TCA Apr 2014

Feeding a Billion: China’s Transforming Agricultural Sector

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As China’s agricultural sector struggles to keep up with the country’s growth in demand, many opportunities are arising for companies interested in capitalising on this challenge. China’s struggle to consistently secure adequate food supplies of a sufficient quality has resulted in its agricultural sector being placed under increasing scrutiny. The State Council, China’s highest decision-making body, released guidelines in February 2014 that suggest that the country will no longer aim to match demand for grain through domestic production alone, as has been the case since the days of Maoism. These are the first public signs that Beijing is coming to terms with the realities facing China’s agricultural sector. China’s shrinking farming capacity, as well as some of its archaic agricultural policies, will hamper its ability to achieve food security in the long term. China’s ability to meet the agricultural demands of its population will usher in a new era off opportunities for agricultural companies. By Dominique Scott

 

The situation

If China were self-sufficient with regard to agricultural products, it would have to feed 20% of the world’s population with only 10% of the world’s arable land and 6% of global water resources. In the past, this situation was manageable due to the fact that Chinese citizens generally depended on vegetables and grains for energy with only small portions of meat for flavour. Arguably, these dietary preferences arose as a consequence of many not possessing the wealth to buy more expensive food products, as many can today.

However, China’s meat and calorie intakes have climbed in conjunction with the country’s GDP. In 1980, for example, China’s average level of protein consumption was a mere 12% of the average of Japan, Malaysia, Australia and New Zealand, a culturally diverse sample. By 2009, China’s protein consumption had risen to 56% of the above sample’s average. China’s large population and the apparent remaining growth in China’s appetite illustrate how much food will be needed to meet future demand.

One of Beijing’s responses to China’s lack of food security was to set a 95% ‘self-sufficiency’ target on key grain products—corn, rice and wheat—to shape the way land and water resources were prioritised and insulate the country from fluctuations in global grain prices. The production of meat is more land and water-intensive than the production of vegetables, fruit and feed. Putting extra pressure on already strained resources was thought to be unwise. A pound of beef requires a staggering 6,810 litres of water, pork 2,180 litres, soybeans 818 litres, potatoes 450 litres, corn 409 litres and apples 70 litres.

Additionally, the low quality of China’s natural resources is exacerbating the country’s resource shortage. The Organisation for Economic Cooperation and Development (OECD) estimates that 70% of China’s arable land is low-yielding, and erosion, salinization and acidification are leading to a further reduction in the quality of China’s soil. Further, these estimates do not take into account the effect of pollution on China’s arable soil. Some analysts say between 8-20% of China’s arable land is contaminated by heavy metals.

Interestingly though, this ‘self-sufficiency’ target has been abandoned for a more open policy according to guidelines released by the State Council in February 2014. Analysts have proposed that land and water-intensive products, like beef, offer higher profit margins than vegetables, fruits and grains. Beijing may be attempting to ameliorate China’s high inequality by allowing farmers to choose to farm more profitable produce. However, this policy alone will be insufficient to overhaul China’s agricultural sector.

Furthermore, food scandals, whether it’s comical glow-in-the-dark pork chops or melamine-tainted milk, emerge in China with alarming regularity. Unsurprisingly, China’s growing middle class is demanding imported food and beverages so long as there is apprehension regarding the quality of local products. The apprehension around the quality of domestically-produced powdered baby milk, in particular, has had profound effects around the world. Supermarket stores in Hong Kong, Australia, New Zealand and even as far as the UK have implemented policies aimed at rationing baby formula due to a surge in demand from China.

Regardless of whether Beijing abandons its ‘self-sufficiency’ targets, opportunities for investors lie in the Middle Kingdom’s future nutritional needs. The Chinese market’s sustained growth will result in an increase in demand for a wide range of food commodities – foreign intervention and innovation will help meet this demand.

 

The outlook

If President Xi Jinping follows through on his commitment to double China’s GDP per capita by 2020, demand for the more expensive categories of food, such as animal protein, will rise the fastest. Most of this increase in demand will be met through an increase in imports due to China’s aforementioned shortage of high quality agricultural inputs.

The OECD and Food and Agriculture Organisation (FAO) have estimated that by 2022, China’s consumption of food commodities will increase considerably across all categories, as demonstrated in the chart below. Possibly as a result of China’s struggle with tainted milk, the dairy category holds one of the largest gaps between domestic production and consumption. Notably, these projections were made before the State Council announced its abandonment of the 95% grain self-sufficiency guidelines, which will expand farmers’ control over which commodities they grow. Now that these targets will likely be removed, China is projected to experience a rapid expansion in grain imports.

 

The solutions

There is little doubt that Beijing faces a challenge in solving the country’s dramatic mismatch between supply and demand of food products. While many propose that it is inconceivable for China to achieve food security due to its scarcity of water and land resources, Beijing can reduce its dependence on imports in the long term through the implementation of strategic policies.

Remnants of Maoist collectivism, for example, remain present in China’s rural land policies and reduce motivation to increase agricultural production. Providing farmers the opportunity to own, sell and borrow against land to expand business opportunities and profits may solve some of China’s food woes. Allowing for consolidation could create an environment that makes unprofitable enterprises financially unsustainable and rewards those that are profitable. The economy of scale achieved through the consolidation of farms will likely achieve higher production volume at a lower unit cost.

Since 1997, an estimated 8.2 million hectares of arable land, roughly the area of Austria, has been lost to property developers catering to a growing urban population. While increasing the size of China’s urban population is an important step towards shifting China to a consumption-driven economy, this process has been administered in a haphazard fashion, which has jeopardised the country’s limited fertile land. A policy that preserves the most fertile land while using infertile land for infrastructure could provide for greater efficiency and productivity in the agricultural sector. China’s urbanisation and property development also presents an opportunity to increase productivity in the agricultural sector.

Urbanisation has resulted in roughly 25 million Chinese farmers becoming defacto urban residents every year, which has led to the rapid development of labour-saving machines, such as tractors, produce sorting machines and refrigeration systems, for farms and food processing factories. According to a report by the Ministry of Agriculture, only 33% of China’s corn and 69% of its rice are mechanically harvested every year. The report also stated that China performs 72% of its post-harvest processing tasks, such as sorting and packaging, by hand. The opportunity for the mechanisation of the agricultural sector is evident. Mechanisation may, however, result in unforeseen consequences related to unemployment in China’s labour market, so policymakers and the business community would benefit from a coordinated approach to solving challenges in the agricultural sector.

Even if new policies could maximise the amount of arable land, China will continue to suffer from its unproductive use of land. While China’s agricultural total factor productivity, a measure of a country’s long-term technological change, has risen in the reform era, it still lags behind that of developed nations. Advanced agricultural techniques and technologies for fertilisation and irrigation, for example, could help with increasing productivity. Gradually opening up the agricultural sector to foreign investment, which the central government currently forbids, is a potentially effective strategy to transfer such techniques and technologies. Unfortunately, Beijing may not have the luxury of time if it wants to reduce its reliance on imports.

Beijing’s ‘Going Out’ policy, through which the central government aids firms, private and state-owned, to make acquisitions and investments abroad with the intention of securing physical assets and the associated intellectual property, could complement the reform of the agricultural sector. From 2010 to 2013, Chinese food and beverage companies made over USD 9 billion worth of deals overseas according to the National Australia Bank. Deals such as Shuanghui’s acquisition of Smithfield, the world’s largest pork producer and processor, in May 2013 and COFCO’s March 2014 acquisition of majority stakes in Noble Group’s agribusiness unit and Nidera stand out, but there are countless examples from around the world. With China already having established good relationships in Africa, Australasia and South America, where some of the most fertile farmlands in the world exist, the opportunity for increased OFDI in agriculture is certainly available.

Genetically modified (GM) food may provide a partial solution to China’s food supply woes as well. GM crops have the potential to overcome many of the challenges of agriculture in China, such as low-yielding arable land and decreasing soil quality. Furthermore, the benefits of lower costs will also aid in keeping inflation in check. However, GM food is a sensitive topic in China—the public remains cautious as to whether the government has fully addressed the potential risks. Nevertheless, the Ministry of Agriculture has taken the lead in publicly declaring the safety of GM food and is slowly pushing domestic production ahead. According to Han Changfu, the Minister of Agriculture, 17 GM products from five plant species are currently sold on the domestic market: soya beans, corn, oilseed rape, cotton and tomatoes. Currently, the only GM crops approved for domestic commercial production are cotton and papaya.

Lastly, firms can mollify China’s food safety fears by exporting from their home country or by producing strategically within China. Tyson Foods, one of the world’s largest processors and marketers of chicken, has shifted from its conventional business model of sourcing from independent chicken farmers and has built its own network of farms in China, providing direct oversight over the production process. In 2010, Tyson did not have any farms in China; today, they have 20, and they plan to own and operate 90 by 2015.

 

The opportunity

The problems that lie ahead are not unique to China. Numerous countries face the prospect of having to rely increasingly on importing food to meet domestic demand. What magnifies China’s challenges is the size of its population, which has the potential to create shocks on global markets. If China cannot meet demand with domestic supply, global prices of certain food commodities will undoubtedly rise. Should prices rise too much, affordability will become a crucial issue around the world. While farmers may benefit the most from this situation, worldwide consumers will be on the receiving end. China’s challenge, to a certain extent, will become the world’s challenge.

China’s growth in domestic food production in the last thirty years is an astonishing feat, yet the country’s deteriorating quality and dwindling availability of natural resources mean that this growth is still not adequate. Pollution must be minimised. Arable land must not be sacrificed for urban sprawl. Land policies should reward profitable agricultural enterprises. Together, these actions could alleviate pressure on China’s agricultural sector.

Companies able to navigate China’s shifting agricultural landscape will be primed to benefit from this key market. China’s agricultural players desire advanced labour-saving technology and will undertake joint ventures to attain it. Agricultural exporters around the global will benefit from increasing levels of demand for agricultural commodities and increasing flows of capital from China. The companies that see the magnitude of China’s agricultural challenges will recognise the opportunities available.

 

Dominique Scott, Consultant
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