Is grain price volatility transmitted from international to local markets?

April 19, 2017
by Sara Gustafson

Since the 2007-2008 food crisis, food price volatility has been front and center in the international development conversation. The crisis saw a dramatic rise in the international price of grains and other important commodities, while the years immediately afterward saw increasing international grain price fluctuations. Rising global prices and their increasing volatility are of particular concern to developing countries because if these trends are transmitted to domestic markets, they can have serious negative impacts on farmers and poor consumers.

In a new paper published in the journal World Development, IFPRI researchers Francisco Ceballos, Manuel A. Hernandez, Nicholas Minot, and Miguel Robles examine the extent to which global grain prices and grain price volatility are actually transmitted to local markets in developing countries. This question has implications for what types of policies—whether global/regional or domestic—can best help developing countries address the issue of price volatility in their local food markets.

While many studies have looked at whether relative price levels are transmitted from global to domestic markets, this is the first study to estimate the transmission of food price volatility from global to local markets across multiple developing countries and regions.

Price and volatility transmission do not necessarily go hand-in-hand. For instance, if prices were transmitted from global to domestic markets after a few months’ lag, that could protect local markets from shorter-term international volatility. Alternatively, in the absence of direct price transmission, high price volatility in global markets may induce uncertainty among local traders, making local prices more volatile.

The paper focuses on the short-term effect of global maize, rice, wheat, and sorghum prices on 41 domestic price returns in 27 countries across Latin America, Asia, and Africa, using monthly data from 2000 through 2013. The study was carried out using a multivariate generalized auto-regressive conditional heteroscedasticity (MGARCH) model. Domestic price data was taken from FEWS Net (Famine Early Warning Network, a USAID-funded project) and FAO GIEWS (FAO’s Global Information and Early Warning System), while international price data came from the FAO International Commodity Prices database. For each commodity, price data were usually taken from the main local market (typically the capital city).

Overall, domestic grain prices appear to move in line with international prices in only a few of the studied markets. For maize, only one of the 16 markets studied (Honduras) saw significant price transmission from global markets. For rice, only six of 15 markets appear to be significantly affected by global prices: One in Mali, two in the Philippines, two in Thailand, and one in Ecuador. In the case of wheat, three of the seven markets (Mumbai, India; New Delhi, India; and Lima, Peru) saw statistically significant levels of price transmission from world markets, while for sorghum, none of the three studied markets was found to have statistically significant links to global markets.

In terms of price volatility, however, the study found more linkages between domestic and global markets. Volatility transmission seems to be more common when the volume of trade is large relative to a country’s domestic consumption requirements. In several cases, the study showed that grain price volatility is transmitted from international to domestic markets when the ratio of traded volume to domestic requirements is above a certain threshold—around 40 percent.

Maize markets seem to be the least susceptible to international price volatility. Only four out of the 16 studied maize markets (Benin, Ethiopia, Nigeria, and Colombia) experienced price volatility transmission from global markets. Rice markets are slightly more sensitive to international volatility, with eight out of the 15 studied markets showing significant transmission. It is domestic wheat markets that appear to see the most impact from international price volatility. All seven of the studied wheat markets showed a statistically significant link between global and domestic price volatility.

These findings suggest that trade plays an important role in determining price volatility transmission. Most of the countries in the study sample are somewhat self-sufficient in maize, with net trade accounting for only 16 percent of domestic consumption. The studied countries are more dependent on trade in rice (around 38 percent on average) and wheat (around 78 percent on average) to meet their domestic needs.

“However, while trade seems to play an important role in explaining price volatility transmission from global to local markets, there are also some exemptions to this general trend, which highlight the need to better understand food price volatility in developing countries to ensure adequate policymaking,” says Manuel Hernandez, a Research Fellow in IFPRI’s Markets, Trade and Institutions Division and one of the paper’s co-authors.

For example, the study found that wheat markets in India experience a significant level of price volatility transmission, despite the fact that India is generally self-sufficient in wheat. Similar results were found for maize in Ethiopia, rice in Peru, and sorghum in Burundi—in all of these cases, trade in the commodity in question is relatively low (less than 40 percent of domestic requirements), but price volatility transmission was found to be statistically significant.

One hypothesis for this finding, according to the authors, is that international volatility prompts local traders to respond in ways that contribute to local volatility—even in the absence of direct trade effects. Alternatively, it could be that price volatility is actually being transmitted through closely related grain markets for which there is trade, such as wheat.

Understanding the extent to which domestic markets are impacted by global food prices and food price volatility can help policymakers craft better strategies to address that volatility. If volatility in global grain markets is in fact transmitted to developing countries on a significant scale, policies enacted through global and regional partnerships and organizations, such as the WTO, may be more effective ways to reduce volatility around the world. However, if a country’s food price volatility stems not from global trends but from its own domestic situation, national policymakers should focus on domestic efforts such as stabilizing food production, reducing grain storage and transportation costs, and strengthening social safety nets to protect both poor producers and consumers from the its negative effects.

Sara Gustafson is a Communications Specialist with IFPRI's Markets, Trade and Institutions Division. This post first appeared on the IFPRI Food Security Portal blog.