Global food price shock and the poor in Egypt and Ukraine: a comparison of impacts and policy options

In 2006, following almost three decades of stability or decline, real global prices of agricultural commodities and food entered a surge that lasted till mid-2008. The scale of this upturn was not unprecedented, but nevertheless quite unusual and one can only quote two comparable episodes in the recent history: developments during World War II and during 1973-1974. The 2006-2008 food price surge coincided with major increases in oil and other energy commodity prices, creating a series of serious macroeconomic and social challenges around the world. The economies of several low- and lower-middle-income countries have been hit with lower income strata of populations bearing a disproportionate burden.

These developments have added a new perspective to the long ongoing discussion on the potential reforms of the large food subsidy programme in Egypt and in some other Middle East and North African countries. The food subsidy system has over the years created a partly effective, although poorly targeted social safety net, which has also increasingly drained budgetary resources. The external food price shock has put the existing systems to a test.

This paper analyses selected aspects of food and agricultural policies in Egypt. It does so by comparing the situation with Ukraine that shares some important common characteristics with Egypt (fairly large territories and populations, similar income levels) but also differs in several important dimensions (agricultural net exporter / importer, food consumption vs. food production subsidies). The analysis focuses on alternative policy options and the extent to which they can mitigate the development, macroeconomic and poverty effects of food price shocks.

In Egypt, prices of many goods and services are subsidized to make them affordable to consumers. Food subsidies are provided through two main channels: the universal subsidy for “baladi” bread available to every citizen with no quota restrictions and the ration cards which offer eligible households a pre-determined monthly allowance of basic foodstuffs including rice, sugar and edible oil.

Global food price surge in 2006-2008 almost doubled the subsidy bill for the Egyptian budget from 1.3% of GDP in 2006/07 to an estimated 2.1% in 2008/09. This signals that food subsidies could have become a major fiscal problem had food prices remained high or in the event of future price shocks. Moreover, food subsidies are poorly targeted with substantial leakage of resources to high-income households. It is believed that between one-quarter and one-third of the poor do not benefit from food subsidies, while majority of support is directed at non-poor households.

In Ukraine, there are no direct food subsidies governed at the central level. However, regional and local authorities use different schemes to provide bread subsidies and/or ensure availability of the so-called “mass consumption” bread at low price. This type of bread accounts for the large majority of all bread produced in the country proving that this cannot be considered an effectively targeted mechanism supporting the poor.

In response to the global food price shock the governments of Egypt and Ukraine responded using a variety of instruments. In particular, some export restrictions were introduced, some import tariffs were cut, ration card coverage was extended in Egypt and in Ukraine a few municipalities tried to switch from a general bread subsidy to targeted monetary support for the poor.

Egypt and Ukraine differ quite significantly with respect to the balance of domestic production, consumption and foreign trade in agricultural and food products. Egypt relies on food imports for at least 50% of domestic consumption and food accounts for more than 15% of all imports. The situation in Ukraine is markedly different. Close to 90% of food consumed in the country is domestically produced. Ukraine ranked among the top five global exporters of wheat and coarse grains and corn in 2008/2009.

Two comparable computable general equilibrium (CGE) models are developed for Egypt and Ukraine. The model simulates direct and indirect impacts of the food price surge and various policy options on the performance of the main macroeconomic indicators including economic growth, inflation, current account, and budget balance. The model sectoral coverage and level of households’ disaggregation allow for analysing the effects of policies on sectoral output growth rates, on the welfare level of households as well as on poverty outcomes.

The analysis starts from simulating the effects of two scenarios of international food price increases. They are constructed on the basis of historical price data from 2006-2008 assuming that a price surge of similar magnitude proves permanent (or highly persistent). In the next step, several policy responses to these price scenarios are introduced in simulations. Specifically, export bans and import tariff cuts are studied for both countries. In the case Egypt there are also other scenarios trying to capture the characteristics of potential changes in the food subsidy scheme, e.g. replacing the general system of subsidies with targeted cash assistance for the poorest 40% of the population.

The results of the analysis indicate that the macroeconomic effects of an external food price shock of the analysed magnitude (without any policy actions) can be quite pronounced. Estimated consumer price index or nominal exchange rate adjustments are of the order of several percentage points in both countries. Significant adjustment takes place through the foreign trade channel with Egypt’s pre-shock current account surplus almost disappearing. In Ukraine real absorption falls by 4.5% with real investment declining by almost 8%.

Household consumption is affected negatively in both countries – by close to 2% in real terms in Egypt and 4.5% in Ukraine in the high price increases scenario. Urban households suffer stronger losses in both countries – the difference between rural and urban outcomes is more pronounced in Ukraine. This is associated with visible rise in poverty levels.

Moving to various possible policy responses to the food price shock one striking observation is the limited ability of the policies to reduce the negative social consequences including a rise in poverty. The results for Egypt suggest that most policy interventions have a negative effect on household consumption across the income distribution. The only exception is a scenario where food import tariffs are cut. Also, the scenarios assuming that the two poorest quintiles can be perfectly compensated in cash for the losses incurred due to elimination of food subsidies by definition imply maintenance of consumption of these groups of households. To what extent such a policy could be executed in practise is not clear. Similarly in Ukraine, the elimination of tariffs on food products improves the real consumption of households, while an export ban slightly improves the situation of rural households at the expense of urban population suffering significant deepening of their consumption losses due to surging food prices. The poverty implications of these policy alternatives are similar with food import tariff eliminations slightly improving poverty situation in both Egypt and Ukraine. In Egypt, theoretical scenarios assuming perfect compensation of the two poorest quintiles also improve poverty outcomes.

Summing up, the CGE modelling exercises illustrate the severity of the shock, and inadequacy of several policy options suggesting cuts in food import tariffs as a partial remedy. Yet, it is also clear that from the analysis that in the case of Egypt maintaining the food subsidy scheme intact is not sustainable from the fiscal perspective.

The policy scenarios analysed in the CGE models are quite stylised and their practical implementation would be very difficult. It is therefore important to discuss the practical policy-relevant conclusions and recommendations.

The Egyptian system of food subsidies needs to be reformed with an objective of making it cheaper and better targeted to the poor. This implies that leakage to better off households should be limited. Several elements could be considered here.

One general direction of change could be a gradual switch from subsidising final products to direct support to farmers to allow them to better cope with the fluctuations of the international food prices. A system of guaranteed prices for strategic crops could be considered. Alternatively, a system of insurance against price shocks could be introduced. Direct subsidies to farmers conditional on their adoption of good practices such as modern irrigation and balanced fertilization might prove effective. With regard to the organisation of the market measures to reduce non-competitive practices by traders regarding food storage, distribution and supply timing could be introduced.

Reducing the fiscal burden of food subsidies while maintaining their poverty-alleviation role could involve geographical targeting of eligible households. As three quarters of the poor in Egypt are concentrated in rural areas, proxy means testing combined with poverty mapping could help identify the most vulnerable groups, reduce errors of inclusion (of least vulnerable groups) and errors of exclusion (of vulnerable households). Direct cash transfers to the poorest households instead of food subsidies could then be implemented. In a similar vein, certain types of support could be targeted only to the poorest farmers (instead of subsidised agricultural inputs) avoiding dual price distorting markets and leading to misallocation of resources. The baladi bread distribution system could be made more efficient if a separation between baladi bread production and distribution process was implemented. Providing direct cash transfers to the poorest households instead of food subsidies and to the poorest farmers instead of agricultural inputs could eliminate dual market pricing that results in distortions and misallocation of resources.

In Ukraine, there are potentially interesting lessons to be taken from an attempt of some regional/city authorities to replace the bread price control system with cash support for the poorest. The breakdown of these reforms due to local budget constraints in the wake of the financial and economic crises, i.e. when it was needed the most, suggests that a more crisis-robust scheme might be needed. The new scheme does not necessarily need to lead to a larger involvement by the government responsible for implementation and financing, but stronger guarantees of the functioning of the system might be needed to win the public support for elimination of the provision of subsidised bread.