Food Prices: Why are prices high despite production surpluses? by Kampamba Shula

1.1. Background
Government has challenged food security researchers to provide comprehensive answers for the continued high food prices despite having food surplus in the country.
Agriculture and Livestock Permanent Secretary Julius Shawa observed that the issue of food prices is complex and requires the involvement of all stakeholders.
During a policy dialogue meeting on food security and nutrition in Zambia organised by the Indaba Agricultural Policy Research Institute (IAPRI) and the International Food Policy Research Institute (IFPRI) in Lusaka, Mr Shawa noted food security had become more complicated with many issues that were cross-border and needed to understand the complexities in order to make strategic decisions.
“Our policy makers are asking why food prices continue to accelerate despite the surpluses the country has been recording lately,” Mr Shawa said. “Researchers and us as policy advisers need to look at that and provide answers.”
He noted that there were various issues that keep coming up regarding high food prices such high cost of production, marketing and that sometimes the blame goes to the middle men. Mr Shawa observed that researchers were key in provide the true findings because good decision making depended on solid evidence and rigorous information.
This paper is an answer to this call for comprehensive answers on the high food prices in Zambia.
1.2. Introduction
For all intents and purposes this article will mainly focus on the price of maize, even though prices of other food commodities have been rising. The reason for this is due to the apparent contradiction that a surplus in maize production coupled with higher prices has perplexed some of the policy makers. This paper will aim to shed light in this regard.
 
1.3. Review
Since 2009/2010 production season, maize harvests have been above 2.5 million metric tons each year
• Projected maize surplus between 2010 & 2012 was 4.4 million MT of which FRA purchased 83%
• Despite maize surpluses, there were widespread maize meal shortages & skyrocketing m/meal prices
The question that seems to perplex stakeholders is how could Zambia face maize shortages and high prices despite three consecutive bumper harvests, large subsidies to mills, and significant maize held by the FRA?
As its initial mandate, FRA was established to maintain national strategic food reserves
• After amendment of Food Reserve Act in 2005,
• FRA has become a major player in the maize market
FRA purchased nearly all surplus maize between 2010 & 2012
Because FRA bought more maize than what they could handle, there were greater levels of FRA maize spoilage estimated at 32% (2013 ministerial statement by MAL Minister). This loss translates to K2.5 billion - loss equals 60% Euro bond. Private sector loss is only about 5%
• Retail maize markets became thinly traded as many traders were forced out of business
• Informal sector squeezed out of market
FRA’s procuring nearly all surplus maize and selling it at subsidized rates to a few selected commercial mills squeezed out informal milling sector
Selected subsidies to large millers provided un-levelled playing field.
• Not all large millers received heavily subsidized grain
• Others lost market share and exited the market
• Concentration of the milling sector
Undermined competition as such mealie meal prices did not come down.
Because FRA purchased majority of the maize, commercial mills’ access to maize directly from the market became limited and this resulted into:
• increased risk of bottlenecks in maize supply chain
Exit of commercial farming sector from maize production
• Because large millers started waiting for cheap FRA maize, it led to loss of forward contracts with commercial farmers
 
1.3.1. Summary
Less competition within large-scale milling sector which resulted into concentration of the sector
• Shortage of maize and mealie meal on the market
• Informal traders and retailers squeezed out of the market
• Overall surplus diminished by spoilage/wastage
• Commercial farmers’ maize production declined
• Major cost to national treasury & big opportunity cost to investments in R&D, extension, irrigation & infrastructure
Total estimated loss to national treasury through FRA maize marketing from 2010 – 2012
Total estimated operating LOSS: total grain sold x average loss/MT = (2.5 x 1,680)
• 4.2 billion kwacha rebased
• Loss more than Euro bond
1.4. Who sets the price for Maize?
Determining an FRA purchase price is a complex matter as it affects a multiplicity of factors that influence the performance of Zambia’s agricultural sector. The sustainability of a maize farmer, however, depends on that farmer’s price competitiveness, both locally and on the regional export market. Issues of adoption of new agricultural technologies and public goods investments that will reduce costs – such as feeder roads, improved agronomic practices, more productive seed varieties, meaningful extension messages, and ensuring the availability of fertilizer at the appropriate time -- are critical for the future competitiveness and viability of Zambia’s farm sector.
The FRA purchase price has normally been below the Lusaka wholesale price. The FRA must incur transport, handling and storage losses associated with moving grain from the outlying production areas to urban areas. As long as the FRA selling price to millers reflects these marketing costs, its selling price will be higher than its buying price. Hence it is unsurprising that the FRA purchase price should be set below the price in urban markets (otherwise its selling price to millers and other buyers would be uncompetitive compared to grain sourced by private traders). Therein lies the problem and effectively, the loss.
A major topical issue that can be informed with accurate production cost estimates is the price offered to farmers by the Zambian Food Reserve Agency (FRA) each year. The FRA sets its maize buying price each year to compensate farmers for the costs incurred during production and provide a reasonable return to their own land, labour, mechanical, and animal inputs. However, the setting of FRA’s producer price has never benefitted from national farm survey evidence on production costs. Rather, illustrative figures are provided by various stakeholder groups to lobby and influence the setting of FRA purchase price levels (Burke, Hichaambwa, Banda, & Jayne, 2011).
A key observation by a report done by (Burke, Hichaambwa, Banda, & Jayne, 2011) is that the FRA pan-territorial pricing policy does not reflect the wide geographic differences in costs and even among farmers in the same village. Geographic variation in production costs follow differences in agro-ecological suitability for maize production and input costs. The average production cost per bag in 2010 varied from as low as ZMK 34 in the Eastern and Northern Provinces (representing 35% of national production) up to ZMK 53 in the Copperbelt and Western Provinces (10% of national production). Within-village production cost differences arise due to differences in farmer ability and knowledge and the various management decisions they make.
These sources of variation result in a wide range of production costs in Zambia, which leads to the conclusion that there is no single “cost of maize production”. There is only a distribution of production costs across the millions of maize farmers in Zambia. This analysis reports the range of production costs for all maize farmers surveyed in the 2010 Crop Forecast Survey. The most productive 20% of farmers in the 2010 CFS produced maize at a mean of ZMK 15.567 per bag.
The next most productive 20% of farmers produced maize at ZMK 29.078 per bag. Mean production costs for the third and fourth quintiles of production costs were ZMK 42.776 and ZMK 64.341 per bag, respectively. The least productive maize farmers’ production costs were well over ZMK 100 per bag, which in many cases likely reflected unexpected events leading to partial or near total crop losses. In such cases, production expenses are extremely high when.
The wide variations in production costs per bag are due to variations in farmers’ production costs per unit of land planted, but especially due to variations in farmers’ yields.
The second key observation from the analysis of 2010 production costs is that 86% (2.06 million MT) of Zambia’s total maize output was produced at a total cost lower than the ZMK 65 FRA buying price. The mean cost of production per bag was ZMK 40.739. Cash expenditure on inputs per bag was ZMK 18.630 on average.
Thirdly, the majority of Zambian maize could be sold at a profit competitively in regional markets. At the beginning of the 2010 harvest season, the export parity price (the landed cost of maize in Lubumbashi, Democratic Republic of Congo (DRC), minus transfer costs from Kabwe to Lubumbashi) was roughly ZMK 59. Meanwhile, 1.8 million metric tons of Zambian maize was produced at costs lower than 50 ZMK/bag. It was found that smallholder households selling or expecting to sell maize produced maize at somewhat lower costs than the average (roughly 38 ZMK/bag). Among this group, 76-82% of the maize produced could have been competitive in regional export markets.
Fourth, there is a strong correlation between higher yields and lower costs of production. This is not surprising. Clearly, a key factor in increasing Zambian maize producers’ comparative advantage in the region will be the promotion of productivity enhancing technologies and agronomic practices.
Rural smallholder production remains highly labour-intensive. On average, family labour accounts for 62% of the total cost of maize production in Zambia’s small- and medium-scale farm sector. Promoting the identification and adoption of practices and technologies that save labour and /or identifying labour-productivity-enhancing technologies through research and development will therefore help to make Zambian maize more competitive and allow farmers to maintain profitability even at lower producer prices.
 

1.4.1. High Maize Price
Truth be told, Zambia’s agriculture sector revolves around maize, never mind the growing of other crops and livestock. The bulk of the maize is grown by peasant farmers who are faced with regular droughts during the rainy season, an unreliable and expensive supply of fertilizer, and difficulties transporting the commodity to markets.
In 1986, Zambians in the Copperbelt and Lusaka regions rioted because the price of maize increased several fold when incomes were stagnant. Four years later, unrest over price increases even sparked a coup attempt.
High maize prices disadvantage many poor rural households Research results indicate that, unfortunately, the majority of households in Zambia, both rural and urban, are not sellers but buyers of maize.
Moreover, the rural poor in Zambia tend to be buyers of maize. Hence, a rise in the maize price surface to ZK 85 per bag would have adverse income distributional effects by transferring income from the majority of the population in Zambia who are relatively poor net maize buyers to large commercial farmers and to about 25% of the nation’s smallholder households who sell relatively small amounts of maize.
In perfectly competitive markets, prices in the domestic country are fully determined by international conditions. Therefore, price setting does not involve any local factors, such as cost or market structures (Dreger & Kholodilin, 2007). From the perspective of consumers an equal amount of money could buy the same bundle of goods and services at home and abroad.
1.5. Imports and Exports
The importance of import prices it is also expected that the FRA purchase price should be lower than the cost of importing grain from South Africa. This has indeed been the case for each year that the FRA has set a purchase price since 2005. As long as the Government of Zambia tries to keep maize prices in the country below import parity levels, the FRA’s buying price will be below the landed cost of imports.
The surplus crop of maize achieved in recent years presents an opportunity to export value added products to the region, thereby increasing demand for the local produce, which will in turn raise the maize prices for the farmers (Cottan, 2006).
DRC has the largest export potential, but lack of signed bilateral trade agreements between Zambia and DRC is restricting the formal flow of exports. The estimated population for the Katanga province including Lubumbashi is 9.5 million.
However, there is very stiff competition mostly, mainly from South Africa and Tanzania for both Maize Meal and Wheat flour. The Zambian millers should therefore find ways and means to minimise the cost of production in order to remain competitive on the export markets.
 

1.6. “Price Floor”
A “price floor” is a government- or group-imposed price control or limit on how low a price can be charged for a product (McGraw-Hill, 1994). A price floor must be higher than the equilibrium price in order to be effective.
A “price floor” set above the market equilibrium price has several side-effects. Consumers find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production.
Taken together, these effects mean there is now an excess supply (known as a "surplus") of the product in the market to maintain the price floor over the long term.
1.7. The Dilemma
The government has finally announced the maize “floor price” of K70 per 50 Kg bag of maize. Maize, Zambia’s staple food is grown by over 2.7 million agricultural households. The crop is not only used as source of food but is a source of income for many of the rural households. The income obtained from maize sales enables the families meet other basic necessities for livelihood and provides the resource needed to purchase inputs for the upcoming agricultural season.
According to (Nguleka, 2014) it is important to consider the economic conditions that farmers face especially in view of the fact that the floor price was last revised in 2009  (6 years ago). Taking inflation as the starting point, the prices of most goods and services in Zambia have continued to rise, with the magnitude of the increment varying from month to month and year to year. As mentioned earlier, the maize floor price has been static from 2009 at ZMK65/50Kg bag which means that while the prices of commodities that farmers face just like any other consumer has been rising the incomes of farmers remained unchanged. Looking at the inflation statistics below, the floor price was eroded by 36.6% from May 2010 to May 2014.  Had this taken into consideration, the maize price would have ranged from K70.79 in 2010 to K92.26 in 2014
Furthermore the costs of major inputs such as fertilizer and seed have been increasing. Fertilizer prices have risen by about 25 percent from ZMK160/50Kg bag during the 2009/10 agricultural season to about ZMK200/50Kg bag in the 2013/14 agricultural season in Lusaka. In other parts of the country, further from Lusaka, the prices of fertilizer are even higher.  The price of seed has also risen from about ZMK120/50 kg bag in 2011 to ZMK310/25 kg bag in 2013.
Other cost centres that should have been considered are;
The cost of fuel was adjusted upwards in April this year by 7.22% on petrol, 8.75% on diesel and 9.54% for kerosene. Increase in the price of fuel immediately raises the cost of transportation for the maize from farm gate to the market and the cost of transporting inputs onto the farmsteads.
The depreciation of the Kwacha drives upwards the cost of all imported farm requirements such as packaging bags, insecticides, fuel, etc.
Interest rates have gone up. The emergent and small scale farmers who have pushed up maize production get seasonal loans through a group lending scheme, the Lima Credit Scheme by depositing 50% of the value of the inputs as collateral to get double the value of inputs. Since last year the policy rate has been adjusted several times upwards and since April it is at 12% hence the cost of money has gone up hence commercial banks’ lending rates have gone up signalling a rise in seasonal finance costs in future.
Maize production is labour-intensive and wage related costs have gone up from ZMK12.200 to ZMK19.03 per man-day.
The general cost of doing business has gone up, the most recent is the increase in electricity tariffs which went up by 5.11% on large power MD3 /MD4 customers to 24.63% the highest on residential consumers. Small power MD1/ MD2 customers and Commercial consumers face an increase of 19.49% and 15.38% respectively while consumers falling in the social services bracket will face a 15.38%. Now since farming has different sizes of farmers falling in different electricity consumption groups what is not in dispute is that most farmers are faced with a double digit increase of 15.38% to 24.63% in the cost of electricity.
 Besides all the factors listed above, it is important to recognize that during the year, new fees/charges were introduced by some local council including toll fees on some main roads meaning that transporters will be adding all these costs to the cost of inputs. And for now since maize marketing is taking place, these costs will reduce the price paid to the farmer making farmers poorer and discontented. Therefore, the FRA floor price has an important bearing on the price that other traders pay the farmer.
At farm level, the rising costs of inputs means that a farmer producing maize at a yield of 2.26 Tons/ha which is the national average yield in 2014 requires a price of at least ZMK83/50Kg bag of maize grain just to break even without considering the fixed cost of production.  A price of ZMK108/50Kg bag of maize grain would make economic sense if the fixed costs were considered as well.  Some districts recorded yields as low as 1.5 tons per hectare, implying that farmers in such districts would need a price of at least ZMK159/50Kg bag to break even.
The inadequate return on the maize affects the productivity of small-scale farmers as they are forced to use less and less of the recommended inputs which reduces the yields even further.  This year, a national average yield of 2.26tons/ha of maize for small and medium scale falls way below the yield potential of hybrid maize varieties currently available on the local market.
Therefore, the maize floor price of ZMK70/ 50 kg bag announced is a source of misery because to a farmer in Kaputa with a yield of just 2tons/ha for a maize crop which cost over ZMK4, 700 per hectare to grow and whose breakeven price is K118.70 for a 50 Kg bag is a total disincentive especially that a fellow farmer in Zimbabwe is getting a price equivalent to ZMK119/50Kg bag (US$390/ton).  This will discourage farmers to continue growing maize because the price does not allow a farmer to cover the variable cost of production. It should therefore not come as a surprise that the yields will continue to remain low while farmers remain poor.

The farmers of Zambia have remained committed to producing the much needed food for the entire Zambian population and this has been demonstrated by the continued positive food balance sheet the country has enjoyed over last six years.  It is rather disappointing and difficult to comprehend that farmers should to get an upward adjustment of only one ngwee/kilogram as a reward after working so hard to produce a bumper harvest and more so after waiting for so long since 2009 when the price was last adjusted.

1.8. Analysis
Let us first understand that price floors are only an issue when they are set above the equilibrium price, since they have no effect if they are set below market clearing price.
Now here is the issue. FRA sets a “floor price” of K70 per 50kg bag. Then the FRA buys ALL the maize from farmers at that price. FRA then sells this maize to millers who in turn place their mark up and sell to end consumers.
It must be noted that the control that FRA places on the maize price is a PRICE CEILING and not a price floor. These two terms cannot be used interchangeably because they mean two different things. So as long as the Zambian government regards the price ceiling as a price floor, then policy direction on this issue will be misguided.
Now one might ask why it should be called a price ceiling instead of a price floor. The reason lies in what exactly is the effect of the actions of the FRA. Let us break it down, FRA “recommends” a price at which farmers should (I use this term loosely) sell their maize to FRA. Now the farmer has two options, he can either sell his maize lower than the price at which FRA sets to other “briefcase” dealers or he can endeavour to sell it at a price higher than what the FRA sets. Selling maize lower than the FRA price is possible but selling higher is impossible because any other dealer would not pay for maize at a price higher than what the FRA is paying. This is the reason this is a price ceiling and not a price floor because it prevents farmers from selling at a higher price but allows them to sell lower at a disincentive of course.
A price floor can only be effective if it is above the equilibrium price level. Factoring in inflation and other costs of production which have increased since the last time the “price floor” was set in 2009, the equilibrium price is actually higher than the price FRA sets. This means FRA is actually setting a price ceiling rather than a price floor. Which means whilst they might believe they are helping the farmers in an effort to keep prices low and protect consumers they are actually hurting farmers.
Now what does this mean effectively? The logic for having a price floor and a price ceiling by government are very different. The main reasons why a lot of government will try to fix the prices of a commodity below a certain limit is that they want to protect consumers from exploitation by suppliers. However the effects of prices control can hurt the economy if it is carried out for long periods without adjustments. If the government continues to impose the price ceiling the supply will continue to reduce hence negatively affecting that sector (This is seen by the increase in disincentive of some farmers to farm maize). The government should therefore not impose policies to protect consumers from exploitation when the real problem is undersupply not exploitation.

Apart from having a price ceiling, the maize market in Zambia is dominated by millers who purchase maize from FRA and resell to consumers. These millers have not always passed on price cuts to consumers (as was evidenced by the unsuccessful subsidies on grain programme).
With the presence of FRA in the maize market there are effectively three mini markets which make up the whole maize market.
The first market is a closed market with occasion intruders between Farmers and FRA. This market is occasionally intruded by briefcase dealers looking to buy from farmers at a low price and sell to FRA at a higher price. This is the market in which FRA sets a price ceiling which it unfortunately mistakes for a price floor.
The second market is the market between FRA and Millers. This was the market in which the subsidies where introduced. FRA would sell subsidized maize to millers in this market but millers never passed on the cost saving to consumers.
The final market is the one between Millers and Consumers. This is the market in which the ordinary person buys the mealie meal which the take home and consume.
If the market was liberalised this would be a two way market, one between farmers and millers and one between millers and consumers. But this is not the case. What is happening is that government is actually setting a price ceiling in the Farmer-FRA market and a price floor in the Miller- Consumer market. What government intends to do is actually set a price floor in the Farmer-FRA market and a price ceiling in the Miller-Consumer market.
This is distortion of policy is what is creating the illusion that higher surpluses will translate to lower prices while the market dynamics between the three mini markets do not support such an assertion.
There is always a trade-off. Government will have to decide an appropriate way to address the welfare of consumers as well as households who make their income from maize. But to do this Government will need to see the maize market for what it really is, a three tier market with little homogeneity formed into one. Under these market dynamics production surpluses will not translate into price decreases due to the inherent difficulty in such a market structure.

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Bibliography
Burke, W. J., Hichaambwa, M., Banda, D., & Jayne, T. S. (2011). FOOD SECURITY RESEARCH PROJECT: The Cost of Maize Production by Smallholder . Lusaka: FOOD SECURITY RESEARCH PROJECT .
Cottan, P. (2006). PROSPECTS FOR REGIONAL . Lusaka: Millers Association of Zambia (MAZ).
Dreger, C., & Kholodilin, K. (2007). Price convergence in the enlarged internal market. European Commission.
McGraw-Hill. (1994). Economics.
Nguleka, E. (2014, June 24). Zambia National Farmers’ Union- Press Statement On Maize Floor Price. Retrieved September 15, 2014, from http://www.znfu.org.zm/: http://www.znfu.org.zm/article/zambia-national-farmers%E2%80%99-union-press-statement-maize-floor-price

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Subsidy Example,Inflation,Problems and Solutions by Kampamba Shula

Mealie Meal subsidy example

A lot of people have been having trouble understanding the subsidy in simple terms so I decided to break the ice here with a clear example.

A farmer has two sons and a brother. Every day he wakes up before everyone and goes into the field to work. Before he leaves, he gives his brother money for house essentials and transport for the sons to school.

The two sons go to different schools. One son is called “Biggie” and the other is called “Smalls”. Sometimes the money for house essentials and transport is not enough and one of the sons has to walk to school instead of using transport, Smalls usually walks while Biggie takes transport. Smalls ends ups missing some of his classes because he is usually late.

Exam time comes and Biggie passes while Smalls fails .The farmer asks the teacher why this is so and the teacher tells him that Smalls misses some his classes and comes late. He goes home and finds out that Smalls misses classes because transport is not enough some times.

This is what the farmer chooses to do. He removes the money he usually includes for transport so that both sons walk to school. He saves this money and goes into town to buy both sons quality textbooks.

At the next exam both sons pass with good marks.

Now in this story the Farmer is the Zambian Government, the Brother is the Food and Reserve Agency (FRA).The two sons Biggie and Smalls are The Big Millers and Small Millers respectively. The transport money is the subsidy which sometimes only goes to the Big Millers. The teacher is the economist and the textbook is the expenditure that Zambian Government wants to use to build universities and schools and hospitals.

This is not an accurate example but is the closest by comparison.

Subsidy Explanation

After the recent subsidy removal by the Zambian Government there has been massive speculation that general prices in the country will go up and by extension Inflation will go up.

Now this article addresses those concerns with Inflation data from the last 5 months.

Just so we are all on the same page firstly what is Inflation??

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services (Abel & Bernanke, 2005).

The term "inflation" originally referred to increases in the amount of money in circulation, and some economists still use the word in this way. However, most economists today use the term "inflation" to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called 'price inflation' (Bryan, October 15 1997).

The Inflation rate is calculated as the change in the consumer price index. The consumer price index measures movements in prices of a fixed basket of goods and services purchased by a "typical consumer" (Mankiw, 2002).

We must now look at the fixed basket of Goods and services and their weights in the consumer price index to find out the effect of the removal of subsidies in Mealie Meal.

Now according to the JCTI Basic food item basket which comprises of Foods like Mealie Meal, Cooking Oil, beans, beef, eggs, Kapenta, tomatoes, onions, vegetables  and other essentials.

Mealie Meal

Mealie Meal accounts for 14 % of the basic food item basket. A 7 % change in the price of Mealie Meal would have a 1% change in the basic food basket.

In September 2011, the Government of Zambia started heavily subsidizing the price of maize held by the Food Reserve Agency (FRA) to maize millers. The expectation was that, by receiving maize at subsidized prices, millers would pass along the subsidy to Zambian consumers in the form of lower retail maize meal prices (Jayne, September 2012).

 Retail maize meal prices have remained virtually constant since September 2011. These findings indicate that very little of the treasury costs incurred in providing FRA grain to millers at below-market prices have benefited urban consumers

THE Millers Association of Zambia (MAZ) says the removal of the subsidy on maize does not necessarily mean that prices of mealie-meal will go up.

MAZ president Allan Sakala says the removal of the subsidy will provide a favourable competition in the milling sector and will create a positive impact on the prices of mealie-meal.

Assuming all things remaining equal the removal of subsidies will not change the price Mealie Meal by any significant margin.

Fuel Subsidy

The Fuel subsidy is however a different matter altogether.

This is a graph of Inflation since the beginning of the year. My calculations lead to an inference that the effect of a 15% percent fuel increase will lead to a possible 1/10 or 1/5 of a percentage point. In other words the Inflation might go up from 6.5 up to 6.7% in the short term.

In the more medium term, that is, later in the year however Inflation might spike up further as the poor harvest of 2012/2013 comes into price effect as well as the effects of expected inflation and as I worry built in inflation.

The reasons for this are as follows using the JCTI basic family basket expenditure. First and foremost the Fuel increase will directly affect the cost of production. This will create an incentive for companies to pass that on to their consumers as a higher price, this may be done gradually or immediately but the eventual effect will see more relatively price inelastic goods absorb the price increases.

An example of a price inelastic good is Mealie Meal. Price elasticity refers to the change in demand of a good given a change in its price. Mealie meal is relatively price inelastic because a change in its price will not change its demand by any significant margin. This is for the reason that if the price of Mealie Meal goes up, people will still buy Mealie Meal.

Secondly, transport costs across the board will go up after the 15% increase. The translation of this to a general price increase will depend upon the type of goods sold and the distance covered to get them to their required destination.

Thirdly and most worryingly is what is called in economics as Built in Inflation. In simple terms what people expect Inflation or general prices to be in the near future also matters, If they expect prices to increase this will have repercussions.

Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

The Built in Inflation I speak of will come into effect in September 2013.Let me explain why.

Government has increased salaries for civil servants with some getting as high as 200 percent effective September 1, 2013 (Lusaka Times, 2013).The windfall follows the successful conclusion of negotiations between Government and the Civil Servants and Allied Workers Union of Zambia (CSAWUZ).

Other benefits in the 2013 collective bargaining include the introduction of the health personnel shift allowance at 15 percent of basic salaries for nurses and other paramedics. The commuted night-duty allowance has been pegged at7%.

Transport and housing allowances have been maintained at the existing rates of 10 and 20% of basic salaries respectively. But given the Government’s recent hike in fuel, workers have valid grounds on which to demand their transport allowances be adjusted to absorb the Price hike, this I fear could cause the Vicious circle.

Solutions

Eleanor Roosevelt said "It is better to light a candle than to curse the darkness". I do not aim to attack the Zambian Government; all I wish to do is give solutions to problems.

Problem 1

High price of Fuel due to in Zambia compared to other countries due to losses in

•          Feedstock Procurement to Dar es Salaam

•          Comparison of CIF Dar es Salaam prices paid by GRZ in 2008 & 2009 with reference (spot) prices shows over-payment. ‘The total “overcharge” vs good international practice was…..US$ 93 million over the two years or 12.5% of total CIF costs 

Solution 1

An agreement is signed to purchase fuel (oil) using futures and options.

What is a Future?

A futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date, unless the holder's position is closed prior to expiration

What is an option?

An option gives the buyer the right, but not the obligation to buy (or sell) a certain asset at a specific price at any time during the life of the contract

Why will this work?

Because the Zambian Government has been procuring Fuel (Oil) at spot rates, in other words they have been paying for what the price of fuel is at the time. This created a 5% loss compared to other countries that use OMC at this stage.

 Fuel prices change every day and month, Options and futures reduce the risk of loss to such volatility.

References

Abel, A., & Bernanke, B. (2005). Macroeconomics (5th ed.). In A. Abel, & B. Bernanke, Macroeconomics (5th ed.). Pearson.

Bryan, M. F. (October 15 1997). On the Origin and Evolution of the Word 'Inflation. In M. F. Bryan, On the Origin and Evolution of the Word 'Inflation. Federal Bank Of Cleveland.

Lusaka Times. (2013, March 27). Civil servants get pay rise. Retrieved May 22, 2013, from Lusaka Times: http://www.lusakatimes.com/2013/03/27/civil-servants-get-pay-rise/

Mankiw, N. G. (2002). Macroeconomics (5th ed.). . In N. G. Mankiw, Macroeconomics (5th ed.). Worth.

Jayne, A. N. (September 2012). Is the Government of Zambia’s Subsidy to Maize Millers. Lusaka Zambia: Indaba Agricultural Policy Research Institute (IAPRI).

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Mealie Meal Subsidy removal analysed by Kampamba Shula

The Government of the Republic of Zambia has resolved to remove the subsidy on Mealie meal.

Agriculture and Livestock Minister Bob Sichinga has announced that cabinet has approved the removal of Maize subsidies He said if the current subsidy was to be maintained, it would mean FRA would continue to be in a loss making position and for it to survive it had to stop depending on Government to support such subsidies. Mr Sichinga said currently the FRA had been buying maize at KR65 and selling it to millers at KR60, with a resultant loss of KR5 for every 50 kg bag sold or KR100 per tonne. He said the FRA would this farming season purchase 500, 000 tonnes of maize and any maize that would be left after the private sector buys the maize from the farmers (Lusaka Times, 2013).
In 2010 and 2011, Zambia achieved record maize harvests of 2,795,483 and 3,020,380 metric tons respectively (Nkonde et al. 2011). Towards the year of elections (2011), the FRA purchased roughly 1.5 million metric tons of maize that it could not fully store, mainly due to inadequate storage facilities. Further, the state could not sell its surplus maize profitably, either in the region or in international markets due to the high price at which it purchased maize locally (Mason and Myers 2011). Moreover, regional transport capacity constraints have limited the volumes that Zambia could export even at a financial loss. Hence, in mid- 2011, and leading into national elections later in the year, the country faced the dilemma of how to offload the large and partially deteriorating maize stocks from the 2010 harvest to make room for incoming maize purchases from the 2011 harvest. Starting in September 2011, the government via FRA offloaded maize to millers at US$140 per metric tonne (roughly 35,000 kwacha per 50kg bag). After accounting for the FRA’s marketing costs and storage losses on top of the 65,000 kwacha per 50kg bag purchase price, it is likely that the FRA lost at least 85,000 kwacha ($340 per tonne) on every bag traded during this period. Further, the government continued to subsidize maize exports within the SADC region at a loss despite the country having to incur high production costs. Thus, while the FRA was spending K65,000 (roughly US$260 per metric tonne) to purchase maize from farmers and incurring additional marketing and storage costs of at least $100 per tonne, it was selling the same maize to other countries within the region at a cost of not more than US$170 per tonne (Lusaka Times 2012).
In September 2011, the Government of Zambia started heavily subsidizing the price of maize held by the Food Reserve Agency (FRA) to maize millers. The expectation was that, by receiving maize at subsidized prices, millers would pass along the subsidy to Zambian consumers in the form of lower retail maize meal prices (Jayne, September 2012).
Over the eleven-year period from 2000 to 2011, inflation-adjusted retail prices for breakfast meal have declined. However, after the subsidy was conferred to millers in September 2011, the mill-to-retail marketing margins have increased significantly. Retail maize meal prices have remained virtually constant since September 2011. These findings indicate that very little of the treasury costs incurred in providing FRA grain to millers at below-market prices have benefited urban consumers.
Moreover, the FRA maize subsidies are only conferred to some millers, not all of the maize millers in Zambia. Millers that did not receive the FRA subsidized maize, in particular the informal and small/medium-scale millers were greatly disadvantaged because they could not acquire maize grain at as low a price as millers receiving subsidized maize from the FRA. This has led to an unbalanced playing field between the millers who benefited from the FRA subsidized maize grain and those who did not. Such an un-level playing field will negatively affect the future competitiveness and market structure of Zambia’s maize milling industry.
Policy Implications
First, because the FRA maize subsidies to millers have so far not been transmitted to Zambian consumers, policy makers might reconsider the policy of providing maize to selected millers at highly subsidized prices, if the aim of doing so is to reduce the price of maize meal to consumers. Second, selective subsidies to particular millers disadvantage other millers plus many informal small-scale millers who are not able to receive the subsidy. Over time, this is likely to entrench the market share of the selected millers having access to subsidized maize supplies, force non-selected millers out of business, and adversely affect the degree of competitiveness within the milling industry. Third, for the Government to achieve its goal of lower maize meal prices to help poor urban consumers, policies should be considered that encourage rather than disadvantage the informal and small/medium-scale food millers and retailers, on whom a large share of Zambian consumers rely.
Conclusions
Research findings agree very well with Chapoto and Jayne (2006) as well as Kuteya and Jayne (2011) that maize meal prices in real terms have been declining over time. However, the rate at which these prices were decreasing after state intervention was less than that of maize grain. As such, the impact of this costly move was not felt by consumers. The mill-to-retail market margins increased tremendously immediately after FRA offloaded maize grain to commercial millers at 400 kwacha per kilogram. These maize grain subsidies which drained the state treasury appear to have benefited large millers alone since the move did not reduce mealie meal prices at the same rate as maize grain from FRA. If government’s objective from these subsidies was also to reduce maize meal prices for the benefit of consumers, it does not appear to be supported by the econometric model results (Jayne, September 2012).
Maize subsidies are perceived as government’s indirect support to commercial millers. But it is a well-documented fact that even small millers (hammer mills) play a major role in ensuring competition in the grain milling industry in the country. Therefore, if the playing field is not leveled, their activities are hampered by selective subsidies and as a result lessening competition in the grain milling industry. The end results are high marketing margins between wholesale maize grain and breakfast meal retail prices. The foregone analysis indicates that selective subsidies conferred to certain players in the market do not necessarily have desired consequences when the market is not fully competitive. If the market were competitive, then subsidies conferred to millers would be passed along fully to consumers, which appear not to be the case in Zambia. Subsidies to maize millers have instead proved to be a drain on the government treasury without trickling down anticipated benefits to intended beneficiaries – urban consumers in this case.


References

Jayne, A. N. (September 2012). Is the Government of Zambia’s Subsidy to Maize Millers. Lusaka Zambia: Indaba Agricultural Policy Research Institute (IAPRI).
Lusaka Times. (2013, May 15). Mealie Meal prices set to go up as Government announces removal of Maize subsidies. Retrieved May 16, 2013, from Lusaka Times: http://www.lusakatimes.com/2013/05/15/mealie-prices-set-to-go-up-as-government-announces-removal-of-maize-subsidies/
Nkonde, C., N.M. Mason, N.J. Sitko, and T.S. Jayne. 2011. Who Gained and Who Lost from
Zambia’s 2010 Maize Marketing Policies? FSRP Working Paper No. 49. Lusaka: Food
Security Research Project.
Mason, M.N. and J.R. Myers. 2011. The Effects of the Food Reserve Agency on Maize
Market Prices in Zambia: Are There Threshold Nonlinearities? FSRP Working Paper
No. 60. Lusaka: Food Security Research Project.
Chapoto, A. and T.S. Jayne. 2006. Trends in Breakfast Meal and Maize Marketing Margins
in Zambia. FSRP Policy Synthesis No. 14. Lusaka: Food Security Research Project.
Kuteya, A.N. and T.S. Jayne. 2011. Trends in Maize Grain, Roller, and Breakfast Meal
Prices in Zambia. FSRP Policy Synthesis No. 47. Lusaka: Food Security Research
Project.

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Mealie Meal Crisis Analysed by Kampamba Shula

The Cause of the Crisis

The roots of the current mealie-meal crisis lie in the seemingly insatiable demand for the commodity from neighbouring countries, particularly the Democratic Republic of Congo (as well as in the broader Great Lakes Region and beyond), which demand has been made even worse by last season’s poor harvest in the United States and Mexico. Here is a summary of the challenge: South Africa has produced about 12 million metric tonnes of maize this year and is able to supply mealie-meal to the Congo more cheaply than Zambia because of its efficient system of planting, harvest, storage, finance and generally well-supported agricultural sector. This year, however, South Africa is not exporting to the Congo because its exports are covering the shortfalls in the North American markets (which were a result of last year’s drought in that region). The massive vacuum in the Congo supply chain has created even greater pressure on Zambian maize. Due to the basic rules of supply and demand, Zambian maize has simply become hot property in the DRC and beyond, pushing up the local sale price to unprecedented levels.

When you add to the regional demand factor, the various problems resulting from (i) the Food Reserve Agency’s confusing role in the maize market (exporting maize when our markets are facing erratic supplies); (ii) infrastructure challenges preventing maize from being collected from rural areas when roads are impassable during the rains and there is no effective storage in these locations; (iii) long-term structural problems in maize marketing; (iv) delays in providing inputs and payments to farmers;

Structural problems from the FRA

Local traders have traditionally had mandates from mills to buy and stock maize for them for release later on in the year but this business has been obliterated by FRA. The reason is simple. If a trader is not sure whether the FRA will also begin releasing maize at a cheap price to millers in the middle of the year, that trader will not want to hold stock that he might have purchased at a high price. This is because even a small reduction in the FRA price to the market could bankrupt a miller that has pre-purchased maize stock for releasing later into the market.

Most millers rely on bank finance but the lack of clarity and planning on the part of FRA makes both the millers and the lending institutions nervous and therefore cautious. They have no certainty as to when the FRA will intervene in the market. The only solution is to focus on the export market or buy limited amounts of stock that they can quickly sell if the FRA drops the price of maize. The financial sector generally prefers to lend to FRA because such lending comes with a Government guarantee. Millers would therefore rather fill their storage sheds with only a few months of stock when FRA is not participating in the market between May and October (a restriction set by the Food Reserve Act).

Further, because not every miller is able to accesses cheaper FRA maize, there is a distortion in the market. A close look at production figures shows that the more efficient producers of maize – essentially the large scale farmers – have tended to diversify into other commodities such as soya beans and tobacco. FRA has therefore only served to promote inefficiency. Current maize yields in Zambia average about 2 tons per hectare when they are supposed to be 5-10 tons per hectare. With its 1.3 million small-scale farmers, Zambia can easily match the average annual South Africa production of 10-12 million tons of maize and feed the continent!

It is also important for Government to begin the exercise of re-thinking our dependence on maize as a staple food as part of a broader crop diversification programme. Consuming huge quantities of maize meal, particularly the refined breakfast meal contributes to the high rates of preventable illnesses – particularly diabetes.

It is important to recall that the private sector has been asking for the recognition of a Warehouse Receipt as a document of title from as far back as 2004. The MMD Government only moved on this in 2010 in an attempt to replace the Agricultural Credits Act. However, the 2012 Act remains unimplemented. This action should be delayed no further. Similarly, an Agricultural Marketing Bill went through stakeholders consultation in 2010 but it is not clear when it will be taken to Parliament despite a Parliamentary Committee report recommending the immediate presentation of the Bill to the National Assembly. It contains important provisions for the improving the sector and curtailing adverse political interference. A Commodity Exchange Bill also underwent stakeholder consultation in February 2010, although it is not clear what stage the Bill has reached.

Current Situation

THE Indaba Agricultural Policy Research Institute (IAPRI) has attributed the hike in mealie-meal prices to lack of competition among large scale millers accessing subsidized maize that have squeezed informal traders out of the market.

 Last month, Government allowed milliers to increase the wholesale price of 25 kilogramme bag of breakfast mealie-meal to KR55 (K55,000) to avoid continued shortages of the commodity on the market.

Making a presentation on Fundamental causes and costs of mealie-meal prices in Lusaka , IAPRI research associate Auckland Kuteya said there has been little benefits transmitted to consumers from the Food Reserve Agency (FRA)’s maize subisidies to millers.

“The question is who is capturing the maize subisidies from FRA…why are retailers or millers able to keep prices so high despite subsidies,” he wondered.

 Mr Kuteya said Government has created a problem where only a few retailers or millers are able to benefit from maize offloaded by FRA, which has squeezed out the informal milling sector.

 He said the millers that are not receiving subsidised maize cannot compete on the market.

 “The Government has brought this problem upon itself by buying most of the marketed maize grain through FRA and selling at too low a price to few millers. If the grains were readily available on the market, the informal milling system could be booming right now,” he said.

 Mr Kuteya said increased demand for Zambian maize in the region has exposed problems in the marketing system which has led to shortages and high prices of mealie-meal.

 He said during the 2010 and 2012 period, the national treasury lost about KR3.8 billion (K3.8 trillion) through FRA due to large scale wastage, transport costs, storage/handling costs and storage losses.

 “Millers are doing what any self-interested business man would do if they had the opportunity. Government can end this behaviour by stopping subsidised millers from operating. Millers should be weaned off the maize subsidies,” he said. He said cross-border traders, millers and traders are not fundamental causes, but the maize marketing system that is not functioning effectively.Mr Kuteya said FRA should concentrate only on strategic food reserves and allow the private sector to get involved in marketing. He acknowledged the difficulties involved in stopping informal cross- border traders from exporting maize or mealie-meal to the Democratic Republic of Congo (DRC) as it offers a good market.

 Speaking at the same function, IAPRI research director and country coordinator Nicholas Sitko said demand for Zambia’s maize and mealie- meal in DRC will always be there as people need food daily.

“If the demand is not met formally, this will create room for informal trade. If mealie-meal cannot be transported on a big truck, people will resort to bicycles and this will push the price of the commodity up as transport costs increase,” he said.

THE IMF says government’s recent increase of mealie-meal prices to cushion transport costs incurred by millers will help improve the availability of maize across the country.

Responding to a press query, International Monetary Fund country representative, Tobias Rasmussen, however said to fully capture the available potential, it would be important for the country to let market forces work.

 “In the present situation, mandated pricing and limits on exports have kept Zambian maize prices well below those in neighbouring countries. This has led to smuggling and is discouraging production. Fixed pricing has also impeded incentives to distribute maize to remote areas where transport costs are high,” Rasmussen said.

Conclusions

FRA should NOT market maize. FRA is like a fork, I am not saying it shouldn't be on the dining table, but you don’t use it to drink soup.

FRA still has a big role to play in the market but not as a marketer but as a store of strategic reserves. Zambia Agricultural and Commodities exchange (ZAMACE), the agricultural commodities exchange must come in to fill in the marketing role. ZAMACE using Options and Futures on Global market prices will be able to secure Farmers a steady market for their crop. Farmers will never be paid late because derivatives like Futures will allow farmers to even be paid up front for crop.

Next, the subsidies of Maize will inevitably have to be reduced and eventually stopped. It is unsustainable in the long run. Maize will need to be depoliticized as a crop; we can’t have the President dictating to Millers at how much they should sell their Maize, Business doesn’t work that way.

Sherlock Holmes (my Favorite fictional character) said that once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth. For Mealie meal prices the impossible is preventing market forces from operating, the improbable is that Zambian must consume less Mealie Meal.

Zambians must eat less Nshima and more cassava, millet or whatever. I know this may sound as disconcerting news but it’s true. Market prices are determined by Supply and Demand. Given that Supply is distorted by FRA and will require Political will to empower ZAMACE, demand is something that as a community and a nation we can begin to address on our own.

The Zambian Government cannot solve all the problems of the country, it is up to ordinary Zambians to stand up and be agents of Change. In this case we have to diversify the Food basket and include other variety of foods.

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