RESTRICTEDWORLD TRADE
ORGANIZATIONG/AG/NG/S/19
23 October 2000
(00-4399)
Committee on Agriculture
Special Session
INFLATION AND EXCHANGE RATE MOVEMENTS
IN THE CONTEXT OF DOMESTIC SUPPORT COMMITMENTS
Background Paper by the Secretariat
1. At the second Special Session of the Committee on Agriculture on 29-30 June 2000, it was
agreed that the Secretariat would provide a background paper on inflation and exchange rate
movements in the context of domestic support co mmitments (paragraph 7(e) of G/AG/NG/2 refers).
In response, the aim of this paper is to show with the help of hypothetical AMS calculationsimplications of inflation and exchange rate movements for domestic support commitments.  It may be
noted that in the framework of the AIE Process two informal papers were submitted by Members
which are relevant to the issue at hand:  by South Africa on "The effects of inflation on reduction
commitments" (AIE/33); and by Iceland on "Ext ernal reference price adjustment" (AIE/42).
2. The paper is structured around five basic examples.   The first example illustrates the
workings of inflation in the case of non-exempt payments which are constrained by a  de minimis
commitment. The second example illustrates aspects of inflation in the case of market price support
under a  de minimis  commitment.  In the third example, non-exempt payments are subject to a Total
AMS commitment.  In the fourth example, market price support is constrained by a Total AMS
commitment that is specified in domestic currency.    The fifth example is designed to show certain
effects of inflation and exchange rate movements in the case of market price support under a Total
AMS commitment that is denominated in a foreign currency.
3. In all five examples it is assumed that the entire agricultural output consists of one
agricultural product only.  While this is a significant simplification, it may be noted that a multi-
product scenario would not fundamentally change the an alysis with regard to the effects of inflation.
It is further assumed that the physical output of the single agricultural product remains constant over
the period under consideration.  It should also be noted that the examples are based on the assumptionof a single rate of inflation (10 per cent annually), without taking into account inflation differentials as
between inputs and outputs.  Agricultural input and producer prices are thus assumed to increase at
the same rate as the general price level.  The de minimis  ceiling is assumed to be 5 per cent of the
value of production.  However, it should be noted that the conclusions derived from the examples
apply irrespective of the  de minimis  level, including with respect to the higher ceiling (10 per cent)
available to developing countries.G/AG/NG/S/19
Page 2
Example 1 -   Non-exempt payments under a  de minimis  commitment
4. In the present example, inflation is represented in the form of a price index.   It will be seen
that the market price per unit of production and the value of production reflect the inflationary
development, as they increase at the same rate as  the price index.  While the nominal value of the  de
minimis  ceiling (at 5 per cent) increases proportionally with the total value of production, in real terms
the  de minimis  threshold remains unchanged at 2,500.   Further, there are non-exempt payments (e.g.
a product-specific fertilizer subsidy) which are below de minimis  in the base period (1986-88).   The
subsidy outlays are indexed according to the movement of the price index.   As a result of the annual
inflation adjustment, the nominal subsidy outlays increase more than threefold between the base
period and 2000, although they remain below de minimis  throughout that period.
5. The essential point of this example is that the de minimis  provision of the Agreement on
Agriculture contains an automatic inflation adju stment mechanism.  This adjustment mechanism
allows the real value of such support to be maintained without breaching the de minimis  ceiling.1
                                                     
1 This conclusion applies to all "amber" support (other than that based on a price gap), whether it be
product-specific or non-product-specific, input or output subsidies, non-exempt direct payments or market price
support calculated using the Equivalent Measurement of Support.   For the developing countries, certain support
measures otherwise covered by the non-product-specific de minimis  ceiling (investment and input subsidies in
conformity with certain conditions) are not subject to this constraint (Art. 6.2 of the Agreement on Agriculture).G/AG/NG/S/19
Page 3  Example 1 - Non-exempt payments under a  de minimis  commitment
Year Price index
(1)Volume
 of production
(2)Market price
 (per unit)
50 * (1) / 100 = (3)Value of
production
(2) * (3) = (4)De minimis
ceiling
(nominal)
0.05 * (4) = (5)De minimis
ceiling
(real)
(5) / (1) * 100Subsidy outlays
(nominal)
2,000 * (1) / 100 = (6)Subsidy
outlays
(real)
(6) / (1) * 100
Base period (1986-88) 100 1,000 50 50,000 2,500 2,500 2,000 2,000
1989 110 1,000 55 55,000 2,750 2,500 2,200 2,000
1990 121 1,000 61 60,500 3,025 2,500 2,420 2,000
1991 133 1,000 67 66,550 3,328 2,500 2,662 2,000
1992 146 1,000 73 73,205 3,660 2,500 2,928 2,000
1993 161 1,000 81 80,526 4,026 2,500 3,221 2,000
1994 177 1,000 89 88,578 4,429 2,500 3,543 2,000
1995 195 1,000 97 97,436 4,872 2,500 3,897 2,000
1996 214 1,000 107 107,179 5,359 2,500 4,287 2,000
1997 236 1,000 118 117,897 5,895 2,500 4,716 2,000
1998 259 1,000 130 129,687 6,484 2,500 5,187 2,000
1999 285 1,000 143 142,656 7,133 2,500 5,706 2,000
2000 314 1,000 157 156,921 7,846 2,500 6,277 2,000
Assumptions:
one product
annual rate of inflation 10%de minimis percentage 5%
product-specific subsidy (base period) 2,000market price follows movement of price index
subsidy outlays adjusted annually according to movement of price indexG/AG/NG/S/19
Page 4
Example 2  - Market price support subject to a de minimis  commitment
6. In the second example, the effects of inflation under a de minimis  commitment are illustrated
for market price support.2    According to the Agreement on Agriculture, "market price support shall
be calculated using the gap between a fixed external reference price and the applied administered
price multiplied by the quantity of production eligible to receive the applied administered price"(paragraph 8 of Annex 3) and "the fixed external reference price shall be based on the years 1986 to
1988" (paragraph 9 of Annex 3).   Applying the above methodology, in this example the market price
support in the base period turns out to be negative since the applied administered price is lower than
the external reference price (i.e. the product is taxed rather than subsidized).   As a result, the de
minimis  commitment applies (5 per cent of the total value of production).  It is important to note that
the fixed external reference price and the applied administered price are both specified in domestic
currency (DCUR).
7. In the years following the base period, the applied administered price is assumed to be
inflation-indexed at a rate of 10 per cent annually.  Eligible production remains unchanged.  It may be
noted that the de minimis  ceiling increases proportionally with the inflated nominal value of
production.  This may give the erroneous impression that indexation of the applied administered price
can be done without running the risk that the resulting market price support breaches the de minimis
ceiling.   However, since a fixed external reference price is employed (100), the nominal value of
market price support increases at a faster rate than the  de minimis  ceiling.  In this example, the market
price support turns from negative into positive by 1996 and exceeds the de minimis  ceiling.  A breach
of the de minimis  rule can only be avoided if either the applied administered price or the volume of
production eligible to receive the applied administer ed price are reduced (or any combination of the
two that respects the de minimis  ceiling).
8. The general point is that the applied administered price in market support schemes subject to
a de minimis  commitment cannot be inflation-indexed without sooner or later breaching this
commitment, where the fixed external reference price is specified in domestic currency.  In such
circumstances, the real value of market price support cannot be sustained.
                                                     
2 The same analysis applies to non-exempt direct payments calculated using the gap between the fixed
external reference price and the applied administered price but not to market price support calculated using theEquivalent Measurement of Support.G/AG/NG/S/19
Page 5  Example 2: Market price support subject to a de minimis  commitment
Year Price index
(1)Applied
administered price
in DCUR
50 * (1) / 100 = (2)Fixed external
reference price in
DCUR
(3)Eligible
production
(4)Value of
production
in DCUR
(2) * (4) = (5)De minimis
ceiling
in DCUR
0.05 * (5)Market price
support
in DCUR
[(2) - (3)] * (4)
Base period (1986-88) 100 50 100 1,000 50,000 2,500 -50,000
1989 110 55 100 1,000 55,000 2,750 -45,000
1990 121 61 100 1,000 60,500 3,025 -39,500
1991 133 67 100 1,000 66,550 3,328 -33,450
1992 146 73 100 1,000 73,205 3,660 -26,795
1993 161 81 100 1,000 80,526 4,026 -19,474
1994 177 89 100 1,000 88,578 4,429 -11,422
1995 195 97 100 1,000 97,436 4,872 -2,564
1996 214 107 100 1,000 107,179 5,359 7,179
1997 236 118 100 1,000 117,897 5,895 17,897
1998 259
1999 285
2000 314
Assumptions:
one product
annual rate of inflation      10%de minimis percentage      5%
applied administered price (base period)      50applied administered price  adjusted annually according to movement of price index
market price equals applied administered price
eligible production equals total productionG/AG/NG/S/19
Page 6
Example 3  -   Non-exempt payments subject to a Total AMS commitment
9. One of the obvious consequences of inflation is that it has the effect of eroding the nominal
value of AMS commitments where they are specified in domestic currency.  Under conditions of
persistent inflation, the value of a given AMS commitment may even be eroded to a point where the
de minimis  level, not the AMS level, becomes the operational constraint.  This is what the third
example is designed to show.
10. In this example,  there is a Total AMS commitment because the base period outlays (1986-88)
on non-exempt payments are above rather than below de minimis  levels.  It is assumed that the
subsidy outlays are inflation-adjusted at a rate of 10 per cent annually until 1994.  In the present
example, subsidy outlays reach 5,315 in 1994.
11. As the example shows, by 1995, the beginning of the implementation period, the practical
constraint for the non-exempt payments is the de minimis  ceiling (4,872) rather than the AMS
commitment level (i.e. 3,000 minus the applicable annual reduction commitment).   The lower  AMScommitment level is not constraining and is therefore, in practice, redundant.  Effectively, the AMS
constraint has been replaced by the  de minimis  constraint (see arrow).G/AG/NG/S/19
Page 7  Example 3 - Non-exempt payments subject to a Total AMS commitment
Year Price index
(1)Volume
 of production
(2)Market price
 (per unit)
50 * (1) / 100 = (3)Value of
production
(2) * (3) = (4)De minimis
ceiling
(nominal)
0.05 * (4) = (5)De minimis
ceiling
(real)
(5) / (1) * 100Subsidy outlays
3,000 * (1) / 100
Base period (1986-88) 100 1,000 50 50,000 2,500 2,500 3,000
1989 110 1,000 55 55,000 2,750 2,500 3,300
1990 121 1,000 61 60,500 3,025 2,500 3,630
1991 133 1,000 67 66,550 3,328 2,500 3,993
1992 146 1,000 73 73,205 3,660 2,500 4,392
1993 161 1,000 81 80,526 4,026 2,500 4,832
1994 177 1,000 89 88,578 4,429 2,500 5,315
1995 195 1,000 97 97,436 4,872 2,500 4,872
1996 214 1,000 107 107,179 5,359 2,500 5,359
1997 236 1,000 118 117,897 5,895 2,500 5,895
1998 259 1,000 130 129,687 6,484 2,500 6,484
1999 285 1,000 143 142,656 7,133 2,500 7,133
2000 314 1,000 157 156,921 7,846 2,500 7,846
Assumptions:
one product
rate of inflation 10%de minimis percentage 5%
product-specific subsidy (base period) 3,000market price follows movement of price index
subsidy outlays adjusted annually according to movement of price indexG/AG/NG/S/19
Page 8
Example 4 - Market price support under a Total AMS commitment specified in domestic
currency
12. The present example is identical to the second example, except that the market price support
in the base period is positive and above the  de minimis  ceiling.   A Total AMS commitment is
therefore applicable.   For the purposes of this example the fixed external reference price and theTotal AMS commitment are assumed to be specified in domestic currency.
13. This example shows that if the applied administered price were to be adjusted for inflation,
the resulting market price support would be in excess of the AMS commitment.  This leads to the
conclusion that the applied administered price under a Total AMS commitment cannot be inflation-
adjusted where the fixed external reference price and the AMS commitment are specified in domestic
currency.G/AG/NG/S/19
Page 9  Example 4: Market price support under a Tota l AMS commitment specified in domestic currency
Year Price index
(1)Applied
administered price
in DCUR
50 * (1) / 100 = (2)Fixed external
reference price
in DCUR
(3)Eligible
production
(4)Value of
production
in DCUR
(2) * (4) = (5)De minimis
ceiling
in DCUR
0.05 * (5)Market price
support
in DCUR
[(2) - (3)] * (4)
Base period (1986-88) 100 150 100 1,000 150,000 7,500 50,000
1989 110 165 100 1,000 165,000 8,250 65,000
1990 121 182 100 1,000 181,500 9,075 81,500
1991 133 200 100 1,000 199,650 9,983 99,650
1992 146 220 100 1,000 219,615 10,981 119,615
1993 161 242 100 1,000 241,577 12,079 141,577
1994 177 266 100 1,000 265,734 13,287 165,734
1995 195 292 100 1,000 292,308 14,615 192,308
1996 214
1997 236
1998 259
1999 285
2000 314
Assumptions:
one product
annual rate of inflation 10%de minimis percentage 5%
applied administered price (base period) 150applied administered price adjusted annually according to movement of price index
market price equals applied administered price
eligible production equals total productionG/AG/NG/S/19
Page 10
Example 5 - Market price support under a Total AMS commitment specified in foreign
currency
14. The present example focuses on the effects of inflation and exchange rate movements on the
level of the AMS.  The crucial difference compared to the previous example is the fact that the fixed
external reference is denominated in foreign currency (US$).  The applied administered price
continues to be expressed in domestic currency (DCU R).   It is then converted into US$ using the
exchange applicable in the base period (2 DCUR pe r US$).   The resulting market price support gives
rise to a  Total AMS commitment specified in US$.
15. Typically, in an economy the price level tends to  move along with the exchange rate.  In this
example, there is inflation as reflected by the increasing price index, while the domestic currency
depreciates against the US dollar (from 2 DCUR/U S$ in the base period to 6.6 DCUR/US$ in 1999).
16. In the example, the applied administered pri ce is inflation-adjusted in accordance with the
movement of the price index.  The first step in the current market price support calculation is theconversion of the applied administered price into US dollars using the exchange rate of the
implementation year in question. In a second step, eligible production is multiplied by the price gap
between the applied administered price in the implementation year in question and the fixed external
reference price.
17. The result of this procedure is a level of market price support which, despite an inflation-
indexed applied administered price, declines year -after-year during the implementation year.   This
decline is brought about by the following:   in the market price support calculation, the exchange rate
in the implementation year in question rather than the base period exchange rate is applied.
3  In this
way, the declining exchange rate is employed to deflate the inflation-indexed applied administered
price.  Indexation of the applied administered price and deflation through the exchange rate wouldoffset each other if the price level increased and the ex change rate declined at the same rate.   In the
present example, however, the exchange rate happens to decline at a faster rate than the price index.
As a result the exchange rate deflator "over-compensates" for inflation and the market price support
declines, thereby creating artificial AMS credit.   
                                                     
3 This would, of course, be different if the base period exchange rate were to be used to convert the
applied administered price for the purposes of this calculation.G/AG/NG/S/19
Page 11  Example 5: Market price support under a To tal AMS commitment specifi ed in foreign currency
Year Price index
(1)Exchange
rate indexExchange rate
DCUR/US$
(2)Applied
administered price
in DCUR
300 * (1) / 100 = (3)Applied
administered
price in US$
(3) / (2) = (4)Fixed external
reference price
in US$
(5)Eligible
production
(6)Market price
support in US$
[ (4) - (5) ] * (6) = (7)
Base period
 (1986-88)100 100 2.0 300 150 100 1,000 50,000
1995 200 200 4.0 600 150 100 1,000 50,000
1996 221 228 4.6 662 145 100 1,000 45,240
1997 246 260 5.2 737 142 100 1,000 41,891
1998 261 286 5.7 784 137 100 1,000 37,203
1999 272 329 6.6 816 124 100 1,000 23,932
Assumptions:
one product
annual rate of inflation variablede minimis  percentage 5%
applied administered price (base period) 300applied administered price adjusted annually according to movement of price indexG/AG/NG/S/19
Page 12
Adjustment of exchanges rates and price levels
18. The adjustment of exchange rates and price levels is illustrated in Table 1 using data from the
International Monetary Fund.  The table shows for four selected Members the development of the
domestic currency against the US dollar (SDR in the case of Iceland) and the price level in 1995-99.
The price level is measured by the Consumer Price Index (CPI) or Wholesale Price Index (WPI).
19. A general observation in Table 1 is that during 1995-99 inflation went along with currency
depreciation (or devaluation as the case may be) but in none of the four cases was there a one-to-one
relationship between the adjustment of the exchange rate and the general price level.   In Iceland and
Turkey, the Consumer Price Index increased at a faster rate than the domestic currencies depreciated,
while in Pakistan and South Africa it was the opposite.
20. To summarize, the adjustment of the exchange rate and the general price level (using the CPI
as a benchmark) has certain implications for the level of the AMS in cases where the Current Total
AMS is specified in foreign currency and the applied administered price is inflation-indexed:
(a) If the rate of currency depreciation equals the rate of inflation,  the use of the foreign
currency in the Current Total AMS calculation offsets inflation.
(b) If the rate of currency depreciation is greater than the rate of inflation,  the use of the
foreign currency in the Current Total AMS calculation "over-compensates" for
inflation.
(c) If the rate of currency depreciation is smaller than the rate of inflation,  the use of the
foreign currency in the Current Total AMS calculation "under-compensates" for
inflation.G/AG/NG/S/19
Page 13
  Table 1 - Adjustment of exchanges rates and price levels in selected Members, 1995-99
ICELANDExchange
rate (ISK/SDR)Exchange rate index
(1995=100)CPI WPI
1995 97.0 100 100 na
1996 96.2 99 102 na
1997 97.4 100 104 na
1998 97.6 101 106 na
1999 99.6 103 109 na
Average annual change 1995-99 (%) 0.7 2.2
TURKEYExchange
rate (Liras/US$)Exchange rate index
(1995=100)CPI WPI
1995 45,845 100 100 100
1996 81,405 178 180 176
1997 151,865 331 335 320
1998 260,724 569 619 550
1999 418,783 913 1,020 841
Average annual change 1995-99 (%) 73.8 78.7 70.3
PAKISTANExchange
rate (Rs/US$)Exchange rate index
(1995=100)CPI WPI
1995 31.5 100 100 100
1996 35.9 114 110 111
1997 40.9 130 123 126
1998 44.9 143 131 134
1999 51.8 165 136 142
Average annual change 1995-99 (%) 13.3 8.0 9.2
SOUTH AFRICAExchange
rate (Rand/US$)Exchange rate index
(1995=100)CPI WPI
1995 3.6 100 100 na
1996 4.3 118 107 na
1997 4.6 127 117 na
1998 5.5 152 125 na
1999 6.1 168 131 na
Average annual change 1995-99 (%) 13.9 7.0
Key:
CPI   consumer price index
WPI  wholesale price index
Source:   International Monetary FundG/AG/NG/S/19
Page 14
Currency specification of Members with Total AMS commitments and fixed external reference
prices
21. Table 2 lists all Members which have a Total AMS commitment and/or market price support
based on fixed external reference prices.  The table also shows the currency in which these
commitments and reference prices are specified in Schedules and the Supporting Material (generally
AGST-documents).4   Those Members having chosen a foreign currency arguably have access to an
built-in inflation adjustment mechanism.  As illust rated above, the exchange rate in Current Total
AMS calculations tends to have the effect of a deflator by reducing the inflationary element that may
be present in price support and non-exempt payments.
22. Leaving aside automatic inflation-ad justment mechanisms, such as the de minimis  provision,
the Agreement on Agriculture contains no mechanism for inflation-adjustment of domestic support
commitments.   However,  Article 18.4 of the Agreement on Agriculture provides that "in the review
process members shall give due consideration to the influence of excessive rates of inflation on theability of any Members to abide by its domestic support commitments".   In addressing notification-
related aspects of this provision, the advice of the Secretariat consistently provided to delegations has
been that the domestic support notifications should be submitted concurrently on both an unadjusted
and an inflation-adjusted basis (G/AG/W/45, paragraph 43 refers).   It may be recalled that this
recommendation was as one of a series of suggesti ons which were considered and approved by the
Committee, with a view to improving the quality of notifications and the efficiency of the
Committee's review process (G/AG/R/20, paragraph 14 refers).
                                                     
4 In their domestic support notifications, some Member s have recalculated their fixed external reference
prices in a foreign currency.G/AG/NG/S/19
Page 15
Table 2 - Currency specifica tion of Members with Total AMS commit ments and fixed external reference prices
AMS
in domestic
currencyAMS
in foreign
currencyFixed external
reference prices
in domestic
currencyFixed external
reference prices
in foreign currencyBuilt-in
deflator
Members with AMS commitments
Argentina US$ (1992 rate) X
Australia $A $A
Brazil US$ US$ X
Bulgaria ECU ECU X
Canada CDN$ CDN$
Colombia US$ US$ X
Costa Rica US$ US$ X
Cyprus £C £C
Czech Re public Kÿ
EC ECU ECU
Hungary Ft
Iceland SDR ISK X
Israel US$ US$ X
Japan ¥ ¥
Jordan JD JD
Korea W W
Latvia SDR SDR X
Mexico constant 1991 pesos peso X
Morocco DH DH
New Zealand NZ$
Norway NOK NOK
Papua New Guinea US$ X
Poland US$ PLZ X
Slovak Republic Sk Sk
Slovenia ECU ECU X
South Africa Rand Rand
Switzerland-Liechtenstein SFr SFr
Thailand B
Tunisia D D
United States US$ US$
Venezuela US$ US$ X
Other Members with fixed external reference prices
India Rs
Pakistan Rs
Philippines P
Turkey US$ X
Notes:
Fixed external reference prices generally from AGST-documents
Israel: fixed external reference prices  first notified in G/AG/N/ISR/8/Rev.1
Latvia:  fixed external reference prices first notified in G/AG/N/LVA/3Slovak Republic:  fixed external reference prices first notified in G/AG/N/SVK/9South Africa:  for fixed external reference prices, see G/AG/W/30
Turkey: fixed external reference prices  first notified in G/AG/N/TUR/3/Add.1
__________