TOBACCO MARKET IMPASSE RISKS FOREX CRISIS

UNCLAS SECTION 01 OF 02 LILONGWE 000433

SIPDIS

SENSITIVE
SIPDIS

STATE FOR AF/S GABRIELLE MALLORY
STATE FOR EB/IFD/ODF LINDA SPECHT AND ELAINE JONES
TREASURY FOR INTERNATIONAL AFFAIRS/AFRICA/BEN CUSHMAN
STATE PLEASE PASS TO MCC
PARIS FOR G. D'ELIA
LONDON FOR R. BELL
JOHANNESBURG FOR FCS

E.O. 12958: N/A
TAGS: ECON EFIN EINV EAGR MI
SUBJECT: TOBACCO MARKET IMPASSE RISKS FOREX CRISIS

REF: A) LILONGWE 275 B) LILONGWE 294

LILONGWE 00000433 001.2 OF 002


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SUMMARY
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1. (U) Malawi's tobacco auctions closed again May 11 in a
continuing dispute over prices. Before this shutdown, a
combination of government price controls, weak demand, and a
large crop were slowing throughput in the market to about 60
percent of normal. About 30 percent of all tobacco presented
for auction is going unsold because bids are not hitting the
GOM-mandated reserve price. The constricted revenues from
tobacco could have an impact on Malawi's strained forex
situation as the GOM loosens its control over the exchange
rate. End summary.


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A RUNNING DISPUTE OVER PRICES
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2. (SBU) On 11 May, a running dispute between growers and
buyers once again reached a pitch sufficient to shut down the
state-run auction floor. The issue is whether buyers are
abiding by the minimum price scheme dictated by President
Bingu wa Mutharika in March. The buyers have consistently
maintained that some of the prices for the 70-odd grades of
tobacco are workable, but many are not, and that the average
price is too high. For their part, the growers are divided
into two camps: those who want to sell at the highest bid,
and those who want to hold out for the government's minimums.
Government, led by Mutharika, has made a big show of facing
down the "neo-colonialist" buyers with its price scheme, and
has threatened to kick them out of the country and sell the
tobacco itself if the buyers continue to "cheat the poor
farmer." This populist rhetoric will make it difficult for
Mutharika to back down to prices that might actually move the
tobacco.


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DESPITE GOOD CROP, LOW VOLUMES
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3. (U) As if this situation needed further complexity and
confusion, it is beginning to look as if the 2006 selling
season may not meet the optimistic expectations for the year
anyway. Growers and the GOM had expected good rains and an
extensive fertilizer subsidy to boost production volumes,
quality, and revenues. Buyers from the two major exporters,
US-owned AllianceOne and Limbe Leaf (Universal Leaf),have
told us that weak demand and inefficiencies resulting from
the government price scheme have seriously reduced the
volumes of tobacco being bought for export. One exporter told
us the volumes are about 60 percent of the usual flow for
this point in the season: 12,000 bales per day as opposed to
a normal 20,000. Total volume to date is roughly 25 million
kilograms of a larger-than-average 125-130 million kg. crop.
At least one source has put the total volume at 45 percent of
last year's volume at this point in the season. Both major
buyers estimated early in the season that up to 15 million
kg. may go unsold.


4. (SBU) Outside the industry, it is widely felt that the
buyers are trying to force the government to back down by
offering deliberately low prices and keeping volumes low.
While there may be some truth to that view, even the head of
the parastatal Tobacco Control Commission privately says the
government's prices are too high, and that it will have to
back down. It is less clear how the government can get there
from here.


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THE REAL PROBLEM: FOREX
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LILONGWE 00000433 002.2 OF 002



5. (SBU) The centrality of tobacco in Malawi's economy would
be difficult to overstate. Tobacco produces around 60
percent of the country's export earnings, and it does so in
the space of a few months of the year. This year, it so
happens that the IMF is considering Malawi for HIPC
completion point, contingent upon satisfactory progress of
its Poverty Reduction and Growth Facility (PRGF) plan. One
of the key performance measures is reduction of its import
backlog and loosening of its foreign exchange policy. With
pent-up demand for forex, recent loosening has dropped the
kwacha to less than 140/USD. However, this will have no
effect on the import backlog without a ready supply of
dollars (usually supplied by tobacco sales),and without such
a supply to support demand for kwacha, a looser exchange
policy may cause the currency to slip precipitously. In
short, Bingu could not have picked a worse time for a
showdown with the tobacco exporters. A recent visit with the
financial sector in Blantyre confirmed that the seasonal flow
of forex has not happened this year, to the point that people
are starting to worry.


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COMMENT: POOR JUDGEMENT AND COMMAND-ECONOMY TENDENCIES
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6. (SBU) This latest battle in the tobacco wars has
highlighted two troubling trends. First is the government's
poor sense of the connection between tobacco and its
situation vis-a-vis the IMF: it failed to recognize the
weakness of its negotiating position, and it seemed not to
consider the timing of the all-important HIPC decision in
deciding to try dictating prices. Secondly, Mutharika seems
not to have understood that, where private exporters are
concerned, it is a negotiation. The GOM's command-economy
mindset has gotten the better of patience and common sense,
and it is proving to have been a spectacularly
counterproductive lapse.
EASTHAM