INTERNATIONAL AGRICULTURE AND TRADE: Europe Update July 18, 1997 July 1997, WRS-97-S2. Approved by the World Agricultural Outlook Board ------------------------------------------------------------------------------ INTERNATIONAL AGRICULTURE AND TRADE (Europe Update) is published four times a year by the Economic Research Service, U.S. Department of Agriculture, Washington, DC 20005-4788. Please note that this release contains only the text of the report --tables and graphics are not included. Subscriptions to the printed version of this report are available from the ERS-NASS order desk. Call, toll-free, 1-800-999-6779 and ask for stock #WRS, $26/year. ERS-NASS accepts MasterCard and Visa. ------------------------------------------------------------------------------- BSE Crisis Unsettles EU Markets While Economic Recovery Fuels CEE Export Growth The long-term (1997-2006) outlook for EU agriculture has been significantly affected by the BSE crisis -- which is influencing not only the beef sector, but other meats and feed grains as well -- and the EU's response to high world grain prices. In Central & Eastern Europe, the outlook remains promising for a significant recovery over the next 10 years, provided that market reforms continue. A Bumpy Ride for EU Agriculture The European Union's (EU) agricultural sector experienced a number of shocks in 1996. Revelations of a possible link between bovine spongiform encephalopathy (BSE) and a related human brain ailment, Creutzfeldt-Jakob Disease (CJD), precipitated a widespread health scare that led to a significant drop in beef consumption, falling producer prices, and uncertainty in beef markets. Additionally, high world grain prices prompted the EU Commission to tax grain exports. Tight supplies on the EU market brought about a reduction in the mandatory set-aside rate for 1997/98 to 5 percent, although a large harvest was expected in 1996/97. These events have significantly affected the European agricultural sector. Each year, the Economic Research Service produces long-term projections of global agricultural production, consumption, and trade. These projections are not forecasts of future events. Rather, they indicate expected outcomes given specific future macroeconomic, climatic, and policy assumptions. The projections are made to serve as a baseline against which one can evaluate the impacts of policy changes and revised price assumptions in Europe and elsewhere. They are obtained using economic models that assume a continuation of current policies, tempered by analysts' judgement, and assume normal weather. Because of the changes the EU agricultural sector has experienced over the past year, projections for 1997-2006 have changed considerably from projections made last year. Macroeconomic Assumptions The projections assume that Economic and Monetary Union (EMU) will be achieved during the forecast period, although possibly by a subset of EU countries. Many EU countries will be forced to adopt tighter fiscal and monetary policies to attain the Maastricht criteria established for member states to be eligible to participate in EMU. The growing certainty of EMU, and the recent economic slowdown in many EU countries, result in projections of continued tight fiscal and monetary policies, yielding a strong European Currency Unit (ECU) (relative to the U.S. dollar), lower inflation, and lower Gross Domestic Product (GDP) growth than in last year's projections. A stronger ECU will lead to lower EU prices for those commodities affected by world prices, and make it slightly harder for the EU to export without subsidies. World prices for many major commodities, including grains and oilseeds, are projected to remain high, offsetting some of the disadvantage of a strong exchange rate. GDP growth is forecast to average 2.4 percent annually over the 1997-2006 forecast period (down from 2.6 percent projected last year). In a high-income region like the EU, only a small increase in food consumption, chiefly of higher value agricultural products, will result from income growth. Population increase is expected to provide little growth in consumption of agricultural products, as population growth is projected to slow from already low levels. Inflation is forecast to slow to about 3 percent per year, down from about 4 percent per year in last year's baseline. Agricultural Policy Assumptions The basic policy assumptions affecting the EU are compliance with Uruguay Round commitments within the current policy framework and continued application of the policies adopted under Common Agricultural Policy (CAP) reform. The EU's Uruguay Round commitments on subsidized exports and minimum import access are incorporated as part of the basic assumptions. The most important commitments for the purpose of our projections are the limits on subsidized exports and minimum import levels agreed to under market access provisions of the Uruguay Round Agreement on Agriculture (URAA). The export subsidy commitments are those submitted by the EU-15 to the World Trade Organization (WTO). No further agreements, such as would result from the impending mini-round on agriculture, are assumed to occur. For some commodities, the EU's current policy is not compatible with its Uruguay Round commitments. No additional reform measures are assumed to deal with this situation, and the EU's intervention prices (the price at which the EU will purchase surplus product to maintain internal prices) are held constant in nominal terms. However, the EU can use existing policy mechanisms to manage markets. The projections assume that the EU will restrict intervention purchases to avoid creating unwieldy stocks. Allowing a greater supply to remain on the market will force down prices on the internal market, thus discouraging higher production. For the livestock sector, the key policy assumption concerns the Commission's response to the BSE crisis. The effect of measures taken to date (described in detail in the following section) are included. Preliminary analysis shows that these measures, specifically the herd liquidation program, will be inadequate to deal with the supply-demand imbalance resulting from sharply reduced consumption. To avoid stock accumulation, the Commission will have to take further measures to reduce beef production. Our assumption is that this will be achieved by allowing internal market prices to fall, thereby stimulating consumption as well as reducing output. The EU will also create incentives to limit production, possibly by promoting early culling and lowering maximum slaughter weights. For crops, the key policy variable is the assumed set-aside level that applies to grains and oilseeds. The set-aside is the EU's most effective tool in managing its markets. Under our assumptions, the EU will use the set-aside rate to decrease production to ensure that limits on subsidized grain exports are respected. High grain prices on world markets will enable the EU to export without subsidies by 2001/02, at which point total exports can exceed the Uruguay Round commitments on subsidized exports. For the 1997/98 crop year, the EU has a 5-percent set-aside in effect (10 percent for oilseeds). Over the projection period, the expected set-aside rate is 12 percent in all but the first forecast year (1998/99). The basic support prices are assumed to remain at nominal 1996/97 levels for most commodities, although internal market prices are allowed to adjust to reflect supply and demand conditions. Commodity Outlook The outlook for meats, grains, oilseeds, and products is presented for 1997-2006. Forecasts of production, consumption, and trade are generated in response to assumed world price levels and assumptions regarding policy. BSE Crisis Affects Many Markets After years of downplaying the risks of BSE to human health, the United Kingdom's (U.K.) government admitted in March 1996 that there may be a link between the cattle brain disease BSE and the related human ailment CJD. The public reaction in the U.K. and the EU seriously disrupted the British beef industry. The announcement ignited an international crisis, as British beef was pulled from menus and shelves around the world. The EU banned exports of British beef indefinitely, pending the implementation of additional safeguard measures. The EU also strengthened restrictions on the use of meat and bone meal as a feed supplement, a practice suspected of transmitting infected tissue from sheep to cattle. The EU approved a plan in April 1996 to help the U.K. eliminate BSE and restore consumer confidence in Europe's beef supply. Under the selective eradication program, the U.K. will slaughter and incinerate roughly 4.7 million cattle at a cost of $2.4 billion. The eradication will be phased in over 6 years, culling roughly 700,000 animals per year. Although this figure is consistent with historical U.K. slaughter, the carcasses will be destroyed rather than processed for meat, causing meat production to decline 3 percent a year. Because of the gradual nature of the eradication program, no extraordinary restocking efforts will be necessary to maintain the current herd size. But this program will not be enough to bring production in line with consumption. Human consumption of beef fell sharply in the wake of the crisis. Consumers have replaced beef with pork, poultry, seafood, and non-meat products. It is difficult to predict how consumers will respond to the BSE crisis over the long term. Based on previous "mad cow" scares, the recovery in beef consumption is likely to be lengthy and gradual -- a complete recovery to pre-BSE crisis levels is unlikely in the projection period. Beef consumption fell 12 percent in the EU in 1996 and will continue to decline in the long term. The decline in EU beef and veal consumption would occur even in the absence of the BSE-precipitated reduction. Consumption of beef in the EU has been steadily declining since the late 1980s, and BSE will accelerate this trend. Consumption is expected to begin to increase slightly by 2005 due to price competitiveness relative to pork and poultry and renewed confidence in the safety of the beef supply. Production of beef is expected to decline 15 percent over the forecast period due to decreases in the dairy herd, limits on direct payments, and lower prices. EU beef production responds primarily to changes in policy, including dairy policy and beef payments. The size of the dairy herd, which accounts for over half of total beef production in the EU, is determined by a quota on milk production. As per cow milk yields grow, the size of the herd falls. The dairy quota and limits on direct payments for beef producers will reduce the capacity for beef production. In addition, the EU's limit on subsidized beef exports will affect beef production. EU market prices for beef remain above world market levels, eliminating any possibility of exporting unsubsidized beef above the level allowed by the URAA. With exports constrained, the supply on the internal market grows at a time when consumption is falling significantly. This situation will depress prices on the internal market. Trade in beef and veal will be constrained by the limits set by the Uruguay Round and bilateral agreements. Subsidized beef and veal exports must decline to 817,000 tons by the end of the Uruguay Round implementation period in 2000/01, and are assumed to remain at that level through the projection period. Imports are projected to remain constant throughout the baseline at levels assured through URAA and bilateral agreements. Beef stocks are projected to peak at 1.4 million tons in 1997/98, and decline thereafter as supply and demand are brought into better balance. Decline in Beef Consumption Boosts Demand for Substitute Meats Due to the BSE scare, consumers are substituting pork and poultry for beef, but lower beef consumption is only partially offset by increases in pork and poultry consumption. EU beef consumption will decline an average of 3 percent a year during the 6-year eradication phase, while pork and poultry consumption will increase by roughly 1 and 2 percent, respectively. Prices for pork and poultry are expected to fall over the projection period, encouraging consumption. However, the larger decline in beef prices will reduce the price advantage pork and poultry have traditionally enjoyed. The projections assume no changes in EU domestic policy for the pork and poultry sectors, which consists chiefly of trade measures, such as import protection and export subsidies. Pork and poultry production are projected to rise over the period in response to lower feed costs. However, production increases are limited by URAA restrictions on subsidized exports and by existing animal welfare and environmental legislation. Exports of pork and poultry are determined based on the EU's URAA commitments for subsidized exports and the estimated capacity for unsubsidized exports. By 2000/01, the EU must limit subsidized exports of pork to 388,000 tons and poultry to 290,000 tons, in both cases down about 50 percent from exports of the early 1990s. This limit is assumed to remain in effect through the end of the projection period. Efficient production methods and lower feed costs will enable some producers to export unsubsidized pork and poultry. Therefore, the EU is expected to export above the URAA export subsidy constraint, especially for pork. The EU has enacted a number of animal welfare measures and environmental regulations that are expected to limit production of pork and poultry toward the end of the decade. For example, the EU has imposed a limit on the length of time an animal can be in transport. Pork producers will not be allowed to tether sows after 2000. These measures impose additional costs on producers and processors. In regions where intensive production techniques are used, pig numbers may be capped due to the EU's Nitrates Directive, which sets maximum nitrate levels in ground water. Pork imports are expected to rise over the projection period with mandated increases in market access levels under the URAA. Poultry imports are expected to remain well above their URAA commitment levels as the EU continues to import ducks, geese, and some specialty products, although less than in recent years. The need for imports is reduced as more product is retained on the internal market because of the Uruguay Round export limits. Grain Markets Respond to High Prices For the past year and a half, world grain markets have experienced large price swings. Because the EU is a large grain exporter, the price swings have affected EU grain markets as well. The largest impact was felt in the wheat market, which accounts for nearly 50 percent of EU grain production. Historically, EU grain producers have been largely insulated from world price swings by the grains regime of the CAP. But when world prices actually rose above the internal EU price, the EU imposed an export tax, a measure not used since 1974. The EU suspended export subsidies for wheat in summer 1995 as global wheat prices reached the EU internal price level. Exports of wheat under the Management Committee's weekly tenders were practically suspended until early November 1995. As world wheat prices continued to climb, the EU imposed a $32-per-ton export tax on wheat in December 1995 to keep the internal EU wheat price from rising along with world prices. (A $5.40-per-ton export tax on barley was implemented in January and later increased to $19.22). As world prices increased, the export taxes increased as well, reaching a high of $58-per-ton for wheat in late April 1996. The export tax kept wheat on the domestic market, causing 1995/96 EU wheat exports to fall a third from the previous year. World wheat production increased in 1996/97, driving world prices downward. The EU wheat harvest for 1996/97 was estimated at slightly over 99 million tons, up 12 million tons from the previous year. When wheat prices began falling, the EU decreased its export tax. The export tax was completely eliminated in September 1996, when the world price of wheat fell below the internal EU price, and the EU began subsidizing its wheat exports once again. Despite the export tax, the internal EU wheat price was high enough to keep wheat from being sold into government intervention stocks, which fell to roughly 450,000 tons at the end of the 1995/96 crop year from 3 million tons at the outset. Though total wheat stocks declined roughly 1 million tons from the 1995/96 crop year, private stocks rose more than 1.5 million tons. The increase was primarily due to on-farm holding in anticipation of higher prices. For 1996/97, intervention stocks have risen little because EU market prices for most grains have remained higher than the intervention price. EU market prices have been buoyed by producers' continuing reluctance to release their grain onto the market. The projections assume that the EU has two major policy goals for the grain sector: Ensuring that the limits on subsidized exports are not exceeded, and increasing the use of grain in animal feed by keeping internal market prices low. The EU can rely on existing policy measures to achieve these goals. The set-aside enables the Commission to affect grain production, and it can affect prices by limiting intervention purchases and exports. Since the 1992 CAP reform, the EU Commission has used both of these tools. It has reduced the set-aside rate when it wanted grain production to increase. It has also made a concerted effort to keep grain prices low, through its management of intervention stocks and its export policy. During the projection period, internal market prices are expected to fall, although the EU's policy prices are not changed. It is assumed that the EU will operate the intervention system in a restrictive manner that allows internal market prices to fall when surpluses that cannot be exported begin to build up on the market. URAA Export Limit To Constrain Wheat Production Through 2001/02 Baseline analysis indicates that prices will remain firm and EU export subsidies are expected to remain small through 2001/02, when the world market price will again equal the EU market price. The 5-percent set-aside that was adopted for 1997/98 will result in another large wheat harvest. Higher production and limits on exports could increase carryover stocks. In response, the EU will increase the set-aside significantly for 1998/99. We assume a 15-percent rate for 1998/99, and, for the remainder of the projection period, a 12-percent rate. The EU is assumed to retain the set-aside option even after it can export wheat without subsidy, because barley exports remain constrained by the URAA export limit. It was demonstrated in 1995/96, a year in which the EU imposed an export tax, that the ability to export without subsidy does not make set-aside irrelevant. The projections show an increase in wheat consumption due to stronger demand for feeding. Feed demand remains strong because internal market prices decline relative to non-grain feed ingredients and protein meals. Further increases in feed use are expected because of BSE-induced increased demand for pork and poultry, both grain-based meats. Coarse Grains Exports To Increase In the URAA, the EU agreed to limit subsidized exports of total coarse grains, rather than individual grains like corn, barley, and other coarse grains. The EU has some flexibility in how to divide up the quantity that can receive export subsidies. In the projections, it is assumed that this limit is allocated mainly to barley and other coarse grains, rather than corn. As with wheat, the EU internal market prices for coarse grains will decline when the constraints on subsidized exports keep larger supplies on the market. Beginning in 2002/03, the internal market price will be low enough that the EU can export other coarse grains without subsidy. As a result, the EU can allocate the entire export subsidy limit to barley, enabling the EU to increase barley exports to about 8 million tons in those years. Although internal market prices for barley will decline, the EU will be unable to export barley without subsidy at any time in the forecast. Declining internal market prices and the set-aside will both constrain production of coarse grains. The internal price declines will encourage feed use. Feed demand for corn and barley will also rise due to increased production of pork and poultry in the wake of the BSE scare. Coarse grains imports are determined by minimum access commitments, most importantly the import commitment for corn for the Iberian countries. Imports of corn for the northern European starch industry, already small, are assumed to be displaced by domestic wheat. Imports of other coarse grains are minimal. Oilseeds and Oilmeals Production Respect Blair House Limits Long term oilseed area and production are determined primarily by the 1992 Blair House Agreement between the United States and the EU. The agreement limits EU oilseed area eligible for oilseed payments to 5.5 million hectares. It also mandates that the area eligible for payments be reduced by the annual set-aside rate established for arable crops, or a minimum of 10 percent. Compliance is enforced through cuts in producer payments that are tied to overplanting. Through 2006, oilseed area is expected to settle at or near the Blair House limit. Any deviation from the limit would be short-lived, as penalties for overplanting would cause eligible area to fall the following year. Though the area planted to oilseeds will remain fairly stable, limited by the Blair House Agreement, production is projected to increase due to higher yields. Industrial oilseeds planted on set-aside area are assumed to remain at the agreed limit due to the development of new uses and processing capacity. Yield growth is expected to sustain production increases for rapeseed, but is assumed to decline for soybeans. Crush demand for oilseeds is expected to rise slightly for soybeans and sunflowerseed in response to rising crush margins but be more variable for rapeseed. Soybean imports will rise slightly with crush demand while sunflowerseed imports decline as rising production outstrips the growth in consumption (crush). Oilseed meals will continue to enter the EU duty-free, hence the internal market price reflects the world market price. Changes in domestic supply and demand will be accommodated through changes in imports and exports. Production of all meals from domestic crush is forecast to rise slowly over the forecast period. Prices of meals are expected to decline, but grain prices will decline more rapidly. Feed use of meals will remain fairly stable, rising slightly from near-term lows early in the projection period to around 32 million tons, with soymeal and sunflower meal gaining slightly, at the expense of rape meal. Imports of soybean meal fall early in the baseline projection, but recover in the later years, reflecting the more favorable price of soymeal to soybeans. Rape meal imports are projected to decline slightly in response to an increase in domestic production, and sunflower meal imports will rise early then decline in response to changes in relative meal prices. Vegetable oil production is projected to rise slowly with crush demand. Domestic consumption will increase steadily in response to growth in income and population. Vegetable oils will enter the EU market with a low tariff, scheduled to be reduced further during the Uruguay Round implementation period. There will be no other price support for the oils covered. Imports of other oils (mainly palm oil) will rise due to palm oil's competitive price, while exports of the domestically produced oils decline due to relatively stable production and higher demand. Conclusions The BSE crisis has affected EU agriculture well beyond the beef sector. EU beef consumption has been gradually declining since the late 1980s, but BSE will accelerate the trend. Consumers have replaced beef with pork, poultry, and other products and they will continue to increase their consumption of pork and poultry. The crisis has also affected the EU grain markets. Because pork and poultry are "grain-based" meats--that is, pigs and chickens eat far more grain than cows--feed use of grain is projected to increase. By contrast, feed use of non-grain feeds, particularly corn gluten feed and other high energy non-grain feeds, will decline due to lower beef production. The BSE crisis highlights a change in the EU's approach to disturbances on the internal market. In the past, the EU could protect producers by subsidizing the export of surplus production, thereby also exporting the burden of adjustment. Because of the URAA commitments to reduce subsidized exports, the EU has to rely on other measures to balance internal markets. These projections show that the EU can respect its URAA commitments, but to do so will entail curtailing production and exposing producers to adjustments in internal market prices. For further information contact: Susan Leetmaa, Mary Lisa Madell, Elizabeth Jones, or Timothy J. Smith at (202) 219-0620. BEGIN BOX 1 How Do the Projections Differ from Last Year's? The BSE crisis is the major reason that the projections differ from those made just last year using the same economic model. Beef consumption is now projected to decline roughly 10 percent more than last year. The sharp drop in consumption and the URAA export subsidy commitments create a severe imbalance on the market. As a result, the projections show a far larger accumulation of beef stocks than last year and a greater decline in internal market prices. Pork and poultry consumption, which increases as a reaction to the BSE problem, is also higher than was projected last year. Pork and poultry production are therefore also greater than in last year's projections. The changes in animal production alter the demand for feeds. Grain consumption is higher than previously projected. Another key difference is the assumption about the set-aside rate for 1997/98. The rate had not been set when the projections were made, and it was assumed to be 10 percent, rather than the 5 percent used in this year's model. Thus, the projections for wheat and coarse grain production are higher than last year. Wheat exports are essentially the same as last year. However, barley exports are higher because of the way the coarse grain export limit has been allocated. Compared with last year's assumptions, economic growth in the EU is slightly slower, the ECU is stronger relative to the dollar, and world prices for some important commodities are higher. The changes in these assumptions also create differences in the projections. The stronger ECU makes EU export prices higher and affect the EU's ability to export without subsidies (although this is in part offset by higher world prices). END BOX 1 BEGIN BOX 2 Genetically Modified Organisms Challenge U.S.- EU Trade Recent advances in genetics have enabled scientists to alter the genetic code of plants and animals by giving them desirable characteristics of other organisms. Geneticists have developed "transgenic" plants that can tolerate herbicides, resist pests, and produce fruit that stays ripe longer. Environmental groups in Europe have been pressuring governments to ban genetically modified organisms (GMOs) for fear they will cause more harm than good. The public health scare over BSE (bovine spongiform encephalopathy), or "mad cow" disease, has caused a lack of faith in science, making many EU consumers skeptical of GMOs, many of which have been scientifically proven to be harmless. Two such GMOs that have recently grabbed headlines are "Round-Up ready" soybeans and Bt corn. Monsanto's "Round-Up ready" soybeans, the result of bioengineering, are resistant to the popular herbicide glyphosate, which is found in Monsanto's Round-Up herbicide. The Round-Up ready soybeans have full regulatory clearance in the United States. The 1996 soybean harvest in the United States included the first batches of the genetically modified soybean, which amounted to an estimated 2 percent of the crop. The EU formally approved the importation and processing of Round-Up ready soybeans in April 1996, by a qualified majority of member states. The new soybeans and their products were not required to be labeled as a genetically modified organism. By the end of 1996, the first genetically modified soybeans began arriving in Europe amid protests by Greenpeace and other environmental groups. Another GMO that was recently introduced is "Bt corn," a genetically modified grain that contains a systemic pesticide. Developed in the United States by Swiss-based Ciba-Geigy, Bt corn contains a gene from the bacterium Bacillus thuringiensis (Bt), which produces a protein that is toxic to European corn borers and a few other caterpillars. Bt bacteria is used as an organic pesticide spray on food crops. The European corn borer is responsible for 10-20 percent of corn yield losses in the United States and significant losses in the EU as well. Because Bt corn is resistant to the European corn borer, it will reduce the need for insecticides. Both Ciba's versions of Bt corn and one produced by Mycogen, another seed company, have been approved and registered by the EPA and are on the market this year. Enough Bt corn seed was produced to plant roughly 400,000 to 650,000 acres in 1996. Environmental groups have been pressuring European governments to ban the modified corn for fear that the European corn borer would build up resistance to Bt, and that genes resistant to Ampicillin, an antibiotic used as the marker gene for Bt corn, could be transferred to human digestive bacteria leading to human resistance to Ampicillin. The European Commission called upon three scientific committees to assess the potential risks of Bt corn, and it was determined the corn posed no risk to human or animal health. The Commission subsequently decided, in December 1996, to approve Bt corn for importation and cultivation, prompting several member states to indicate their intention to challenge the Commission ruling. At issue now is the willingness of consumers to accept food from genetically modified organisms. Despite approval of biotech soybeans and corn by the EU, there have been protests from consumer and environmental organizations over introduction of GMOs, and calls for boycotts of products not labeled as GMO-free. Because soybeans and corn are bulk commodities, it is difficult and costly to segregate the genetically modified from the standard crops. The implication is that if genetically modified soybeans and corn were not allowed to be imported into the EU, no U.S. soybean or corn products would be imported by the EU. Labeling of the genetically modified soybean, corn and derivative products would be impractical and unneccesary. Soybean oil is used in a vast array of final consumer goods, and both soybean and corn meal are important inputs in meat and milk production. The prospect of a labeling requirement for GMOs in food products raises the question whether all final products would have to be labeled. The United States annually exports roughly $2.5 billion of soybeans and products, and another $1 billion in corn products (including corn gluten feed). Currently, the EU is the largest export market for U.S. soybeans and corn gluten feed. The EU may soon have few, if any, alternative sources of non-genetically modified soybeans. The Round-Up ready soybean was approved in Argentina earlier this year and has been planted in the crop to be harvested in 1997. It will also be grown in Brazil this year in field trials. END BOX 2 Central and Eastern Europe: An Emerging Agricultural Exporter Seven years after beginning the transition to a market-oriented economy, much of Central and Eastern Europe (CEE) 1/ has entered a period of sustained Gross Domestic Product (GDP) growth. Most countries have adhered to prudent monetary and fiscal policies, and undertaken the privatization of state-owned enterprises. Agricultural production has begun to recover under stable market conditions in Poland, the Czech Republic, and Hungary, while it continues to lag in countries such as Bulgaria and Romania, that are experiencing high inflation and banking crises. Provided that inflation is brought under control, the outlook remains promising for a significant recovery throughout the region over the next 10 years. 1/ For the ERS baseline projection, CEE refers to the Czech Republic, Hungary, Poland, Slovakia (the "Visegrad Four"), Albania, Bulgaria, Romania, and the former Yugoslav republics. The projection for the Baltic countries of Estonia, Latvia, and Lithuania is included as part of the Newly Independent States/Baltics (NIS/B) grouping. Additionally, CEE countries have begun to integrate into western economic and political structures. Many have signed Association Agreements with the European Union (EU), entered the Council of Europe, developed ties with the North Atlantic Treaty Organization, and are members of the World Trade Organization (WTO). Three have become members of the Organization for Economic Cooperation and Development (OECD). On a regional level, Poland, the Czech Republic, Slovakia, Hungary, and Slovenia are members of the Central European Free Trade Agreement (CEFTA), which provides for the reduction or elimination of tariffs on agricultural trade beginning January 1, 1998. Romania is currently under consideration for CEFTA membership. Finally, there exists a number of preferential bilateral trade agreements within the CEE region and between CEEs and other countries. This article presents the main conclusions for the CEE of the 1997-2006 long-term projection of the Economic Research Service. The results for Central and Eastern Europe were obtained using European Simulation (ESIM) models for Poland, Hungary, Czech Republic, Slovakia, and a Country Projections and Policy Analysis (CPPA) model for the Other CEE region (Romania, Bulgaria, the republics of the former Yugoslavia, and Albania). Five major assumptions underlie the CEE projections: o GDP growth is sustained and inflation falls to single-digit levels. One result is rising per capita real incomes and growth in consumer demand for foodstuffs. o Productivity rises due to more affordable, higher-quality fertilizers, seeds, and farm equipment, combined with more stable market conditions -- including the resolution of private property rights, the development of a land market, and improved access to credit for farmers. o World price changes are fully transmitted to CEE domestic markets for most grains, oilseeds, and meats. o The real appreciation of most currencies vis-a-vis the U.S. dollar and ECU continues. o None of the CEEs join the European Union during the projection period. Macroeconomic Outlook Most of the CEEs are well on their way to recovery. Nearly all achieved positive GDP growth in 1996, and economic growth is projected to continue throughout the projection period. An average regional GDP growth rate of 5 percent is projected through 2000, slowing to around 4 percent thereafter. This forecast marks a slowing of growth for Poland, Slovakia, the Czech Republic, Slovenia, and Albania, which have recently seen growth rates exceeding 5 percent. Hungary, Bulgaria, and some former Yugoslav Republics have experienced more difficulties in recent years, achieving growth rates of 1 or 2 percent. These countries are expected to overcome their current problems and reach growth rates close to those of their neighbors by 2000. This optimistic forecast assumes continued commitment to market reform throughout the region. Bulgaria, for example, currently faces a severe financial crisis stemming from continued failure to implement economy-wide reforms. There is hope that the new government will bring the money supply under control, and the International Monetary Fund (IMF) has agreed to the disbursement of a new credit facility. The current forecast assumes that Bulgaria will control inflation in the future, and join in the market reform of its neighbors. Other Balkan countries, particularly Romania, may encounter similar problems. Many of the Balkan countries have been slow to privatize state-owned enterprises. Fearful of growing unemployment, Balkan governments have been hesitant to shut down loss-makers, preferring instead to bail them out with soft credit. The practice could lead to a liquidity crisis in these countries. Inflation is projected to decline to single-digit levels throughout the region by 2000. Inflation is already less than 8 percent in the Czech Republic and Slovakia, and has fallen steadily in Poland, Hungary, and Slovenia. However, it continues to be a problem in most of the Balkan countries. Romania and Bulgaria both experienced triple-digit inflation in 1996. The optimistic forecast presented here depends on greater willingness by governments to discontinue soft credit to state enterprises and accelerate privatization. The assumption of a continued real appreciation of CEE currencies reflects the strong-currency policies that CEE governments are following to help reduce inflation. However, appreciating real exchange rates mean deteriorating terms of trade with the West. Some countries like Poland, the Czech Republic, and Slovakia are experiencing sizable current account deficits, which may bring about a departure from strong-currency policies in the medium term. Most importantly for the projection, appreciating real exchange rates constrain the growth of CEE agricultural exports. Resource and Technology Outlook Significant potential exists for productivity increases during the outlook period. Currently, there are two main obstacles that prevent yields from reaching their potential: o Investment in agriculture has been lagging. Farmers are reluctant to apply for credit because of high nominal interest rates, and banks are reluctant to grant credit to agriculture because of its uncertain income. In many countries these difficulties are compounded by uncertainties surrounding land ownership. Governments have been slow to grant titles and many farmers have only recently received their land. Without permanent titles, farmers cannot offer any collateral for loans. Farmers are also reluctant to make long term investments in land that could be taken away from them. o The farm structure in many CEEs has not fully adjusted. Many of the countries are characterized by very large state farms in the process of privatization, juxtaposed with tiny, fragmented private farms. Private farms are often less than 2 hectares and tend to consist of several noncontiguous plots. Farmers have difficulty acquiring machinery suitable for such small plots, so much of the work is done by hand. State farms are burdened with heavy debt inherited from the Communist past, making them costly and inefficient producers. It is assumed that during the projection period most of these obstacles will be overcome. As the CEE governments bring inflation under control, interest rates should fall, thus encouraging more investment. As land tenure becomes more permanent and capital markets improve, true land markets will develop. Eventually, these developments should lead to more efficient farms. For most commodities, productivity was assumed to rise 1 percent per year, based on these developments. This year's baseline assumes that feeding efficiency will improve only slightly, with a certain shift towards compound feeds. Following the liquidation of cooperative farms, most of the animals throughout the region are now in private ownership. But many private farmers cannot afford compound feed and instead feed grain, potatoes, sugarbeet tops, or whatever else is on hand. For this reason, the ratio of feed to liveweight gain is well above that of West European countries. Limited improvements in feeding efficiency are projected to keep feed demand at relatively high levels, constraining CEE exports of grains and oilseeds in the projection period. Agricultural Policy Outlook EU Membership. A key assumption underlying this forecast is that none of the CEEs join the EU during the projection period. Most have signed association agreements and applied for full EU membership, and several candidates expect to join between 2002 and 2005. EU membership could dramatically alter the forecast. However, there are three reasons why eventual CEE membership in the EU has not been included in the 1997 baseline models: o The timing of eventual accession remains uncertain. o It is unknown how long the transition period will be for joining the EU's Common Agricultural Policy (CAP). o The CAP will probably be changed significantly to accommodate the new members -- it is still impossible to forecast accurately the amount and form of CAP subsidies under an enlarged EU. Market regulation and trade policies. All CEEs have resorted to market price regulation for various commodities, by purchasing into and selling from state intervention stocks. For example, Poland and the Czech Republic have used this system to regulate pork prices. In Hungary, prices are relatively high, and producer surpluses are disposed of through intervention purchasing and export subsidies. Between 1995 and 1996, most CEEs imposed a ban on grain exports and reduced import tariffs to zero, the result of poor harvests and world prices that were significantly higher than domestic prices. CEEs maintain varying degrees of import protection under the Uruguay Round Agreement on Agriculture (URAA), laid out in schedules of bound tariffs, tariff-rate quotas for Most-Favored Nation, or preferential trading partners (mainly EU, CEFTA, or EFTA countries), export subsidy ceilings, and bound levels of subsidies to producers. Most tariffs range from zero to 50 percent, depending on the country and product. However, countries such as Hungary and Romania have taken advantage of high bound tariffs under the agreement to raise their applied tariffs for a number of products. Other countries such as Poland have maintained a more selective system of high out-of-quota import tariffs. Overall, despite moderately protectionist policies in the region, it is assumed that domestic prices will fluctuate along with world prices. Furthermore, there will be continued pressure in all countries to keep state budgets in balance. Even if the CEEs -- with the current exception of Hungary -- could substantially raise their levels of domestic support and still comply with URAA commitments, doing so would entail additional budgetary pressures. Input and investment policies. All the CEEs grant some form of subsidies for input purchases and credit. High nominal interest rates have been used to justify credit subsidies, while subsidies for the purchase of certified seeds, fertilizers, and farm machinery aim to increase productivity and narrow the technological gap with the West. The projection assumes that some input subsidies will continue, but will not be very high relative to the value of production. Meanwhile, the need for credit subsidies will decrease as interest rates fall. Commodity Outlook The key assumptions underlying the commodity projections are as follows: o Changes in world market prices will be fully transmitted to domestic CEE markets, with both producers and consumers responding to such changes. Current CEE-to-world price ratios are maintained over the projection period for all commodities. o Productivity will rise, increasing supply. o Real appreciation of CEE exchange rates will mean falling real domestic prices for most commodities over the projection period, dampening production and stimulating consumption. o Continued GDP growth will mean rising personal incomes throughout the projection period. The commodity projections through 2006 are strongly influenced by rising domestic incomes and steady declines in real domestic prices. Domestic price declines in the models are the result of declining real world prices and appreciating real exchange rates. Area planted to most crops changes little. But modest productivity gains lead to rising yields and production increases of 9 percent for grains and 5 percent for oilseeds. Productivity gains thereby cause the region to become a larger net grain exporter. The Hungarian, Romanian, and Bulgarian shares of the region's grain exports grow, while Poland and Slovakia remain net importers. On the demand side, rising incomes lead to consumption growth, especially for livestock products. Over the long term, the impact can be seen in declining net exports of pork and poultry from the region as a whole. Wheat and Corn Exports Rise The CEEs together are projected to be net exporters of 4.4 million tons of grain by 2005/06. This includes net exports of 2.6 million tons of wheat and 2.7 million tons of corn. All the CEEs except Poland will become net wheat exporters. Wheat exports are expected to grow fastest from Hungary, Other CEEs, and the Czech Republic. Meanwhile, Hungary, Romania, and the former Yugoslav Republics will remain the principal exporters of corn. Net corn exports are set to more than triple from the Other CEEs, from an average of 650,000 tons in marketing years 1993-95 to more than 2.7 million tons in 2006. On the other hand, Poland, the Czech Republic, and Slovakia are expected to become growing importers of corn as hog numbers rise. Although net CEE grain exports are set to rise, the region is projected to remain a net importer of barley. The reason is barley prices fall more sharply than wheat or corn prices throughout the projection period. While production changes very little, decreasing prices stimulate demand and lead to net barley imports of nearly 500,000 tons by 2006. Besides productivity gains, the increasing proportion of oilmeals in livestock feed is another reason why CEE grain exports are expected to rise over the projection period. As oilmeals are substituted for grains, more grain surpluses will be exported. The substitution is forecast to take place mostly in the Visegrad Four, which are more advanced in their recovery and which will adopt western feeding practices faster than the other CEEs. Soymeal Imports Rise To Satisfy Growing Livestock Sector The three major oilseeds grown in the CEEs are rapeseed, sunflowerseed, and soybeans. Rapeseed is grown mainly in Poland, the Czech Republic, and Slovakia. Sunflowerseed production is largest in Bulgaria, Romania, and Hungary, while Romania and the former Yugoslav Republics are the principal soybean producers. The region has always been a net importer of oilmeals, mostly soymeal, and is a net exporter of rapeseed and sunflowerseed. Soybean production in recent years has been less than half the level of the 1980s, and it is not projected to rise significantly during the projection period. In the past the only two significant producers have been Romania and Yugoslavia, each with about 300,000 tons per year. All the countries were net importers of soybeans and soymeal. Since the transition began, soybean production has plummeted in all countries, but for different reasons. In former Yugoslavia, the decline was due to disruptions caused by civil war, while Romania and Bulgaria never had good conditions for growing soybeans. Yields were barely 1 ton per hectare, and soybeans were cultivated only because the central planners said they should be. With the demise of central planning, growers have lost interest in cultivating soybeans, and it is unlikely that this will change. Regional soybean output is projected to rise 6 percent by 2006, due mainly to the expected recovery in Serbia and Croatia. Sunflowerseed output increased substantially in the early years of the transition, as new private farmers found cultivation profitable. Production is projected to rise further over the projection period, the result of favorable prices relative to other oilseeds. Yet, exports are expected to fall, because production increases will be outstripped by growing consumer demand for vegetable oil and increasing demand for meal in the livestock sector. As previously discussed, feed demand for oilmeals is expected to rise significantly over the projection period. This results from continued recovery in the livestock sector and a long-term shift from direct grain feeding to compound feeds. The increased demand will be met in part through higher domestic sunflower meal production, but it will also lead to rising imports of soymeal and soybeans. Soymeal imports are projected to rise 31 percent to more than 2.7 million tons, and imports of soybeans are expected to rise 15 percent to over 350,000 tons. Most of the rise in soymeal and soybean imports is projected to come from growing livestock numbers in Poland, Hungary, Czech Republic, and Slovakia. Projected ratios of soybean to soymeal imports depend most on future investment in domestic soybean crushing plants. Region To Remain Net Exporter of Meats and Livestock The initial years of the transition were marked by a dramatic downward adjustment in the livestock sector. Animal numbers plummeted in response to rising feed costs and a sharp decline in consumer demand. However, recovery began in 1996 as hog and poultry inventories began to stabilize, and in 1997 and 1998 cattle numbers are expected to turn around. The outlook through 2006 is for continued recovery. Production of all meats is projected to rise due to declining prices for grains and oilmeals and strong domestic demand. Pork and beef production are projected to increase 12 percent, while poultry production is expected to rise 10 percent. As a whole, the CEE region is projected to remain a net exporter of all three meats. However, because of rising real income, the demand for pork and poultry -- the preferred meats of CEE consumers -- will generally rise faster than production, leading to a steady decline in net exports. Over the projection period, poultry consumption is expected to grow 17 percent and pork consumption 14 percent, while beef demand is set to grow only 6 percent. Weaker consumption growth will generate increased net exports of beef from the region. While net pork exports fall from 100,000 tons in the base year to 40,000 tons and net poultry exports fall to zero, net beef exports are set to rise to 100,000 tons over the projection period. Poland was the largest CEE pork producer at 1.5 million tons in 1996, and is projected to produce 1.8 million tons in 2006. Czech Republic and Hungary both produced less than 0.7 million tons in 1996, and are projected to produce more than 0.8 million tons in 10 years. Although production will grow fastest in the Visegrad Four, demand is projected to catch up to supply, as incomes in those countries continue to rise and consumers increasingly favor pork. In the long term, Poland and the Czech Republic are projected to remain net importers of pork, and Hungary and Romania net exporters. Of the Visegrad countries, Poland and the Czech Republic are by far the largest beef markets at roughly 410,000 and 320,000 tons of production, respectively, in 1996. Most of the projected increase in beef exports comes from the Other CEE countries, where consumption is expected to decline most heavily in favor of pork and poultry. The baseline projects poultry trade from the CEEs to be roughly in balance by 2006, with equal quantities of imports and exports. While the CEEs currently export approximately 150,000 tons per year, mostly from Hungary, strong demand growth over the coming decade will likely create opportunities for U.S. and other poultry exporters to the region, in particular to Poland. Agreements such as the one currently guaranteeing U.S. companies minimum access to Poland's poultry market will probably remain a major determinant of future poultry import levels. Conclusions The 1997 ERS baseline for Central and Eastern Europe projects the region to become a growing net exporter of wheat, corn, and beef, a declining net exporter of pork and poultry, and a growing importer of soymeal and soybeans. Grain and beef exports should increase over the 1997-2006 projection period despite rising incomes and falling prices, because productivity gains outpace consumption growth. Net exports of pork and poultry should decline due to strong growth in consumer demand. Finally, healthy demand growth for oilmeals -- at 2.6 percent per year -- is projected to make the region an increasingly significant importer of soymeal and soybeans, as well as a declining net exporter of domestically produced oilseeds and oilmeals. These projections would be significantly altered if some CEEs were to join the EU, or increase domestic price levels through "CAP-like" policies in preparation for EU membership. While higher grain surpluses would result, the budgetary costs of maintaining subsidies could be high. Furthermore, if domestic prices are pushed above world levels, subsidies would be necessary to make exports price-competitive. Such increases in export subsidies, however, will be constrained by commitments under the Uruguay Round Agreement on Agriculture. For further information contact: Todd Morath or Nancy Cochrane, at (202) 219-0620. END_OF_FILE