Investors are underestimating the severity of the “global food shock”, which is set to hammer public finances and stir up social unrest in emerging market countries for years to come, according to rating agency S&P Global.
Food prices have soared since Russia’s invasion of Ukraine stymied the flow of agricultural produce from one of the world’s top exporters of wheat and other grains as well as sunflower oil. Combined with an accompanying surge in oil prices, this is likely to pressure the creditworthiness of a slew of emerging economies, S&P Global said in a report published on Wednesday.
“Rising energy and food prices represent yet further balance-of-payments, fiscal, and growth shocks to the majority of emerging markets. This intensifies strains on their public finances and ratings, which are already impacted negatively by the global pandemic,” said Frank Gill, sovereign specialist for Europe, Middle East and Africa at the ratings firm.
S&P Global said that although many of the sovereigns most exposed to the rising pressure from food prices already had low credit ratings, the negative economic or political fallout of the food shock could contribute to further downgrades. Emerging market bonds have steadied in recent days after suffering the worst start to a year in decades because of rising global interest rates.
Investors in emerging market debt said food costs had become a looming problem for poorer countries since the war. “For emerging markets, food is a much more significant part of your disposable income. If you’re a big importer or a poorer country this is painful. This is an issue that can cause governments to fall,” said Uday Patnaik, head of emerging market debt at Legal & General Investment Management.
Sri Lanka, which defaulted on its international debts last month, was an example of where surging food prices contributed to dwindling foreign reserves as well as a rise in protests and social instability. The government has faced severe shortages of essential goods and has appealed for food assistance from a food bank operated by the South Asian Association for Regional Cooperation.
“Sri Lanka was already highly distressed before the Ukraine conflict. But [the food price shock] was the final straw that pushed them over the edge,” said Patnaik.
The report said low and low-to-middle income countries in Central Asia, the Middle East, Africa and the Caucasus would be worst hit by the immediate shocks in the food commodity markets. In the Caucasus, Tajikistan and Uzbekistan have a high food import dependency, and normally buy the bulk of their wheat from Kazakhstan which has export restrictions in place. Of the Arab states, Morocco, Lebanon, Egypt and Jordan rely on Ukraine for their food supply and were susceptible to war-induced price disruption.
Given that many of these countries had limited capacity to replace imports with substitutes, adjustment to the price shocks would lead to lower food availability, raising the risk of social unrest, according to the report.
Not all emerging market debt has been affected, however, with the commodity price increases benefiting raw material producers. “For the middle eastern countries, you might be paying more for agricultural products but that is more than offset by crude prices,” said Patnaik.
Brett Diment, head of global emerging market debt at Abrdn noted that, while local currency bonds in the JPMorgan GBI-EM index have delivered total returns of minus 10.5 per cent so far this year in dollar terms, there is wide divergence between countries.
Brazilian debt, for example, has rallied in part thanks to its status as a leading agricultural exporter. After the invasion, Abrdn cut its exposure to large food importers such as Egypt but increased its exposure to agricultural commodity producers including Brazil and Argentina. “We’ve already seen the impact of food inflation play out in the market,” said Diment. “Egypt devalued its currency in March, but Argentina, Brazil, and Uruguay as big food exporters have all performed very strongly.”
He said the movements in bond and foreign exchange markets “presupposes we don’t see another leg higher in food prices” as the issue has moved up the global political agenda leading to optimism about possible grain and vegetable oil exports being shipped out of Ukraine. Absent that, “we could see things get worse again for vulnerable countries”, he added.
S&P Global said rising input costs such as fertilisers and machinery were placing additional costs on agricultural production. Russia, a leading fertiliser exporter, could continue with export controls and increasing competition for key agricultural inputs in 2022 and 2023 would limit the output rises, prolonging the impact from high food prices.
“International markets appear to be viewing the fallout of the war in Ukraine on food prices as a single-year shock,” the report said. “In contrast, we believe the shock to food supply will last through 2024 and beyond.”