Holding speculative investments in food and the market overreaction largely responsible for the recent phase of high food prices, a global food policy think tank has mooted a two-pronged strategy to avert recurrence of such situations in future.

The proposed strategy involves creation of a small physical stock of food and putting in place a mechanism for market intelligence-based intervention in food markets to discourage speculation.

A Policy Brief (No 10) released recently by the Washington-based International Food Policy Research Institute has stated that the changes in supply and demand fundamentals could not fully explain the drastic increase in food prices in the first six months of 2008.

"Rising expectations, hoarding and hysteria also played a role in the increasing level and volatility of food prices, as did the flow of speculative capital from financial investors into agricultural commodity markets."

The paper points out that between May 2007 and May 2008, the volume of globally traded grain futures and options had increased substantially, reflecting higher speculative investment in the agricultural commodity markets. Another indicator of the speculative activity -- the ratio of the monthly volume of futures trading to open interest -- also increased substantially.

In 2008, soyabean and rice ratio of futures to open interest increased by 27 per cent and 19 per cent, respectively, as wheat ratios continued to grow at 19 per cent. "There is evidence that speculative activity partly explains the price spike since January 2008," the report maintains.

It also rules out the traditional options for dealing with such a situation by either building up a significant physical publicly held and managed world grain reserve or changing the regulations for commodity markets to limit the volume of speculation versus hedging. Both these are impractical for financial and other reasons.

Instead, the policy paper suggests creation of only a modest emergency food reserve of around 300,000 to 500,000 tonnes of basic grains (about 5 per cent of the current global food aid flows of 6.7 million tonnes) to be used exclusively for emergency response and humanitarian assistance to the needy countries. The food can be donated by the member countries of the Group of 8 plus 5 (G-8 plus 5) and others who can afford to do so, including India and China.

As second tier of the proposed arrangement, the strategy paper commends creation of 'virtual gain reserve' (in the form of supply commitments in case of need) and a market intervention mechanism. Such commitments would consist not of actual budgetary expenditure, but of promissory finance to be provided as and when needed.

The market intervention would be based on the advice of a global market intelligence unit, which would fix a dynamic price band and raise alarm bells when the actual prices tend to defy the band, thus, indicating need for intervention in the futures market.

"The virtual reserve concept is a viable innovative option that could prevent speculators from unduly affecting this basic food market, which is so central for the livelihoods of the poorest two billion people," the paper maintains.

It adds: "This would also help prevent the kind of harmful and ad hoc trade policy interventions, such as export bans, high export tariffs and high import subsidies that have been both a cause and an effect of the recent price crisis."