PRT/KUNDUZ: FRENCH COMPANY TRIES TO REVIVE COTTON

UNCLAS SECTION 01 OF 03 KABUL 000195 SIPDIS SENSITIVE SIPDIS DEPT FOR SCA/FO, SCA/A, S/CR, S/CT, SCA/PAB, EUR/RPM STATE PASS TO USAID FOR AID/ANE NSC FOR AHARRIMAN OSD FOR KIMMITT TREASURY FOR ABAUKOL CENTCOM FOR CG CFC-A, CG CJTF-76, AND POLAD RELEASABLE TO NATO/ISAF/AUS/NZ E.O. 12958: N/A TAGS: ECON EAGR PGOV PREL SNAR AF SUBJECT: PRT/KUNDUZ: FRENCH COMPANY TRIES TO REVIVE COTTON INDUSTRY -------------- SUMMARY -------------- ¶1. (SBU) The New Afghan Project for Cotton and Oil Development (NAPCOD),a joint venture between the Afghan Government and a French company, continues to struggle to re-establish the successful cotton processing industry of the pre-war North. It currently produces cotton lint, cottonseed oil, cakes, and hulls. Many of NAPCOD's efforts in the region are constructive and admirable. It has improved seed and quality control, launched credit arrangements for farmers, and hired extension agents who train farmers in better techniques. But the company remains unprofitable. One of the main obstacles to profitability is competition from private cotton gins, to which farmers sell the cotton they have grown with NAPCOD's subsidized inputs. Part of the deal at NAPCOD,s creation was an agreement that the GOA would suppress competition by not granting any licenses to private ginning. The establishment of a government-sponsored monopoly in an industry such as cotton processing distorts the market and is probably unworkable in the foreseeable future. We note that in Helmand the state-owned gin has been buying cotton at below market prices, turning many cotton farmers to poppy. NAPCOD may still be able to survive, however, by adjusting its business model -- it must work with cotton farmers and provide them with appropriate incentives so that they honor their contracts and sell their crop to NAPCOD. END SUMMARY. -------------- Company Aims to Re-establish Cotton Industry -------------- ¶2. (SBU) PRTOff recently met with Bertrand Ricard, the Kunduz-based Agriculture Manager for the New Afghan Project for Cotton and Oil Development (NAPCOD) in Kunduz. NAPCOD, which began operations in Afghanistan in late 2004, is a joint venture between French cotton and textile company Dagris S.A. (60 percent) -- itself majority-owned by the French Development Agency -- and the Afghan Government (40 percent). The company operates as a private firm and aims to become profitable as soon as possible. According to Ricard, NAPCOD is currently operating in seven provinces of northern Afghanistan and is headquartered in Mazar-e Sharif. -------------- -------------- Founded on the Spinzar Cotton Empire...But not a Rebirth -------------- -------------- ¶3. (U) The French investors are taking advantage of the legacy of the successful pre-war Spinzar cotton empire, which was one of the largest industrial operations in Afghanistan and made Kunduz Province one of the richest in the country. Reportedly founded by Sher Khan Nasher, an Afghan entrepreneur with a German wife and a westernized outlook, Spinzar (meaning "white gold" in Pashto) produced cotton for the international market and had numerous spin-off processing facilities making cottonseed oil, soap, animal feed, and other products. Spinzar facilities are dotted across the landscape in Kunduz, Baghlan, and other provinces, but only the factories in Kunduz and Mazar-e Sharif escaped total destruction during the decades of war and neglect in Afghanistan. Spinzar was largely responsible for the modernization of the city of Kunduz. Most of the facilities it built remain visible, though many no longer function, or only at a much reduced level. KABUL 00000195 002 OF 003 ¶4. (SBU) The current French-Afghan joint venture, however, is not a rebirth of the Spinzar Company and has no direct connection to the old company. It rents a portion of the Spinzar factory facilities from the company, which appears to be entirely in the hands of the Afghan Ministry of Mines and Industry. -------------- --- Partnership of Company and Cotton Farmers is Key -------------- --- ¶5. (SBU) The current joint venture grew out of a desire to create a sustainable private company to produce jobs, develop the international market for an Afghan product, and provide needed access to credit. According to Ricard, NAPCOD is, out of necessity, based on a partnership with the farmers who grow the cotton, without which an effective business could not prosper. Northern Afghanistan offers good soil, good water, and a climate that is conducive to cotton farming, but NAPCOD is still struggling to re-establish the industry. Its efforts include introduction and dissemination of improved seed, better quality control, credit arrangements for farmers, and extension agents who train farmers in better techniques. -------------- - Problems with Competition from Illegal Gins... -------------- - ¶6. (SBU) The main obstacle to this partnership at the moment, according to Ricard, is the activity of private cotton gins, whose owners buy the cotton that NAPCOD needs to build up its business. As part of the creation of NAPCOD, the Government of Afghanistan agreed that private ginning would be suppressed to ensure that most cotton grown in the area would go to the company for ginning and further processing. Private gins are required to have licenses, but in fact, almost none of them do, and because they have very low overhead -- no payments for licenses, no taxes, and very low labor or other overhead costs -- they are able to buy cotton at a higher price than NAPCOD can afford to pay. ¶7. (SBU) The company tried to get around this problem by signing contracts with farmers to provide seed and fertilizer at planting time, while the farmers agreed to sell their entire cotton crop to the company at a fixed price that is named in the contract. When this did not work very well the first year, NAPCOD changed the contract so that only a portion of the harvest would be sold to them -- the rest could be sold to the private ginners -- and the fixed price was raised to be more competitive. They also provided lower-priced access to the company's products, including oil seed cake for livestock feed and hulls to burn for household heat and cooking. -------------- ...And Farmers' Failure to Honor Contracts -------------- ¶8. (SBU) Unfortunately, many farmers who sign contracts and receive seed and fertilizer in return for their agreement to sell their harvest to NAPCOD fail to honor the contract and sell much of their crop -- or even their entire harvest-- to the private ginners. The cotton produced by private ginners is almost entirely sold on the local Afghan market for use as stuffing for pillows and mattresses, unlike that sold to KABUL 00000195 003 OF 003 NAPCOD, which adds value by additional processing and by marketing at least part of the cotton lint on the world market. Because the amount of cotton grown is still relatively small -- less than one tenth of what was grown in pre-war times -- the Afghan market has been able to absorb most of the current production. Ricard had heard, however, that much of the cotton bought at higher prices in 2006 has been sent to Kabul for storage because the price was too low. It was not clear whether the Afghan "investors" would be able to sell the raw cotton later for a profit, but Ricard was hopeful that this apparent local market saturation -- he estimated the market at about 20,000 tons -- would lead to a lower price from private ginners and would encourage more cotton farmers to sell their crop to NAPCOD. -------------- -------------- NAPCOD Will Continue Efforts, but Wants GOA Support to Succeed -------------- -------------- ¶9. (SBU) Whatever the outcome for this year, the company intends to continue its program of pre-season inputs and extension programs to encourage farmers to grow cotton and to sell the harvest to the company, and hope for a better return next year. Ricard was convinced, however, that without GOA commitment to enforce existing laws and restrictions on private ginners, as well as to at least encourage contract fulfillment, NAPCOD will have a difficult time establishing a viable and profitable cotton industry in Northern Afghanistan. -------------- Comment -------------- ¶10. (SBU) NAPCOD is a joint venture between DAGRIS, S.A., which is majority-owned by the French government, and the government of Afghanistan. The Agence Francaise de Developpement is supporting the investment, and MIGA, the World Bank,s investment promotion arm, has provided NAPCOD with a $1 million guarantee. NAPCOD,s activities here appear to be based on a flawed business plan: partner with the GOA, have the GOA suppress competing buyers and ginners, and operate as a government-sponsored monopoly. However, NAPCOD's efforts to reset its terms with farmers are encouraging, as are its efforts to get the GOA to help with contract enforcement. In the final analysis, more intensive work on the contractual issue may be the key to making the business model work in something approaching free market conditions. Given the weak state of governance in Afghanistan, criminalizing private ginning is unlikely to be enforceable in the foreseeable future, and could be damaging to the cotton economy in the longer term. We also note that in Helmand, the State-owned cotton gin has been paying below market prices to cotton farmers, many of whom have responded by growing poppy instead. NEUMANN