ROBERT MATSILA: Farmers and retailers are protecting, not fleecing, vulnerable households

Global food inflation remains high due to Covid-19-induced bottlenecks and the effect of the war in Ukraine. SA is highly integrated with the global economy and domestic food inflation will trend in tandem with the global FAO Food Price Index. The current weakness of the rand-dollar exchange rate will further expose SA to imported inflation, which will probably prompt the Reserve Bank to continue reining in inflation, largely driven by food prices.

Besides the Reserve Bank, the Competition Commission also expressed concern about persistent high food inflation and announced a pricing investigation on food items at retail and wholesale levels. As the economist Thomas Sowell remarked, “nothing is easier, or more emotionally satisfying, than blaming high prices on those who charge them, rather than on those who cause them.”

The Competition Commission investigation came after the regulator instituted a formal Fresh Produce Market Inquiry (FPMI) in March 2023 to examine whether any features in the fresh produce value chain impeded, restricted or distorted competition.

Wholesale and retail prices are derived prices, meaning that their levels are influenced by upstream production or manufacturing activities. In the case of food, wholesale and retail prices are derived from farm-gate prices, which in turn equate to marginal costs. Wholesale and retail prices are indicative of the value add along value chains, with primary food products serving as a foundation upon which value add and associated costs are added. Therefore, margins measure the extent of the value add to a product. If the extent of a value add is constant, margins should also be constant.

Prompted by the commission’s concern over what it calls “instances of unjustifiable price increases”, this article investigates possible incidences of price gouging at primary and retail levels. This analysis was at the aggregate level.

Starting at the primary farm-gate level it uses the domestic terms of trade. Agricultural terms of trade measure average prices received by farmers for their produce, relative to what they paid for production inputs. A movement of the terms of trade over time indicates a movement of gross margins. Increasing terms of trade would mean that farmers are adding to their margins. Conversely, declining terms of trade mean that farmers are either absorbing some of the increases in production costs or are squeezed by downstream agro-processors. When this happens, farmers are unable to pass on all increases in production costs down the value chain. Stable terms of trade indicate that farmers are protective of their margins by passing-on production cost increases, gaining no margin improvements.

Between the outbreak of Covid-19 and the end of 2022, domestic terms of trade declined 4% (see Figure 1). Over this period, production costs increased at a much faster pace than the increase in farm-gate prices. Therefore, farmers either absorbed a 4% increase in production costs or were squeezed by downstream agro-processors and distributors, something colloquially known as the “cost-price squeeze”.

This brings us to the second assessment at retail level. SA’s major retailers dominate both the rural and urban landscapes, providing a good proxy of general pricing behaviours. A measure like the terms of trade is the gross profit (GP) margin. The advantage with the GP margins analysis is it is at a level before other cost line items come into play, which would be different across all retailers.

Widening GP margins over time would suggest a retailer is adding more to the final retail price relative to the cost of sale. If this trend is pervasive across all major retailers, it may give the impression of market co-ordination. A decline in GP margins over time would indicate cases of retailers absorbing some of the increases in the costs of sale to protect consumers. Lastly, stable margins in an environment of rising retail food inflation are mainly a product of the pass-through effects of rising costs of sale. Since 2019, average retail margins have been stable, averaging 23% with a slight decrease of about 2%.

Viewed together, farmers absorbed 4% (voluntarily or involuntarily) of the costs increases while retailers absorbed approximately 2% of the increases on the costs of sale. Therefore, these calculations indicate that there has been an average of 6% cushion provided to cash-strapped consumers. All these are happening in an environment of rising imported inflation, high electricity tariffs, load-shedding and rising interest rates, all adding to production costs.

Despite the above, it is possible for any retailer to increase markups on fast-moving line items while reducing margins on less-moving items to the extent that overall margins remain stable.

Policy options to protect vulnerable households

As a public entity, the Competition Commission derives its mandate from the government. The commission expressing a concern over high food prices can be regarded as an expression of concern by the government. During Covid-19, the government deployed various fiscal and regulatory measures that sought to offset, to some extent, the effects of the pandemic on households. Although these measures entailed higher fiscal spending, the positive social effects were noticeable. Persistent high food prices are a threat to food security. In fact, Stats SA reports that there are 2.6-million households that are food insecure. Fortunately, there are solutions, but these would, however, require further fiscal support:

• While several of the food items covered by the investigation are already zero-rated VAT items, others such as pasta are still not exempted from VAT. The list of food items exempted from VAT could be expanded.
• There is also a possibility of a temporary reduction of import tariffs on critical food imports. A depreciating rand is adding to imported inflation. In 2022, the government suspended anti-dumping duties on imported poultry products. Similar measures with minimal negative effect on employment, could be extended to other critical food imports.
• Since Covid-19, there has been an increasing level of consolidation and concentration in the economy, combined with vertical integration in the agricultural value chain. Consolidation, vertical integration and concentration lead to an oligopolistic market structure and attended pricing structure. Therefore, it is important that the Competition Commission pay particular attention to the effectiveness of the Competition Act for the current economic conditions to safeguard a competitive business landscape.
• During Covid-19, the government devised the Covid-19 loan guarantee scheme to assist eligible businesses during the pandemic. The current high-interest rate environment is already claiming businesses, including farming ventures, and threatening food security. The government should consider similar schemes targeted at farmers with concessionary loans to refinance the now expensive floating rate loans.
• Fresh produce markets (FPMs) proved critical to the agricultural sector and the informal sector during Covid-19 lockdowns. These FPMs handle approximately 3-million tonnes of produce each year. Pervasive load-shedding calls for the FPMs to be equipped with alternative energy sources to preserve the quality and shelf-life of agricultural produce. Loss of food through wastage is also accounted for in the production cost and ultimately in the final price of food. Therefore, increased wastage also contributes to cost-push inflation. While the commission has instituted a market inquiry in this space, the impact of wastage from load-shedding on the operations of FPMs should also be considered.
• SA is not self-sufficient in wheat production and imports approximately 40% of the total domestic requirements. Due to these supply and demand dynamics, SAFEX wheat prices are not only volatile but normally trade at import parity levels (the landed price of an import). The government should therefore consider mandating the National Agricultural Marketing Council or any other relevant agency to start maintaining strategic food reserves. SA is normally self-sufficient in maize production and as such, an intervention in the maize market may not yield as much benefit as it would for wheat. An intervention of this kind would improve the security of supply and reduce price volatility and pricing levels. Countries in North Africa and the Middle East do maintain strategic reserves of staple food, through state agencies, helping in preserving food security. These countries are performing better on the Global Food Security Index.

• Matsila is a sector specialist in agriculture and agro-processing for the Public Investment Corporation.