Monday, October 27, 2008

The current crisis in the Tea Industry

Yesterday the representatives of the Tea Smallholders (those having tea extents of less than 5 hectares each), the backbone of the tea industry in Sri Lanka, were in crisis talks with the Tea Board over the need to address and resolve the problem, which for them is one of halving the price received by them for their leaf, within a matter of a month, after a prolonged period where they received in the region of Rs50/- per kg for their plucked leaf sold to the factories. Many are losing money at this price.

The reason for this is that there are many consignments of tea at the auction (which is the primary method of bulk tea sales in Sri Lanka), not fetching even the reserve price. This is because overseas buyers have lately been absent from the market, and which has also resulted in most varieties of tea fetching substantially lower prices than in the recent past.

We do not know for how long these buyers will stay away, but looking into why they are absent, it is logical to assume that as many buyers are traders, they have not been able to raise the necessary finance to make these purchases owing to the international credit crisis.

It is very unlikely that the world demand for tea will fall sharply owing to the recession, so it is a timing problem, so that when credit lines are made available, the market will return to normalcy.

The government is in a quandary over what to do. If they provide money to the local buyers such as MJF or Akbar, to purchase this tea, then it is just helping them to stockpile at a lower price to off load when prices rise. Actually these entities are better able to finance stocks anyway, are most likely waiting for prices to drop further so they can snap up bargains, as the prices they will purchase at will be much less than the cost of production.

If they help the factory owners with finance, to buy tea from the Tea Smallholders, to keep the factories operating then they have an unfair advantage, where they will continue to offer lower prices to the Smallholder, while keeping the future profits to themselves, when they eventually sell the tea they manufacture. We then come to the Smallholders who can be loaned money to tide them over, but the government will be unable to collect on these loans, as they will not have any collateral to enforce collection.

One other matter that needs to be mentioned to appreciate one of the practical problems is that due to the demand for tea and the need for factories to run at capacity, to ensure lowest cost of production, there has been a lot of competition to collect as much leaf as possible. Due to this competition, the Smallholder sells the tea to the factory that offers the best terms, not just in price, but also if the factory offers free pickup, and then only deducts a nominal 2% for moisture content of wet leaf, and also being lax on the quality of the leaf itself, as it is likely that with so many smallholders, the strict adherence to leaf standard could be compromised, resulting in a quality reduction.

Factory owners thus complain that some of these factories with low leaf quality have unsold tea at auction, resulting in their closure temporarily, affecting the smallholder who sold to them, now trying to find a buyer. They may have to find a factory further away, that charges a transport fee, and a higher moisture retention as well as a lower price, which in turn reduces the smallholders revenue by a substantial amount in the current trading environment.

How does one resolve the catch 22 situation, as the tea must be plucked. Once plucked the tea has to be manufactured, as one cannot leave leaf for more than a few hours. Once manufactured, tea stock that remains unsold can create a glut and a drag on prices once the demand increases. Tea can be kept in stock for a period if it is well sealed and stored in dry warehouses.

When the free market creates a temporary problem such as this, government intervention must also be very temporary, just for the duration of the problem, but one that will not create either an unfair advantage to the buyer or factory owner both of whom are usually at a much higher income bracket, at the expense of the sector most affected, namely the small tea farmer, who is suffering the most at this stage.

I can only think of one way where there is a Rs10 per kg subsidy given to the Smallholder who sells at a lower price to the factory that is operating and when it works its way through the system is a subsidy to the factory owner that is operating despite the lower orders so he can contemplate holding stock taking an element of risk himself until such time as the prices stabilize and the orders resume. This scheme should be strictly temporary for a stipulated period and the subsidy given a month in arrears once the tea has been sold to the factory from where the data is obtained to pay the subsidy