Emerging Markets: China’s changing consumption habits spell danger

Emerging Markets, May 5 2011

China’s shift to a domestic consumption economy will have drastic impacts on the country’s need for soft commodities and could exacerbate global problems of food prices and water scarcity, bankers have warned.

China has a stated objective to move away from an export-led model to one fuelled by consumption at home, which suggests a move away from needing metals to instead needing foodstuffs such as meat and grain. Changes in diet that have accompanied the growth of the Chinese middle class, particularly towards meat and dairy, will also have major knock-on effects. “Unfortunately, meat eats 12 times as much grain as grain does,” noted Donald Hanna, managing director of global liquid markets research at Fortress Investment Group.

“The issue for China is really a question of scale: it really is huge,” Mr Hanna said. “And the other complication we have in markets for food is that when supplies get tight, markets don’t work very well. In fact, as consumers get concerned there might be scarcity, demand doesn’t fall with price increases: demand rises.

“And what do the producers do? They don’t supply more, they supply less. You get this dynamic we last saw in 2008, in which you get these periods in which the markets go completely haywire.” Chinese consumption growth could bring around these circumstances again, he suggested.  “Until we can manage this process of growth and gain some level of efficiency,” such as through technology, “you’re going to have the potential for much more volatile food prices. That’s going to take hedge funds to some interesting places, but it’s not going to be very helpful in dealing with issues like poverty.”

Hiroshi Watanabe, President and CEO of the Japan Bank for International Cooperation, said China’s consumption and industrialization was increasing the pressure on water needed for agriculture, not just in China but regionally. “For agriculture, we need pure water, and unfortunately China doesn’t have very much of it,” he said. “And now the inland provinces of China are going to use more water for industrial use. That industrial use can be replaced by some recycled water, so that the clear water can be kept for agriculture in Laos, Cambodia, Thailand and Vietnam.” That would suggest a level of integration on regional water use that does not exist today, but Mr Watanabe said it was essential. “We need more international coordination, not only one private company or country,” he said. “We need a joint effort, and if not we are going to have a very sad situation.”

Anita George, Director of infrastructure and natural resources at IFC, said water challenges were illustrated by instances such as Saudi Arabia investing into large tracts of land in Africa “to tap into this key resource of water. In a country like India 85% of the water is already being used in agriculture: it’s very inefficient.” But she appeared to suggest the situation could be salvaged, or at least improved. “In fact, the gap between water supply and demand – which is already significant and promising to be one of the biggest crises the world has to handle, can be filled by demand-side management on the agricultural side.”

Chinese consumption is already causing major changes in regional exports. “The rising middle class and the change of consumption patterns in places like China are knocking into other countries in the region and globally,” said Paul Gruenwald, chief economist for Asia Pacific at ANZ. “Because of China’s rising demand for commodities, both soft and hard, Asean countries exports have actually done a U-turn in terms of their composition,” he said: from a declining proportion of commodities in exports through the last decade, the proportion has increased again the last five years “largely because of the effect of China.”