Agricultural markets looking beyond economic jitters in China

FCC Economic Update

Highlights

  • There are definite signs of the Chinese economy slowing down. The sudden 4.6 per cent depreciation of the Renminbi was the most significant decline in 20 years.
  • The value of Chinese currency may not be the best way to gauge the health of agricultural markets.
  • China is a major importer of soybeans, pork and skim milk powder. The country carries considerable weight in the global marketplace.
  • Recent news of the liquidation of the Chinese sow herd is good news for exporting countries like Canada.

Economic and financial updates out of China are met with apprehension these days. There are definite signs the Chinese economy is slowing down. It started with the sudden 4.6 per cent depreciation of the Chinese currency (Renminbi, or RMB) against the United States dollar in August. This was the most significant decline in 20 years.

Conventional wisdom suggests that a weaker currency raises prices for commodities traded in U.S. dollars, leading to a decline in demand and ultimately lower prices for Canadian agricultural producers.

But is the value of the Chinese currency the most useful statistic to gauge the health of agricultural markets? Is it Gross Domestic Product? And if not, what are the alternatives?

" The value of the Chinese currency should not be the primary focus of agricultural producers and agribusinesses. After all, the depreciation of the Euro and Japanese yen has been a lot more substantial over a long horizon and both destinations are important markets for Canadian agriculture. "

China imports 64 per cent of all globally-traded soybeans. It also imports 10 per cent and 13 per cent of all pork meat and skim milk powder trade flows, respectively. So the country carries considerable weight in the global marketplace.

Putting the economic slowdown in context
The Chinese economy officially grew at an annual rate of seven per cent during the first half of 2015. Statistics coming out of China have always been met with a certain degree of scepticism, yet the current pace of growth appears in line with the government’s target.

There are signs that a significant economic slowdown will occur as the economy transitions away from investment, such as construction and infrastructure development. The ironic part of the discussion about the depreciation of the Chinese currency is that net exports have not been a major contributor to economic growth in recent years, at least not as much as investment.

Investment contributed on average to more than 50 per cent of growth in China’s GDP in the last decade.

The decline in investment lowers the demand for materials and commodities. But this is mostly impacting hard commodities, not necessarily food and agricultural products. Unless consumers start feeling the impact of the slowdown.

The labour market remains strong – at least by official accounts. Unemployment remains low. Consumer income went up 11 per cent year-over-year in July. Upward pressures on wages still exist because of the declining active population – workers in the age bracket between 15 and 59. Yet, the Chinese total population is growing. And that expands their demand for food along with rising income.

Demand for agricultural commodities remains strong
The most recent United States Department of Agriculture report on world demand and supply conditions revised the projections of China’s soybeans imports upward for the 2015-16 marketing year.

Underlying demand for oilseeds appears strong and the liquidation of the sow herd continues in China - the most recent statistics reveal a 15 per cent decline, year-over-year. That’s bullish for the pork market and positive for exporting nations like Canada.

The International Grains Council recently suggested policy changes in the Chinese grain market are likely coming. Reducing the price support in China for corn would potentially unlock a stronger demand for corn. Incidentally, Chinese corn imports increased again for a fourth consecutive month in June.

Volatility surge expected
China’s economy is not without risks. The greatest threat to their economic stability is the level of debt and current deflationary pressures. When prices in the overall economy come down, debt levels do not adjust proportionally and that can cause major disruptions that would have far-reaching consequences.

The value of the Chinese currency should not be the primary focus of agricultural producers and agribusinesses. After all, the depreciation of the Euro and Japanese yen has been a lot more substantial over a long horizon and both destinations are important markets for Canadian agriculture.

Continued emphasis should remain on market fundamentals lie the strength of demand and available supplies. The Chinese economy will continue to slowdown and the currency is likely to further drop against the U.S. dollar. And that would be a positive development overall for agricultural markets because it will ultimately balance economic forces in China. But the road may be bumpy – we better brace for some volatility.

J.P. Gervais, Chief Agricultural Economist

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