Intense climate pattern is prompting economists to calculate potential impact on global food production; possibly reverse recent prices drop in Brazil
Daniel Karp — Foto: Carol Carquejeiro/Valor
The relief that food is currently bringing to Brazilian inflation could give way to new price pressures in 2024 or even later this year, depending on how and when the growing projections of a strong El Niño climate pattern in the Pacific materialize. Although few analysts have included the possibility of a more extreme event into their scenarios, given the high degree of uncertainty about its impact, the growing likelihood of a more intense episode is prompting economists to do the math on its potential impact in Brazil.
“The market is not yet concerned about this. It hasn’t driven prices or inflation projections. But it’s important, depending mainly on the intensity of the event,” said Daniel Karp, a senior economist at Santander. “It can have a relevant impact, especially considering that it may be accompanied by pressures related to the end of the grain agreement between Russia and Ukraine.”
A phenomenon that occurs at intervals of up to seven years, El Niño is the warming of the surface waters of the equatorial Pacific Ocean, which ends up generating changes in climate around the world. In Brazil, it usually means milder temperatures and increased rainfall in the South-Central region, and hotter and drier weather in the North and Northeast regions. Its classification varies according to how far the sea surface temperature deviates from the average: up to 1.4°C above the average, it is considered weak or moderate, with no major impact on the world economy. From 1.5°C to 2°C, it is considered strong, and above 2°C, very strong.
Last week, the aggregator of climate models that predict the behavior of the Pacific temperature used by the U.S. National Oceanic and Atmospheric Administration (NOAA) began to indicate an average increase of 1.57°C in the surface this year, which configures a strong El Niño.
“The latest revisions are all upward, so we can have some confidence that we will have a strong episode this year. We just don’t know what the real impact on the economy will be,” said Alexandre Lohmann, chief economist at Constância Investimentos.
This uncertainty arises because even episodes that are considered severe can have both negative and positive effects on world agricultural production. According to Bradesco, in the 1997-1998 El Niño, global cereal production increased by 2.6% and sugar by 0.9% – Brazil also experienced a decline in the domestic harvest, but the global variation was such that the international one fell and food inflation in the country rose by only 1.9% that year. In 2015-2016, there was a 1.8% drop in the grain harvest and a 7.1% drop in the sugar harvest. In Brazil, a crop failure meant a decline of 11% in output, causing food inflation in the country to spike by 9.4%.
“We are hearing more that there is a combination of factors this year that could lead to an El Niño worse than the 1998 and 2016 episodes. But each episode is quite different,” said Priscila Trigo, an economist at Bradesco.
She thinks that losses similar to those in 2016 would have a slightly smaller impact in Brazil this time. This is because soybeans – a crop less affected by the climatic phenomenon – have since gained relative importance in domestic production, to the detriment of rice, beans, and corn. Thus, recalculating the crop failure in light of these changes, Ms. Trigo estimates that an event of the same magnitude would result in a 10% loss this year. As a result, the projected food inflation would also be softer, to something between 8% and 9% from 9.4% in 2016, she said.
Bradesco’s scenario for 2024 already includes an El Niño that is considered standard, estimating food inflation at 4.5% and full IPCA (Brazil’s official inflation index) at 3.6%. In this more extreme scenario, however, household inflation would double, adding 0.70 percentage points to the IPCA, which would end the year at 4.3%. In this environment, the GDP forecast, currently at 1.5%, would also fall to 1.1%.
In a more benign scenario, such as that of 1997-1998, in which the domestic crop failure would be more than offset by the increase in world production, GDP would lose less and grow by 1.4%. Inflation, on the other hand, would benefit more, ending the year at 3.2%, 0.2 points below the baseline projection.
For Mr. Lohmann, with Constância, the net effect of a strong El Niño at the end of 2024 is a 0.3 percentage point increase in the IPCA, mainly as a result of rising fresh food prices, which would suffer more from excessive rainfall in the South-Central region and drought in the North and Northeast regions. However, this figure takes into account that inflation will decelerate somewhat during the year.
“Initially, there would be a stronger impact coming mainly from vegetables and other crops. Then there would be some deflation as the world grain supply tends to increase, which would cause feed prices to fall and consequently animal protein,” he said.
Mr. Lohmann estimates that in the face of a severe episode of the climatic phenomenon, 12-month IPCA could reach 4.68% in the first quarter of 2024, or 0.64 point above what would be expected for a scenario without El Niño. As for inflation in the full year 2023, the base scenario went to 5.38% from 4.84%, already incorporating a more intense climate pattern.
Mr. Karp also sees potential upward pressure from the fresh food component. “These are quick crops. If there is a crop failure, there is a one-off spike in prices in one month. In theory, this makes producers to increase production the following month, which normalizes prices. The problem is that if there are successive crop failures, there is no time to replant and therefore bring the price down later. This is the biggest risk for inflation in Brazil that comes from El Niño,” the economist at Santander said.
The bank is still waiting for more information to consider this event into its forecasts. Currently, Mr. Karp expects a deflation of 0.5% of food at home this year, followed by a high of 1.5% next year. “Because the base of comparison is lower, there is a risk of increase next year, a stronger one because of this issue. Yet, I don’t see a scenario of unchecked food inflation. Perhaps it could reach 3%,” he said. “It is also important to note that our projection of IPCA closing at 3.9% in 2024 also brings downside risks in other groups, such as services inflation. Thus, even with a stronger El Niño, we do not have an upward bias for this number at this time.”
In a recent study, Bank of America also warned of the potential impact of El Niño on the disinflationary picture in South America. The bank notes that Colombia and Peru have historically been the most affected, followed by Brazil. Using data from 1997 to 2023, BofA calculated a potential increase in annual inflation of up to 2.5 points and 1.5 points in the first two countries and 1.3 points in Brazil. However, the median of the episodes shows a cumulative impact of about 0.5 point in the case of Brazil.
*Por Marcelo Osakabe — São Paulo
Source: Valor International