Understanding China’s painfully large 250 million tonne corn inventory

China’s recent announcement to end its costly state stockpiling programme for the 2016/17 crop represents a significant change. With weak policy support, domestic corn prices have already taken a hit and are projected to experience a further drop in the market year 2016/17, affecting not only the domestic market but also international trade. What kind of measures can China take to shrink its over 250 million tonne corn inventory? And how long will it take, Rabobank asks in its latest report.

Corncob 1China has one of the highest corn prices in the world, being 40-50% higher than the US farmgate prices. On 28 March, the Chinese government officially announced the end of its nine-year-old state corn procurement programme, effective from the 2016/17 new crop. The aim of this programme was to stabilise corn acreage and boost rural incomes. But the programme also distorted the market equilibrium, leading to artificially inflated domestic prices and a massive inventory held by the state reserve.

The reformed policy entails market-oriented pricing without governmental intervention as well as producer subsidies to supplement some of the farmers’ losses. With weak government support, domestic corn prices are estimated to see a steep decline, which is already reflected in the steep backwardation of the futures market.

As a result of the oversupply in the previous years, the state reserve currently holds over 250 million tonnes of corn. In 2015/16 only, domestic production exceeds consumption by 60-80 million tonnes. It is also estimated that government is to bear USD 10-15 billion per annum in the coming years, which includes storage costs, interest subsidies and other fees, and that’s not even considering the inventory write-downs due to falling prices. So what measures can the Chinese government take to deal with this enormous inventory?

  1. Switching corn acreage to soybean and other crops

Facing excessive oversupply, the Chinese government plans to reduce corn acreage by 9 percent by 2020, especially in the so-called ‘sickle-shape region’—an environmentally fragile, cold, arid, mountainous and eroded area on the fringes of the key corn production regions. With declining corn prices, Rabobank expects some farmers to switch to other crops, such as soybean, forage grass, potatoes and coarse grains. This comes after the government already encouraging crop rotation to improve soil fertility. Rabobank believes that the planting structure adjustment will not be accomplished in the next planting season, but will take the next few years.

A chunk of the corn acreage reduction will be filled by domestic soybean. The Chinese Ministry of Agriculture (MOA) released guiding opinions to increase the domestic soybean acreage and improve yields in the next 5 years. According to MOA’s plan, the soybean output shall reach 19 million tonnes by 2020, compared to 10-12 million tonnes in 2015. Nearly all the additional domestic soybean, which is non-GM, will be used for consumer foods such as tofu and soy milk.

  1. Reducing China’s imports of non-corn feed grains

Although corn imports are protected by quota, China imports a significant amount of alternative feed grains, such as sorghum, feed barley and DDGS. It is worth mentioning that China accounts for roughly 20 percent of global feed grain imports—three-fourth of all sorghum trade, one-third of all barley trade (even though 30 percent of it is for brewing) and nearly half of US DDGS exports. In 2015, the import volume of sorghum, barely and DDGS were 10.69 million tonnes, 10.73 million tonnes and 6.82 million tonnes, respectively.

On the one hand, plummeting corn prices will already reduce the appeal of imported feed grains. On the other, the government will still want to pose more protective trade policies, further impeding imports in order to boost domestic corn consumption and to absorb the massive overhang in state reserves.

China’s slowing demand will also have consequences for exporting countries. A proportion of the feed grains will need to find a different outlet in the world market and therefore it will be exported to other traditional destinations, while larger volumes will also need to be used in the country of production.

  1. Expanding the bioethanol mandate

The next two solutions are a bit more challenging. Expanding the bioethanol mandate is an effective way to absorb excessive corn, as seen in the US in recent years. There, the bioethanol sector consumes one-third of the national corn output. However, since crude oil prices are low, it will require the government to either implement mandated quantities that need to be blended into gasoline or to offer a considerably large amount of subsidies to the corn processors.

On top of that, the milling capacity for ethanol in China is around 30 million tonnes and the utilization ratio is 50-55 percent. In order to reduce corn stocks significantly through bioethanol, more milling plants would need to be established, resulting in high capex investment. And once the large domestic stocks have been lowered, the continuation of grain-based biofuel programmes remain a big question mark in China, given the scarcity of land and water in the long run.

  1. Increasing exports of corn and corn-based derivatives

Corn exports could be another potential solution for a fast inventory reduction. China’s neighbours, such as Japan, Korea, Taiwan and Southeast Asia, import over 40 million tonnes of corn every year. China has the advantage of geographic proximity when it comes to supplying these deficit regions. However, owing to lack of scaled farming, high production costs make it extremely difficult to export without government subsidies, which has the potential to violate WTO rules. Rabobank projects that instead China will increasingly export certain types of corn-based derivatives, including—but not limited to—lysine, citric acid, MSG, HFCs and crystalline dextrose. But this can only mitigate the imbalance to a limited extent.

No matter the solution(s), the process will take time

The Chinese government strives to relieve the corn imbalance, both on the supply and demand side. And more innovative measures could surface. However, keeping in mind social stability and long-term food security, the government also emphasizes the need to keep corn acreage stable in key production regions. In addition, Chinese local farmers need time to change their farming habits. Therefore, domestic corn production is projected to have a gradual but not dramatic shrinkage in coming years. Without additional increases in demand, the whole de-inventory procedure could take more than a decade.

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