Year of Food Supply and Food Safety. Also, the government has launched a Third Crop Rehabilitation Campaign. ¶35. (U) Are there changes in trade, environment, biotech, SPS or other policies? -- MoFA is looking for possibilities in bio-fuel production. However, at the moment, Mongolia lacks the technical, legal, regulatory, and financial capacity to implement any plans in this area. ¶36. (SBU) Is there any impact on relations with other countries? -- Countries willing to help Mongolia secure its food supply at a reasonable price would likely find Mongolia reasonably supportive of that country's efforts in other fields of endeavor, and possibly in international fora. As Russia and China are the best positioned to assist Mongolia with food-supply concerns, they may derive the lion's share of gratitude from Mongolia -- if they are accommodating with their exports of wheat/flour and rice, respectively. There is a risk, should China ban rice exports, that long-standing prejudices against Chinese could flare-up. IMPACT ON POST PROGRAMS -------------- ¶37. (SBU) What impact, if any, has there been on post's programs? -- Post is keenly interested in maintaining or increasing the levels of the USDA Food for Progress program. Post's LES and American personnel have also suffered from skyrocketing food prices. Not only are the American staff without the benefit of a COLA, they are spending more on food at a time when post's differential was inexplicably slashed from 25% to 20%. -- We are seeing more press coverage about U.S.-related food price increases, so there is a risk that some of the blame for high local food prices may be directed at the U.S. POLICY PROPOSALS -------------- ¶38. (SBU) What policy recommendations would post recommend to host government? -- Urgent Measures to Address High Food Prices: ¶A. Increase agricultural productivity by deploying available science and technology (esp. related to livestock and higher yield, drought resistant plant varieties and seeds); enhance resource management (esp. sustainable range management); and increase educational alliances in support of the two previous items. ULAANBAATA 00000205 010 OF 010 ¶B. Alleviate transportation, distribution, and supply chain bottlenecks by developing trade and transport corridors, and increase access to capital development. ¶C. Promote sound, market-based principles by implementing sound agricultural and food policies, and develop contingency planning. ¶39. (SBU) What changes in USG policy would you recommend in order to address the problem of food price rises, given the experience of your host country? -- Post is consulting with USDA and USAID regarding recommended changes. In 2006, the Embassy explored with the GOM the possibility of using USDA General Sales Manager (GSM) food export credits, but the GOM, per the IMF's instructions, would not/not offer GOM guarantees for local banks, a policy the IMF has partially backed away from, saying limited, carefully controlled guarantees are appropriate now given Mongolia's financial state. It may be time to revisit this prospect as a possible source of rapid, short-term funding for needed imports. -- USDA might look at what commodities, such as rice, that it might be able to supply/sell should China ban exports. GOLDBECK