Russia’s war in Ukraine has contributed to soaring food prices, supercharging global inflation. Poorer countries will likely be hardest hit, adding to the risk of social unrest. With public finances and incomes already under strain, emerging-market debt investors should be on high alert.

Read this article to understand:

  • Why soaring food prices are causing big problems for poorer nations
  • Why investors should be alert to the threat of social unrest
  • How these two factors are intertwined with EM countries’ fiscal positions

Food prices, which were already at a ten-year high because of a series of poor global harvests, skyrocketed this spring as the war in Ukraine cut off supplies from the world's biggest exporter of sunflower oil and a major producer of cereals such as maize and wheat.

The Food and Agriculture Organisation of the United Nations recently reported that its food price index averaged 157.4 points in May. That was 22.9 per cent higher than May 2021 and left prices up a whopping 73 per cent from two years ago.1

Figure 1: Food costs soar (FAO food cost index)
Source: Food and Agriculture Organization of the United Nations. Data as of June 30, 20222

Across emerging markets, the rate at which food prices are rising varies significantly. In some countries it is running at less than five per cent. Perhaps most notably, comparatively stable rice prices have helped suppress food inflation across much of Asia, at least for now. Countries with pegged or heavily managed exchange rates, for example some Middle East states as well as Ecuador and Gabon, have also been less impacted.

By contrast, Angola, Ghana, Columbia, Sri Lanka and Egypt are all currently experiencing food inflation of 25 per cent or more.

Soaring food prices are especially problematic for poorer countries where food accounts for far more of the average household shopping basket than it does in richer nations. Often the biggest single constituent of consumer price indices, it typically accounts for around 25 per cent of household outlays.

Figure 2: Percentage of household expenditure spent on food
Percentage of household expenditure spent on food
Source: BNP Paribas, May 18, 20223

Worsening terms of trade

Although rising food prices could be of overall benefit to some countries, such as Uruguay, which is a major food exporter, they are the exception. Analysis by Goldman Sachs shows that so far this year, the food terms of trade – the change in the price of food exports / the change in the price of food imports, weighted according to exports’ and imports’ respective shares of GDP – have worsened for 80 per cent of emerging market countries.4 In other words, the economic benefit to these countries of a rise in the value of their food exports is being outweighed by the rising cost of imported foodstuffs.

Any economic benefit of a rise in the value of food exports is outweighed by the rising cost of imports

Even for the few countries that have experienced an improvement in the food terms of trade, while this will benefit farmers and agricultural exporters, it does not necessarily cushion consumers from the impact of rising international food costs. Brazil is a case in point. Even though the Brazilian agricultural sector stands to benefit from rising soyabean prices, the government may still feel the need to step in with subsidies or transfer payments. Argentina is in a similar position.

Figure 3: Higher food prices leave most countries worse off
Higher food prices leave most countries worse off
Source: Goldman Sachs. Data as of May 2022

Rising social unrest

High food inflation is an issue in its own right. However, it becomes especially concerning when it risks stoking social unrest and political upheaval.

Having declined sharply at the start of the pandemic, social unrest has been rising around the world in recent months, according to a recent blog by the International Monetary Fund.5 While many richer nations have seen people taking to the streets to protest the rising cost of living, the risk of unrest is especially high in poorer countries where pre-existing levels of malnutrition and food insecurity are relatively high.

Sri Lanka was rocked by an economic and political crisis, brought to a head by soaring food and energy prices

At the start of the year, Sri Lanka was rocked by an economic and political crisis, brought to a head by soaring food and energy prices, triggered in part by the war in Ukraine. Although Sri Lanka had been at risk of defaulting on its debt for some time, the worsening social situation likely accelerated the decision of a ‘pre-emptive default’ in May by the central bank.6

The default came after a collapse in the rupee weeks before that left the country short of the foreign currency needed to pay for essential imports. Power blackouts, inflation at an all-time high and shortages of food, fuel and medicines, led to weeks of violent, sometimes fatal, protests across the country.

We assess social stability risks along two dimensions. The first measure aims to capture changes in living standards and the second aims to capture social protest risks more directly. Together, these are used to assess where social pressures may be building.

We begin by constructing a proprietary index that attempts to rank countries according to levels of ‘misery’. This is loosely based on Arthur Okun’s Misery Index, created in the 1970s, which adds together unemployment and inflation as an easy way to determine how the average citizen is doing.

We refine the measure by including changes in per-capita income, to provide a proxy for whether people might have been able to build up financial buffers. Simply put, countries that have experienced faster per capita income growth, should be in a better position to cope with higher inflation and rising unemployment.

We assess social stability risks along two dimensions: living standards and social protest risks

Next, we construct an index that tries to approximate individual countries’ vulnerability to the threat of rising social unrest, capturing a nation’s social and governance characteristics.

This index comprises six different factors: wealth inequality, changes in per capita income and labour force participation rates, which attempt to capture living standards. In terms of governance considerations, we account for levels of corruption and political stability. Finally, we include the level of economic freedom, which some studies suggest correlates strongly with happier societies. The results are shown in Figure 4.

Figure 4: Social risks
Note: Colours represent key countries within different regions.
Source: Aviva Investors’ calculations using data from Transparency International, Heritage Foundation, World Bank, and Credit Suisse. Data as of June 30, 2022

Assessing which countries are at most risk of social pressure is not just about predicting protests, but about creating a framework to better understand where there is capacity to address rising tensions. For example, some countries may be under pressure to consolidate public finances. In other cases, it might become socially, and therefore politically, difficult to approach the IMF for support. Increasingly, unpredictable election outcomes also need to be considered.

Even though many poorer countries are struggling to kick-start their economies following the pandemic, central banks are being forced to jack up interest rates to combat inflation. The risk is that in countries facing growing social pressure, the onus will fall on governments to step in by subsidising food or making transfer payments to the poorest.

Fiscal constraints

With budget deficits having already widened sharply during the pandemic, not all countries will have the ability to respond. Even where they do, policymakers are likely to face tough spending decisions. For example, food subsidies may necessitate reduced spending on infrastructure investment, with potentially adverse consequences for economic growth.

If governments have insufficient fiscal headroom to subsidise food, the danger is social unrest

As Sri Lanka has shown, if governments have insufficient fiscal headroom to subsidise food, the danger is social unrest ensues. Sri Lanka borrowed heavily to fund infrastructure-led growth after the end of its civil war in 2009, but policies including a 2019 tax cut and the loss of tourism during the pandemic left it unable to refinance in international capital markets.

According to data from Citibank, debt at the end of 2021 totalled $82 billion – equivalent to 106 per cent of GDP – with about $51 billion owed to international bondholders and bilateral creditors including China, Japan, and India. Debt is forecast to rise to around 140 per cent of GDP by the end of 2022.7

To better understand which nations have the least fiscal headroom to cope with social challenges, Figure 5 plots countries’ projected 2022 fiscal balance versus the risk of social unrest.

Figure 5: Fiscal balance versus food vulnerability
Source: IMF and Aviva Investors’ calculations using data from Transparency International, Heritage Foundation, World Bank, and Credit Suisse. Data as of June 30, 2022

The danger of soaring food prices leading to social unrest and rising risk of default is increasingly being appreciated by markets, and among the factors contributing to the current sell-off in emerging-market debt. Sri Lanka is unlikely to be the last to default. The IMF has opened programme talks with Egypt and Tunisia, both big importers of wheat from Russia and Ukraine, and with Pakistan, which has imposed power cuts because of the high cost of imported energy. Turkey is battling 70 per cent inflation and the risk of a balance of payments crisis is building.

Potential fault lines

By considering countries’ vulnerability to the kind of pressures which led to Sri Lanka defaulting, we believe it is possible to glean useful insight into the location of other potential fault lines within the emerging sovereign debt universe.

Several countries stand out consistently as being vulnerable to the kind of pressures which led to Sri Lanka defaulting

Several countries – namely Angola, Nigeria, Ghana, Tunisia, Morocco, Egypt, and Pakistan – stand out consistently as being in danger, even when considering the risks from a variety of different angles. This does not mean any of these countries will default in the near term, but it does suggest extra emphasis must be placed on understanding and assessing any building social pressures, and how each government is likely to respond.

We can also get a better understanding of those countries and regions that might find themselves challenged should events take a turn for the worse. For instance, while food inflation is currently contained in Brazil, the country’s limited fiscal space combined with high social protest and misery scores leaves it particularly exposed. El Salvador is in a similar situation. Turkey and Argentina’s already high inflation levels, combined with high social pressure scores, leave both countries exposed. In Turkey’s case, authorities have, for now, subsidised food and fuel, and introduced price controls to curb the impact on the population.

As for the bulk of Asian nations, they have so far been helped by healthy supplies of rice, resulting in comparatively limited price rises. However, should recent trends persist, there is a growing likelihood people will begin substituting rice for wheat. That would put upward pressure on prices, especially if countries such as Thailand were to respond by restricting exports. The Philippines and India, with high levels of malnutrition and a high risk of social unrest, could also find themselves in difficulty.

Rising food prices have the potential to spark widespread unrest and political upheaval

As the Arab Spring of the early 2010s showed, rising food prices have the potential to spark widespread unrest and political upheaval. Although underlying pressures were building up for years, it was only when the price of bread went up and people could not afford to buy it that they took to the streets.

Given the pace at which food prices have been rising, emerging-market countries look to be at growing risk of social unrest. The concern is greatest for those countries where public finances are under strain or likely to deteriorate. Investors should keep a close eye on events.

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