UNCLAS SECTION 01 OF 02 LILONGWE 000719

SIPDIS

STATE FOR AF/S
STATE FOR EB/IFD/ODF
STATE FOR EB/IFD/OMA
USAID FOR AFR/SA - IAN MACNAIRN
TREASURY FOR INTERNATIONAL AFFAIRS/AFRICA
TREASURY FOR OTA - BOB WARFIELD

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EAID EFIN EAGR PGOV MI
SUBJECT: PRESIDENT DECLARES "WAR" ON FOREIGN TOBACCO BUYERS

REF: LILONGWE 275

LILONGWE 00000719 001.2 OF 002



1. (U) Summary: President Mutharika has again lashed out at
foreign tobacco buyers, castigating them for paying low prices
at the state-run auction. The president singled out for
criticism the manager of the local subsidiary of an American
tobacco company, telling him to pay more or leave the country.
Buyers reacted nervously, concerned that the strong rhetoric
will scare away international customers and damage Malawi's
weak investment climate. End summary.

Declaration of "War"
--------------


2. (U) In a reprise of his fiery performance at the opening of
tobacco season in March (reftel), President Mutharika has
again attacked foreign tobacco buyers over the low prices that
Malawi's smallholder farmers are receiving at the state-run
auction. In a speech opening the annual Agricultural Fair in
Blantyre on August 10, Mutharika accused the buyers of
"stealing from us" and "exploiting us" by paying low prices at
the auction.


3. (U) The president focused his criticism on the manager of
Limbe Leaf, the local subsidiary of American tobacco company
Universal Leaf. Mutharika declared the manager "and his
cohorts" should pay higher prices or leave the country,
eliciting a roar of approval from the crowd. The president
continued, "this is my home and it's not their home. So,
someone has to leave, and the person who will leave is not
me."


4. (U) Ratcheting up the tone, Mutharika bellowed, "This is
war. And in any war, of course there are casualties. I'd
like them to stay, but they are not going to stay on their
terms. They will stay on my terms."

Tough Words Won't Fix the Problem
--------------


5. (U) Malawi tobacco prices are depressed for a number of

reasons, primarily relating to basic supply and demand.
Thanks to good rains and GOM fertilizer subsidies, the country
has produced a record tobacco crop of approximately 158,000 MT
this year. Production has risen steadily in the past 10 years
since the liberalization of the sector in the mid-1990s.
Prior to that time, tobacco production was strictly limited by
law under the Banda-era Special Crops Act. Under that law,
permits were issued to friends of the regime who grew tobacco
on large estates. Production quantity was controlled, quality
was good, and prices were high. Since the abolition of the
act and the liberalization of the sector, some 400,000
smallholder farmers have entered the market, steadily
increasing the quantity of tobacco produced, while the overall
quality has fallen. At the same time, global demand for
tobacco has been flat.


6. (U) A further problem is the inefficient method by which
smallholder tobacco is sold through the government-owned
auction, with several parastatal agencies taking their cut of
farmers' meager profits. Smallholders must also pay steep
fees for transporting their product to market, and for
warehousing it at the auction. Operators of larger farms who
grow tobacco on contract (thereby avoiding the auction) do
command higher prices. But the vast majority of producers are
trapped in the auction system. The GOM is, of course,
reluctant to change a system that provides considerable
revenue and a large number of patronage jobs.


7. (U) With all of these factors, it is easy to see why
Malawian smallholders are not commanding the kind of prices
they would wish for. For several years now, most small
farmers have only been able to break even growing tobacco.

Buyer Reaction
--------------


8. (SBU) Local tobacco company executives told us the reaction
to Mutharika's speech was swift, and they received calls the
next day from nervous customers as far away as the U.S. and
Japan. One local buyer was hosting a group of overseas
clients who decided to cut short their visit and depart,

LILONGWE 00000719 002.2 OF 002


fearful of public reaction to the speech. Buyers are anxious,
and concerned that the president's remarks will prompt another
disruption in the market, as happened earlier in the season.
Following Mutharika's earlier outburst in March, sales volumes
at the auction in the first two months of the season were
seriously depressed, and foreign exchange income fell
precipitously. Since June, sales have increased as the market
settled down, and record volumes have compensated for the
lower average prices.

Comment
--------------


9. (SBU) Mutharika's remarks on this and other occasions
reveal a basic misunderstanding of the global tobacco market
and the impediments to smallholder tobacco production in
Malawi. His attack on Limbe Leaf is particularly curious,
since the majority shareholder in the company is the locally-
owned Press Corporation, and a large portion of Press is owned
by none other than the Government of Malawi (American company
Universal Leaf owns less than 50 percent of Limbe).


10. (SBU) Mutharika's tough talk may go down well with the
masses, but the message to investors, both domestic and
foreign, is more ominous. Many local and foreign business
people have told us of their fears that, with such an
attitude, the GOM might arbitrarily decide to change the terms
of contracts or nationalize assets.


11. (SBU) In the case of tobacco, the president is taking a
particular risk in attacking the foreign buyers. Both of the
major foreign buyers, Universal and Alliance One, have large
investments and spare capacity elsewhere. Universal has
expanded its operations in Mozambique in recent years, and
company executives have told us that their new processing
plant in Mozambique has room for expansion. Malawi is also
competing against low-cost, high-efficiency producers like
Brazil. If the GOM continues to show a hostile attitude,
those companies might well look to expand their operations
elsewhere. With 60 percent of the country's foreign exchange
income derived from tobacco, Mutharika is taking a gamble
that, if he loses, could see a sizeable chunk of the Malawi
economy go up in smoke.

EASTHAM