MALAWI: AN ACRIMONIOUS START TO TOBACCO SEASON

UNCLAS SECTION 01 OF 02 LILONGWE 000152

SENSITIVE
SIPDIS

LONDON FOR AF WATCHER PETER LORD

E.O. 12958: N/A
TAGS: EAGR EFIN ETRD ECON MI
SUBJECT: MALAWI: AN ACRIMONIOUS START TO TOBACCO SEASON

REF: A. 08 LILONGWE 574

B. LILONGWE 77

LILONGWE 00000152 001.2 OF 002



1. SUMMARY: Malawi's tobacco auction season began on March 16
in conflict and confusion. By far the country's most
important export, tobacco plays a critical role in the
country's economy. President Mutharika's attempt to fix
minimum floor prices in this election year has further
increased farmers' already high expectations. At the same
time, a bumper crop and the global economic slowdown are both
putting downward pressure on prices. After bitter auction
floor disputes in the first several days, sales have to
resumed at disappointing prices. The Chinese buyers the GOM
and growers were counting on ultimately failed to appear.
Tobacco prices will be a key determinant in how severely the
global economic downturn impacts Malawi. End summary.

Tobacco - Malawi's Leading Export
--------------


2. Malawi's all-important tobacco auction season began
inauspiciously on March 16. In overwhelmingly agricultural
Malawi, maize and tobacco dominate the economy. While most
of the country's maize is grown for domestic consumption, the
entire tobacco crop is exported, as Malawi has no domestic
production. Tobacco alone generates over 60% of Malawi's
export earnings. With chronically low foreign exchange
reserves (currently about one month's import cover)(Ref.A)
the importance of tobacco sales to the country cannot be
overstated.


3. With a limited exposure to the global financial system,
little manufacturing, and most of its population engaged in
subsistence agriculture, Malawi has thus far been relatively
unaffected by the global economic downturn. Lower world oil
prices have in fact been a significant benefit to the local
economy. The most likely transmission channel for the global
economic crisis is through the commodity markets, which for
Malawi means tobacco above all. How the auction season plays
out is therefore a key factor in any projections for the
country's near-term economic health.

Bumper Crop, Global Crisis Threaten Prices
--------------


4. Historically Malawi has produced between 150,000 and
200,000 metric tons of mostly burley (air dried) tobacco.
With good rains and more acreage planted in tobacco following
record earnings in 2008, 2009 production is expected to be
close to 250,000 metric tons. While enough to make the
country one of the world's three largest producers of burley,
Malawi is still a price taker. To the extent that Malawi's
production can impact prices, the large 2009 crop will tend
to exert downward pressure. Other factors affecting the
market price are likely to be the global financial crisis,
which could make financing difficult to obtain for the
buyers, and the depreciation of the Brazilian real, since
Brazil is the world's largest producer of burley tobacco.

Presidential Intervention
--------------


5. At the same time that the buyers are expecting a softer
market, the growers expect higher prices, following record
auction prices in 2008. President Mutharika's announcement
that the GOM had set minimum floor prices at USD 2.15/kg
further raised farmers' expectations. The GOM claimed it was
trying to protect small farmers by basing prices on the
actual cost of production, plus an acceptable profit margin.
Dramatically higher fertilizer prices in 2008 significantly
increased production costs in the 2008-09 growing season. It
was not clear, however, whether or how the GOM would enforce
its floor price, which in any case failed to account for
differences in types and grades of tobacco. In fact,
Mutharika was probably referring to an average floor price
for all types, but failed to make this clear in his remarks.


6. Disappointment was widespread on opening day of annual
tobacco auctions, as the prices offered by the buyers failed
to reach levels expected by the growers. Prices paid ranged
from a low of USD 0.90 per kg to a high of USD 2.65/kg. Few
sales were made. Second day results were no better; with
prices offered well below expectations buying was suspended
in the morning with only a fraction of the floor's tobacco
sold. By March 19, however, auctions had resumed following
discussions between buyers, sellers and auction officials
that improved transparency by having grade-specific minimum

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prices displayed on each bale of tobacco prior to auction.

Government Bailout?
--------------


7. Media reports quote a senior government minister (NFI) as
promising that the government would buy whatever tobacco is
not sold to the private sector buyers. While this would be
politically popular with tobacco farmers, it is unclear how
the GOM could finance such a plan if downstream customers are
otherwise unwilling to absorb all of Malawi's production.

China Stays Away
--------------


8. GOM officials and growers have recently expressed the hope
that weakening demand for tobacco in the West would be
partially offset by greater demand from China. The entrance
of Chinese buyers into the Malawi market was also expected to
dilute the influence of the small circle of traditional
buyers - including several U.S. firms - and bring higher
prices to Malawi's farmers. In the end, however, the 2009
auction floors opened with no new buyers registered with the
Tobacco Control Commission. The Chinese impact was never
likely to match public speculation, since the Chinese market
prefers the flue-cured tobacco that represents only a small
share of Malawi's production (Ref. B).

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


9. With elections barely two months away, President Mutharika
has a powerful incentive to please Malawi's farmers. In a
soft market, however, the President may be playing a
dangerous game. Setting minimum prices too high risks
bringing sales to a complete stop, with a potential negative
backlash. Malawi's tobacco auctions are interrupted by
disagreements over price most years, so current squabbles are
not unique, but farmers and the GOM may well be disappointed
by this year's crop. On a macro level, the lower prices paid
may be offset by larger volumes sold, leaving Malawi's
balance of payment situation more or less unaffected. Much
will depend on how much of Malawi's tobacco crop - which is
projected to break all previous production records - traders
ultimately buy. After a particularly tight few months in
foreign currency markets, everyone, including the GOM, is
looking forward to renewed flows of tobacco dollars.
BODDE