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 LILONGWE 00000152 002.2 OF 002 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