Strong Exchange Rate Hurts Canadian Agriculture

Influence of the Greenback. Although Canada is the fourth-largest exporter of grain and oilseeds in the world (with the exception of wheat, particularly durum wheat), Canada is a price taker in the world grain markets and follows international prices closely. Since most agricultural commodities are traded in U.S. dollars, a strong Canadian dollar lowers prices.

The United States is Canada's largest agricultural export market. Indeed, a majority of its agricultural commodities are sent south across the border, and domestic prices of most commodities are largely determined in the United States. Prices of major commodities, such as corn and soybeans, are based on Chicago Board of Trade futures prices, while Canadian wheat prices are based on futures contract with the Minneapolis Grain Exchange. Therefore, currency appreciation normally tends to lower domestic and export prices in terms of Canadian dollars. Over the past 12 months, the loonie has appreciated from US$0.83 to US$1.00. So, for example, if the Minneapolis futures wheat price averaged US$400/tonne (metric ton) over this period, the price received by Canadian farmers decreased from C$480 to C$400/tonne.

Impact on Canadian Imports. Imported inputs equal nearly 50% of the value of Canadian agricultural exports. A significant portion is imported from the United States, mainly machinery, fertilizer, and feed inputs. Currency appreciation normally has a positive impact on imports—they become cheaper. Because the purchase of most inputs for the 2007 crop year took place before the Canadian dollar attained its peak value in the latter half of last year, Canadian growers saw little cost advantage from the exchange rate move during 2007. In the case of capital input, such as equipment, any price advantage takes several years to be fully realized. Canadian imports from the United States have increased due to the exchange rate move; corn imports nearly doubled last year, much of it when the loonie peaked.

Impact on the Livestock Sector. Canada's livestock industry has been affected the most, with escalating input costs triggered by high commodity prices and the strong loonie. U.S. restrictions on beef imports remain a problem. The European Union's decision to subsidize pork exports and U.S. producers increasing their herd sizes last year put further pressure on prices. Future profitability is largely dependant on a significant decline in feed input costs and the exchange rate (both of which seem unlikely), as well as abundant global supplies. Currently, Global Insight expects a downtick in the value of the Canadian dollar, to around US$0.95 by the end of 2008.

Impact on the Grain and Oilseed Sector. Recent changes in commodity prices have a dominant role in determining farm sector performance. If there is a significant increase in a commodity's price, the price effect often overrides any exchange-rate effect and shields some of the negative impact from a stronger exchange rate. This is evident in the world grain and oilseed market, which witnessed a sharp increase in prices. Indeed, wheat and barley prices have more than doubled over the past two years. Similarly, other crops such as canola, mustard seeds, lentils and peas also benefited from higher commodity prices.

While the outlook for the livestock sector remains bleak, increased production of canola, wheat and some specialty crops represents profitable opportunities. Strong demand for grains and oilseeds should persist over the short term. As always, future commodity prices will depend on demand and supply conditions in the world's larger markets like the European Union and the United States, and increasingly China.

Competitiveness of Exports. On the export side, the competitiveness of Canadian exports will also depend largely on how the currencies of Canada's major competitors fare against the U.S. dollar. Canadian grain competes with the United States, the European Union, Australia, Argentina, Brazil, and the Black Sea countries. In recent years, with the exception of Argentina, the currencies of major exporters such as Australia, the European Union, and Brazil have appreciated against the U.S. dollar. Therefore, so long as global demand stays strong, Canada will remain competitive. The limiting constraint will be its ability to increase exports at the cost of maintaining domestic inventories. Canada will not be the only exporting country with a steady market for grain and oilseeds.

The past few years have witnessed tremendous growth in the world biofuel industry, with the demand for cereal grains far outpacing supply, resulting in high commodity prices. Therefore, the increased domestic demand for the grains and oilseeds needed for biofuel production will limit the product available for export. On the supply side, incidences of drought in Australia and below-normal yields in Canada and Western Europe have reduced the available supplies of grains and oilseeds. Indeed, more than exchange rates, global demand and supply conditions will determine the competitiveness of Canadian grain, livestock, and oilseeds.