Financial crisis impact study

by Arvin Donley
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A report issued in January by Rabobank Group paints a relatively optimistic picture for the global agricultural industry in 2009.

Despite a significant deterioration of the global economy in recent months, demand for food and agricultural products in volume terms is not expected to decline, but to keep growing in 2009, said the Utrecht, Netherlands-based bank that specializes in serving the food and agriculture industries.

"With long-term demand drivers — such as a growing world population, changing diets and increasing production of biofuels in a time of low stock levels for the important grains (such as corn and wheat) — still in place, a rise in prices of agricultural commodities is possible as soon as the (economic) situation normalizes," Rabobank said. "In theory, it only takes one crop that does not fully meet demand to bring back the situation seen at the beginning of the last commodity boom. This could be the case in the first half of 2009 for the southern hemisphere and the second half of 2009 for the northern hemisphere."

Rabobank said it expected global economic growth to decline in 2009 after four years of above-average growth. In advanced economies, a contraction of the economy is expected, whereas emerging and developing countries are expected to continue to grow, although at a slower rate.

As for inflation, Rabobank forsees it dropping significantly in 2009 after peaking in 2008. Food price inflation in particular can be expected to fall even faster in the coming months now that agricultural commodity prices have rapidly declined.

After 2009, Rabobank expects the global economy to start recovering from the recession. The report said that the U.S. economy is expected to lead this development and will show the first signs of recovery in the second half of 2009, followed by Europe and other regions in 2010.

In the short term, however, Rabobank said many food and agribusiness companies will struggle with issues stemming from the global recession.

The report noted that default risks of suppliers, clients and banks have suddenly risen for many players in the food and agribusiness value chain, and foreign exchange risks have also grown. In some markets, suppliers have become wary of selling, while buyers are not willing to enter into the market and some long-term contracts have been renegotiated.

The growing loss of confidence and the financial crisis have reduced the availability of letters of credit, export credit insurance and working capital from banks, which many companies in the food and agribusiness value chain depend on.

For all companies, it is difficult to take long-term positions. Many financial investors have stepped out of the agricultural commodity markets and liquidated their positions, which has contributed to the dramatic fall in agricultural commodity prices.

Refinancing risks have risen rapidly and access to credit and capital markets has declined. The result has been a decline in prices and an increase in uncertainty over price direction for most agricultural products, as well as a subsequent increase in the costs of long-term hedging and a reduction in the number of participants willing to take a position in the market.

Rabobank noted that in this environment it is difficult to execute effective risk-management strategies.


While the demand elasticity of food is generally low because it is a basic good, within the food category a "trading down" (switching to lower-cost alternatives) is taking place such as consumers switching from beef to poultry and from beef to sausage, Rabobank said.

In recent years, the changing diets in Asia, following economic growth and urbanization, have been a strong demand driver in global commodity markets. Asian consumers switching from rice to meat and dairy has had a multiplier effect on the demand for commodities, as it takes several kilograms of feed to produce one kilogram of meat. As economic growth in Asia is still relatively high, the dietary change can be expected to continue, albeit at a somewhat slower rate, Rabobank said.

Moreover, food price inflation in Asia, as in other parts of the world, can be expected to come down now that commodity prices have declined sharply and freight rates have declined considerably (see figure 1). This is another reason for relatively strong demand expectations for food staples such as grain, oilseeds and meat in Asia.

Rabobank foresees biofuel demand to keep growing, primarily because the sector is largely driven by government support ranging from subsidies for feedstock production to tax breaks and compulsory blending requirements. Therefore, the bulk of the demand for biofuels is not likely to be directly affected by the economic crisis, particularly in countries with requirements for the use of biofuels.

Discretionary demand for biofuels (most notably in the U.S. and Brazil) may be affected to some extent as the result of falling gas prices in the U.S. and a decline in new car sales in Brazil.

The potential supply of biofuels will be affected by the financial crisis as capacity expansion in the short to medium term will probably become restricted as in most other sectors, due to limited availability of credit. Another issue that could reduce biofuel supply — and thus demand for feedstocks such as corn and oilseeds — is that many biofuel producers, particularly in the U.S. and E.U., are in financial trouble or having difficulty obtaining credit. Rabobank foresees smaller global crop production as a result of declining commodity prices. Farmers in the Southern Hemisphere, particularly in South America, are forecast to apply less fertilizer on the current crop since, at the time of planting, the cost of fertilizer had not dropped as quickly as grain and oilseed prices. The report also said farmers in this region will likely take marginal land, which requires high input levels to deliver a crop, out of production. Add to that the devastating drought that is plaguing South America’s top crop producing nations Argentina and Brazil, and a smaller crop in the Southern Hemisphere is likely in 2009. The situation in the northern hemisphere is more favorable as fertilizer prices are coming down, meaning the margin squeeze for farmers my have eased by the time they have to apply fertilizer in the spring.



Rabobank said the impact of the financial crisis on availability of credit to farmers around the world has been relatively small, as most rural banks were not directly affected by the subprime lending issue that played a major role in the failure of dozens of banks worldwide.

However, these rural banks are faced with lower availability of capital and have to revise margins upward to absorb the increased cost of capital. Moreover, the deteriorating short-term outlook of profitability and farmers’ liquidity, due to lower sales prices and margins, increases the financial risk and thus reduces the availability of credit and raises spreads on loans.

The subsequent rise in interest costs will impact farmers and may result in shifts in crop plantings. In Brazil, for example, the capital required for inputs to grow cotton is four times the capital required to grow soybeans, which may stimulate farmers to switch from cotton to soybeans due to rising interest costs.

Although the food and agribusiness industries typically enjoy relatively low risks and stable returns, they will be negatively affected by the financial crisis. Consolidation will no longer be fueled by private equity houses that were supported with abundantly available debt, but rather by strategic investors with strong balance sheets. Refinancing risks of highly leveraged companies have increased, and a return to more conservative financial models and long-term relationship banking can be expected, as this will secure access to credit for food and agribusiness companies in the long run.



According to the report, the effect of consumers "trading down" will result in lower margins along most of the food and agribusiness industry value chains. The following factors have increased the risk profile of many players in these value chains:

• The past period of high commodity prices has eaten into the reserves of those that could not transfer rising commodity prices to their customers.

• The recent downturn in prices of agricultural products negatively affects the margins of primary producers, just as the high prices of farm inputs did the past year and a half.

• Significant problems arose for those that hedged imperfectly on commodities in the past period, due to huge price fluctuations.

• The increased price volatility, the lack of willingness to engage in longerterm commitments, and the rising cost of price hedging makes it more difficult to mitigate price risk.

• The recent wave of highly leveraged consolidation deals caused significant refinancing risks for a number of companies.

• Financial institutions are setting stricter criteria to grant further credit or refinancing.

The combination of these factors has resulted in a precarious situation in which opportunities will arise for those players in the food and agribusiness value chain that look for strategic opportunities and can rely on a strong balance sheet, the report said.

"Due to a deteriorating investment climate, it can be expected that investments along the food and agriculture value chain will be postponed," Rabobank said. "This may have a depressing effect on the food supply in the next few years, which would make it even more challenging to meet the future world food requirements."