Analyzing Afghanistan's wheat flour market

by Arvin Donley
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Since the turn of the century, Afghanistan has emerged as one of the world’s largest importers of flour, consistently ranked among the top three annually along with Uzbekistan and Iraq.

In the post-2000 period, although flour production has increased rapidly in Afghanistan, demand has grown even faster, spurred by a rapidly expanding population and strong economic growth, albeit from a low base. The gap between domestic supply and demand began expanding in 2001 and exploded in 2006, when flour imports first surpassed 1 million tonnes.

A study, “Afghanistan’s Wheat Flour Market: Policies and Prospects,” released in the fall of 2013 by the U.S. Department of Agriculture’s Economic Research Service (ERS), examines trends in the industry and the role that policy interventions aimed at protecting the country’s wheat milling and farming sectors play in shaping the country’s long-term growth prospects for domestic flour production and imports.

The report notes that Afghanistan stands in sharp contrast to the international norm in its ratio of wheat grain to wheat flour imports, as flour comprises about 74% of the country’s total wheat imports. Afghanistan relies more heavily on imports of the processed commodity, in effect leaving the value-added from milling to other countries.

Afghanistan is a landlocked country, bordered on the west by Iran, on the south and east by Pakistan, and on the north by Turkmenistan, Uzbekistan and Tajikistan. It imports wheat and flour from a number of these neighboring countries, with Pakistan being the leading supplier.

The ERS report said the private millers and traders of Pakistan work closely with Afghan traders.

“Pakistani flour is widely accepted by Afghan consumers because of its quality, and Pakistani mills extend credit to Afghan traders seeking to purchase flour,” the report said.

Kazakhstan, the largest exporter of wheat in the region and in recent years a dominant flour exporter, is the other major supplier, although it does not share a border with Afghanistan. The quantities of Kazakh wheat and flour that have been exported to Afghanistan arrive via circuitous routes through Tajikistan, Uzbekistan, and Turkmenistan.

“In 2008, extremely tight supply situations in Afghanistan and Pakistan allowed Kazakhstan to increase its exports to Afghanistan to an unprecedented level of 1.3 million tonnes, or 34% of the Afghan import market,” the report said. “However, even then substantial price hikes were needed to ring these increased Kazakh flour shipments through the inefficient transport system from the north. The supply situation in Pakistan eased in the following years, allowing that country to again increase its share of the Afghan import market at the expense of Kazakhstan.”

Struggling milling industry

Afghanistan’s milling industry has, over the past three decades, deteriorated to the point that it has difficulty competing with flour producers in neighboring countries, the ERS said. Small-scale water, diesel and electric mills, known as “asiabs” or “zirandas,” provide the vast majority of domestically produced flour in Afghanistan. These mills each process 1 to 3 tonnes of wheat per day and account for approximately 90% of the country’s flour production, according to a 2012 USDA report. These small stone/disk grinding machines, powered mostly by diesel fuel or electricity, mill wheat as whole meal without separating the bran, implying an extraction rate of 100%. These traditional processors are particularly important in rural areas where underdeveloped infrastructure impedes transportation.

The country’s five public mills and eight commercial facilities capture only a small fraction of the flour production market, the ERS said.

“During the Afghan civil war, the public mills that were built by the Soviet Union in the 1980s were partially or completely destroyed,” the report said. “The remaining five Soviet-constructed mills in Mazar, Kandahar, Hirat, and Pul-e-Khumri are mostly used for grain storage, while the public mill in Kabul provides flour for the Afghan National Army.

The eight commercial mills in Kabul, Mazar, Jalalabad and Hirat, with milling capacities ranging from 80 to 500 tonnes per day, operate at less than full capacity, or in some instances, not at all, according to the ERS. In addition to unreliable supplies of electricity and competition from Pakistani flour, limited marketed surpluses of Afghan wheat have discouraged the growth of commercial milling activity.

Although there is a paucity of empirical data on wheat sales within Afghanistan, available information indicates that rural households consume most of the wheat they grow, with little surplus production available for domestic commercial market, the report said. In a typical year, the northern region of Afghanistan accounts for the vast majority of the relatively small quantity of wheat that is marketed.

Smaller-scale enterprises are better suited to Afghan conditions than larger scale “modern” flour mills, the report said, because the small-scale mills are more flexible in terms of power sources.

“The country’s limited infrastructure and low farm yields also favor small-scale mills,” the ERS said. “Since yield per acre is low, a large mill would have to procure wheat over a large land area to obtain enough wheat to operate at capacity and keep costs low, which is difficult when infrastructure is poor. So until farm productivity, road transportation and power supplies improve, the milling sector is likely to be dominated by a large number of widely dispersed, small-scale agro-processing mills.”

Unstable domestic wheat supply

Afghan flour producers, whether small scale, commercial or public mills, must cope with highly variable domestic wheat supplies, the report said.

“During the main growing period there is little, if any, reliable rainfall, meaning that the country must depend on irrigation to meet the majority of its crop-water requirements,” the ERS said. “Winter snowfall in the mountain ranges of central Afghanistan supplies over 80% of the country’s annual precipitation. Given the absence of sufficient rainfall during the critical growing period, the timing and duration of annual snowmelt is a key factor in determining the volume of irrigation water and the length of time it is available.”

In 1980, Afghanistan produced 3.1 million tonnes of flour on a wheat equivalent basis, relying largely on domestically produced wheat. Flour production remained stable for about five years afterward and then deteriorated beginning in 1986. By 1992, following years of domestic conflict, flour output was little more than half of its 1980 level as decreases in the country’s wheat harvests, combined with falling imports of wheat, reduced the total amount of wheat available for milling in Afghanistan.

Flour production in Afghanistan was on a general upward trend from 1993-99, supported primarily by expanding Afghan wheat output, driven by strong gains in yield.

“Nevertheless, during this period domestic production of both flour and wheat remained below their 1985 peaks due to relatively slow growth in area cultivated to wheat,” the report said.

The country’s flour production grew rapidly in the post-2001 period and was more stable than its wheat harvests. Growing conditions, which were relatively favorable between 2002 and 2007, contributed strongly to increases in the total amount of wheat available for milling. In 2003, the country’s production of wheat and flour finally surpassed the 1985 peaks.

Wheat production in 2008 was 37% below the prior year, while in contrast, the contraction in flour output was relatively modest at 8.8% Excellent growing conditions allowed the production of wheat and flour to rebound in 2009-10. Yield rose to a new high of 1.65 tonnes per hectare, but erratic domestic wheat supplies remain a challenge for the milling industry (USDA estimates indicate the 2011-12 harvest was 32% below that of 2010-11).

Strong link to Pakistani wheat market

Afghanistan’s domestic public and commercial milling industry has been slow to rebuild after years of war, in large part because of competition from government-subsidized wheat flour from Pakistan, the report noted. The Pakistani government has implemented price policies aimed at improving the availability of food for its population and it intervenes in domestic wheat markets by procuring wheat from farmers at a support price. It also releases wheat to the provinces, which is sold to the flour mills at a government-determined “issue” or “release” price.

“The government’s interventions, which tend to involve sales of wheat to flour mills at below-market rates, generate profits for millers while incurring fiscal costs for the government because the issue prices do not cover the full cost of wheat procurement, storage and handling,” the report said.

It said the growth of Pakistan’s flour mills has been concentrated in provinces neighboring Afghanistan, and Pakistan’s domestic policies do not prevent unofficial flows of wheat grain into Afghan markets. However, a large number of Pakistani mills operate only when they are able to purchase subsidized wheat from their government. After Pakistani mills purchase wheat at the government issue price, they have a choice of exporting their wheat quota or processing it into flour.

Despite variations in its official trade policies, Pakistan has for the most part been a reliable supplier of flour to Afghan consumers, according to the ERS.

“For example, Pakistan’s export ban from 2003 to early 2007 did not prevent flour movements into Afghanistan,” the ERS said. “Although Afghanistan’s production of wheat fluctuated sharply, domestic prices were fairly stable, suggesting that trade helped to dampen price variability. From December 2003 to December 2007, flour prices in Afghanistan followed those in Pakistan reasonably well. However, 2008 was an exception in that the gap between Afghan and Pakistani wheat prices increased sharply that year. Pakistan had an export ban in place at the time, and yet the country exported a record amount of approximately 2 million tonnes of wheat, mainly flour, to Afghanistan through unofficial channels, according to USDA.”

Pakistan’s trade restriction may have had some effect on wheat and flour movements into Afghanistan as exports might have been event greater in the absence of trade restrictions, the report said. However, two additional factors contributed to reducing Pakistani exports to Afghanistan: Pakistan itself had to resort to importing wheat later in 2008, due in part to a shortfall in domestic production, and there was increased armed conflict in major transport corridors along the Pakistani border. As supply disruptions eased, Afghan-Pakistani price gaps decreased after May 2008.

Afghanistan’s import policies

According to the ERS report, Afghanistan’s trade policies have played only a limited role in protecting domestic wheat and flour producers. Although import duties are the main source of revenue in Afghanistan, the country has one of the most open trade regimes in the region and is characterized by atypically low revenue mobilization.

The report noted that tax revenues in Afghanistan, which amount to 3.4% of GDP, are far below the average of 14.9% of low-income countries. In the case of the wheat and flour sector, Afghanistan’s official import policies have been fairly liberal in that the government has not established countervailing policies to Pakistan’s domestic grain market interventions. In 2007, import tariffs on wheat and flour were 3.5%. In response to the 2008 price spikes, Afghanistan eliminated its import tariffs on wheat and flour in February of that year. In 2009, Afghan wheat production rebounded, and growing conditions continued favorable in 2010. In an attempt to protect producers from falling prices, the Afghan government set tariffs on wheat and flour imports at 10%. The following year brought a combination of poor growing conditions in Afghanistan and rising domestic and international prices. Accordingly, the Afghan government reduced the tariff on imported wheat flour from 10% to 5%.

“The degree to which the government border policies have restricted movement of wheat and flour is uncertain,” the ERS said. “Private Afghani traders have a track record of successfully procuring imported wheat from regional suppliers. The Afghan border is difficult to control, allowing significant amounts of undocumented trade.

“Afghanistan’s trade network is comprised of multiple routes along which wheat and flour are transported across long and porous borders. Afghan traders have adapted to recurring transport blockages by developing ways to circumvent these obstructions, an ability that would also be useful for evading tariffs. On the other hand, efforts to avoid import duties involve costs. Profit-maximizing traders may find it worthwhile to pay relatively modest tariffs, while high tariffs or trade bans encourage smuggling.”

Afghani flour market prospects

Despite their drawbacks, policies aimed at protecting domestic millers and farmers from foreign competition have been recommended as a means of enhancing livelihoods of Aghan producers, the report said. The basis for this recommendation is that imports of relatively low-priced commodities, while providing immediate positive impacts on food security, particularly for Afghan consumers, could be disincentive for Afghan producers.

The report noted that the country’s millers and farmers are at a disadvantage when competing with Pakistan’s wheat and flour sector, which benefits from fertilizer subsidies, the use of government-determined support prices to further encourage wheat production, and Pakistan’s release-price policy that encourages the growth of its milling industry.

The Afghan government has demonstrated some willingness to protect domestic producers by setting tariffs and by supporting prices through procuring small quantities of wheat from farmers, reportedly to discourage opium production.

“Imposing higher tariffs or stepping up enforcement of existing border policies would necessitate investments in improved monitoring and surveillance efforts, as well as expanding and defending border checkpoints,” the ERS said. “These efforts would be costly, given Afghanistan’s rugged terrain, unstable conditions, and poor security in border areas. Even if the Afghan government were successful at providing significantly higher levels of protection for domestic producers of flour and wheat, the result would be to impose costs on consumers, with the likelihood of relatively small positive impacts on domestic production.

“Flour is Afghanistan’s key staple food, providing more than half of the calories consumed. Policies that lead to higher flour prices are likely to have adverse impacts on low-income consumers. Further, though higher wheat prices might provide some incentive for producers, they would not address the critical constraint to domestic wheat production.”

Conclusions reached in report

The analyses developed in the ERS report highlight the potential tradeoffs that are likely to occur between Afghan farmers, consumers and millers should the government be successful at enforcing various combinations of tariffs on wheat and flour imports. The results indicate that increased protection for millers, accomplished by raising flour tariffs without altering the wheat tariff, delivers no economic gains to farmers and only benefits millers by imposing costs on consumers.

By increasing the flour tariff, Afghanistan reduces its dependence on flour imports and growth in domestic flour production accelerates, while imports of wheat expand, the report said. However, domestic consumers must pay a higher (tariff-adjusted) flour prices, and farmers receive no benefit as the farm price of wheat remains unchanged.

If, on the other hand, the wheat tariff is increased in order to increase benefits to wheat producers, the results indicate that higher (tariff-adjusted) prices alone are not likely to lead to significant output gain, primarily because water shortages are a constraint on wheat yields. Also, Afghanistan’s imports of wheat — unlike those of flour — are already low, implying that barriers to wheat imports have limited potential to affect domestic prices. To the extent that higher wheat prices are achieved through wheat tariffs, the milling sector pays more for its critical raw material, leading to slower growth in domestic flour production, the report said. Efforts to boost production of wheat through border policies would require a combination of flour and wheat tariffs that protect both miller and farmers while imposing costs on consumers.

“Finally, model-based simulation results suggest that by completely eliminating tariffs on wheat and flour imports, Afghanistan could benefit more fully from Pakistan’s relatively abundant supplies of wheat and flour,” the report said. “This scenario leads to stronger growth in domestic flour production and consumption, with relatively small losses in farm output, compared with other scenarios analyzed.