UZBEKISTAN'S COTTON SECTOR STILL A BASTION OF THE COMMAND

UNCLAS SECTION 01 OF 04 TASHKENT 001567

SIPDIS
AMEMBASSY ANKARA FOR AG COUNSELOR

E.O. 12958: N/A
TAGS: ECON SOCI PHUM UZ
SUBJECT: UZBEKISTAN'S COTTON SECTOR STILL A BASTION OF THE COMMAND
ECONOMY

REF: 08TASHKENT1204; 08TASHKENT1323; 08TASHKENT1356; 1511; 1547


1. (SBU) SUMMARY: The Government of Uzbekistan (GOU) continues to
control the "commanding heights" of the cotton sector, exercising
strict control over all aspects of cotton production and sale, from
setting planting and harvest quotas to negotiating all ginning and
export contracts on behalf of farmers. Major cotton policy
provisions in Uzbekistan are aimed at stabilizing the cotton
cultivation area, improving yields, efficient use of irrigation
water, and increasing domestic mill use of cotton. Although the
sector is in dire need of reform to alleviate environmental
problems and the traditional reliance on child labor, little has
changed since Soviet times. Cotton still accounts for an important
(albeit shrinking) portion of Uzbekistan's GDP. END SUMMARY.



COTTON PRODUCTION DOWN SLIGHTLY




2. (SBU) Uzbekistan's cotton harvest was later than usual this year
after an exceptionally wet spring required replanting of crops.
Total hectares of seed cotton planted in 2009 approximate 1.3
million, down by around 70,000 hectares from last year. This drop
may be attributable to a presidential decree in October 2008
ordering a decrease in the cotton planting area in order to
increase farmland available for food cultivation and to combat
on-going irrigation issues. (See Ref B.) Nevertheless, this year's
plant area amount is consistent with the GOU's aim to maintain the
cotton-producing area at about 1.4 million hectares. Cotton remains
the country's main agricultural export, accounting for roughly 12%
of all exports and 7-8% of the country's GDP (2008 estimate). The
global economic crisis has slowed the demand for Uzbek cotton, and
exports are estimated to decline this year from 3.0 million bales
to 2.9 million bales.




3. (SBU) Uzbekistan is one of the few countries clinging to a
Soviet-era command economy for cotton. Uzbekistan's Ministry of
Agriculture and Water Resources (MOA),in consultation with
regional advisors and local farm associations, mandates the amount
of seed cotton to plant throughout the country. Each fall, local
associations meet collectively to estimate the next season's
expected output and necessary inputs. District plans are submitted
to the regional authorities, and regional plans are approved at the
national level.




4. (SBU) This year, the Ferghana valley area accounted for more
than 20% of the land under cotton cultivation (303,560 hectares),
with significant portions of land also being cultivated in
Kashkadarya (161,000 hectares) and Bukhara (117,948 hectares). On
October 30, 2009, the GOU announced it reached its production
target of 3.4 million metric tons (MMT) of seed cotton harvested.
The GOU sets its production target each spring. This number is then
broken down by region, and district hokims (governors) are
responsible for making sure that the delivery quota is filled, down
to each individual plot's share of the overall quota. Over the last
several years, it has become increasingly difficult for producers
to meet state targets due to poor farming practices and the absence
of appropriate production incentives. (Note: Official production
reports generally match the production targets, regardless of the
actual yields. In December 2008, state media declared that farmers
had harvested 98% of the total state target for seed cotton -- 3.6
MMT. Independent analysts found this report unrealistic, as farmers
struggled against an unusually cold winter with above-normal snow
followed by an early and dry spring. End note.)



COMPULSORY STATE ORDER SYSTEM STILL THE NORM




5. (SBU) The Ministry of Finance has set the new average
procurement price for seed cotton at Uzbek Soums 502,550 per ton
(about USD 330),an increase of about 20% over last year's price,
largely due to inflationary pressures. The GOU calculates its
procurement price by subtracting official costs from export
revenues. These costs include loans to farmers for inputs such as

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fertilizers and pesticides, irrigation system maintenance (water is
free for the agricultural sector),ginning and marketing costs, and
financing of farmers' debt. In theory, this procurement price
should be the full international price minus costs; however, the
world price is calculated at an overvalued official exchange rate,
and the charges for inputs, processing and marketing are typically
understated. Thus, the price paid to farmers rarely results in
profits, and every year Uzbek farmers cross the border to fetch
higher returns in Kazakhstan.




6. (SBU) Uzbekistan has established a special fund under the
Ministry of Finance for purchasing agricultural commodities for
State needs. At the beginning of the cotton season, the GOU
deposits funds into local commercial banks, which then issue an 80%
advance payment (actually a 3% loan) to cotton farmers. The banks
pay this advance to farmers in two tranches: one paid before cotton
planting, a second during vegetation and watering. After all cotton
has been delivered to gins and the quality assessed, the balance is
settled. Farmers must repay the original loan, if able, or seek
debt-write-offs or other remedies if their revenues do not exceed
their expenses, including financing costs.




7. (SBU) In December of 2002, the GOU adopted a decree that allows
farmers to sell up to 50% of their cotton output either
domestically or abroad. This decree theoretically was supposed to
bring the government's monopoly on the cotton market to an end and
create production incentives. However, no concrete practical
mechanisms have developed to allow this process to begin.
Consequently, although officially the State order remains at 50% of
the cotton produced, the State remains the only major player in
cotton production and marketing.



GINNING INDUSTRY DOMINATED BY STATE




8. (SBU) The state cotton ginning association -- Khlopkopromsbyt, a
joint-stock company in which the GOU holds 51% ownership, procures
and gins all state-ordered and over-quota cotton. It coordinates
the activities of farmers and approximately one hundred and fifty
gins located throughout Uzbekistan. Financial issues between the
cotton farmers and cotton gins are handled in accordance with a
model agreement prepared between the MOA and Khlopkopromsbyt and
approved by the Ministry of Finance. Khlopkopromsbyt earns a two
percent commission for its coordination efforts, which is deducted
from the cotton lint price at the time of sale.




9. (SBU) Uzbek gins, on average, sell cotton lint at cost plus 10%.
This 10% does not necessarily translate into revenue for the gin,
however, because regional authorities may impose "social
responsibility" fees on gins, such as to support a school or
kindergarten located close to its territory. Uzbek cotton gins are
less efficient than other cotton producers: gins have a relatively
low outturn ratio (about 32%, compared to 35-36% in the U.S.),and
gin fewer bales per hour on old Soviet equipment. Currently,
average production costs of Uzbek cotton gins approximate USD
240-250 per ton. In comparison, Kazakh gins' average production
cost is reportedly USD 120-130 per ton -- almost half of Uzbek
gins' production costs. There is little incentive to increase
productivity, as any increase in the average profit margin becomes
a basis for a decrease in the following year's State payments.




10. (SBU) Three trading companies under the Ministry of Foreign
Economic Relations, Investments and Trade (MFERIT) have a monopoly
on contracts for exporting Uzbek cotton with Khlopkopromsbyt.
Approximately 85% of Uzbek cotton is exported by these trading
entities, with the remaining 15% sold through the Republican
Commodity exchange or directly to domestic buyers by gins. After
deducting a 2% percent commission for exporting services, the
trading companies surrender hard currency receipts to the Uzbek
Central Bank at the official exchange rate (an implicit tax). The
difference between the national currency receipts and the domestic
price is then transferred to the state budget. This year's average
cotton lint price sold by cotton gins to the trading companies is
Soums 1,812,000 per ton (excluding 20% VAT),or about USD 1,193.
Uzbekistan expects to export around 700,000 tons of cotton lint at
an average export price of approximately USD 1,460 per ton, netting

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approximately USD 267 per ton (exclusive of commission and taxes)
for the State.




11. (SBU) Currently, Uzpromashimpeks, one of the MFERIT trading
companies, is on the Committee for International Cooperation among
Cotton Associations' (CICCA) default list after Noble Cotton, a
Singapore-based cotton supply chain management firm, won an
arbitration judgment against Uzpromashimpeks for failing to deliver
cotton according to contract terms. This judgment does not appear
to have substantially impacted Uzpromashimpeks' selling position:
at the recent Fifth International Uzbek Cotton Fair, which took
place in Tashkent on October 14-15, 2009, several international
companies made commitments with Uzpromashimpeks, including Chinatex
Corporation and the newly-formed Dubai Cotton Center (DCC). (See
Ref E.)



MECHANIZATION OF INDUSTRY CONTINUES TO LAG




12. (SBU) Currently, only 2-3% of Uzbekistan's cotton is
machine-harvested, as compared to 70% machine harvested in Soviet
times. Uzbekistan does not have the capacity (or any incentive) to
manufacture modern cotton-picking harvesters, and the abundance of
cheap labor, including child labor, makes it economically
unattractive to invest heavily in machinery. The average price paid
to cotton pickers in 2008 was 80 Uzbek Soums per kilo (about USD
0.05). One harvester machine will clear about 500 hectares in a
season; however, each machine costs hundreds of thousands of
dollars. (Note: Few countries have the capacity to manufacture the
industrial components for cotton-harvesting machines. Uzbekistan,
if appropriately incentivized, could import harvester components
and assemble machines domestically.) Contrary to Uzbek claims,
hand-picked cotton is not necessarily of higher quality than the
machine-harvested variety. While some international experts have
cautioned against mechanization because of the need to use
defoliants, other experts maintain that defoliants are safe for the
environment and people if properly used. Recent press reports
indicate that the GOU may be taking a second look at mechanization.
According to Uznews.net, an online media outlet, the GOU plans to
reequip four industrial enterprises that produce agriculture
equipment, including cotton harvesters.




13. (SBU) Recent farm reorganization legislation may allow for
greater mechanization of the cotton harvest. In late 2008, the GOU
began the process of farm amalgamation, according to which smaller
farms were merged into larger farms. The government set a minimum
size of 80-100 hectares for cotton-and-grain producing farms and
15-20 hectares for vegetable and fruit farms. While modern harvest
equipment is simply too expensive for small farmers, the growth of
large farms could make purchase of machinery more feasible. The
World Bank supports a program whereby farmers can access credit to
buy farm equipment, including harvesters, while at the same time
undertaking not to employ child labor.



DOMESTIC CONSUMPTION AND TRADE




14. (SBU) Uzbekistan is actively pursuing the goal of becoming a
textile exporter. Current domestic consumption is about 25%, and
outdated gins operate significantly below capacity. Since 2005, the
GOU has invested significantly in developing the spinning industry,
including offering tax (excluding VAT) and import duty exemptions
for foreign investors. An Uzbek enterprise with direct foreign
investment automatically receives a 15% discount from the world
price of cotton fiber with a 120-day delay in payment. Forty-one
joint ventures now exist with companies from Korea, Turkey,
Germany, Japan and Switzerland. Total foreign investment in the
sector was estimated at USD 1 billion at the end of 2008.




15. (SBU) Currently, the main products produced by textile mills
are cotton yarn and gray fabrics. The industry is expanding
production of value-added products, such as shirts and other
garments for the export market. At the recent cotton fair, the GOU
announced that domestic cotton consumption for 2009 will reach
300,000 tons, up from 250,000 tons in 2008. This increase is

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smaller than previously predicted by the GOU, which had sought to
increase the 2009 volume of domestic consumption as much as 50%
through its modernization program. In addition to expanding ginning
capacity, the GOU also is active in scientific research relating to
cotton, including seed multiplication and other sophisticated
biotechnology research.




16. (SBU) Uzbekistan is a primary supplier of cotton to Asia, with
Bangladesh, China (Mainland),and South Korea the major markets for
Uzbek cotton. Uzbekistan accounts for 60% of cotton imports by
Bangladesh and for about 10% of imports by China (Mainland). Russia
still remains a significant and stable buyer of Uzbek cotton,
importing about 100,000 tons per year. Uzbek cotton is also
transported by rail to ports in the Baltics and Turkey for sale to
Europe. The bulk of Uzbek cotton, however, passes through Iran to
the port of Bandar-Abbas for export to Asia. The Trans-China
corridor via Kazakhstan also serves as an alternative to the
Iranian route.



CHILD LABOR AND FORCED LABOR ISSUES REMAIN




17. (SBU) The practice of using child labor in cotton harvesting
remains prevalent and dates from the Soviet era. Last year, on
September 12, the Cabinet of Ministers issued a resolution on the
implementation of two ILO conventions against child labor that the
GOU had signed earlier in the year, and this reportedly reduced the
number of children in the fields at the beginning of the harvest.
The GOU has also formulated a national action plan to carry out the
ILO Conventions, but implementation of this action plan is still
nascent. The extent to which child labor was used in the 2009
harvest is difficult to estimate, as no independent assessment has
been carried out, and there is no real baseline number with which
to compare. Post continues to receive reports of some school
districts mobilizing children to help meet quotas at local farms in
this year's harvest.



Comment




18. (SBU) This year's cotton production is in line with previous
years, at least officially. The cotton sector is in need of
comprehensive reform from top to bottom. Although the GOU has made
strides in diversification of crops, it has taken no steps to grant
farmers greater control over what they plant, or to develop the
necessary infrastructure that would allow farmers to sell their
cotton themselves on an open market. Doing so would increase
efficiency in the system, and, if farmers could pay a decent wage
rate, attract unemployed adult workers (of which there are many) to
work the fields, obviating the need to mobilize children during the
harvest. Post will submit septel some ideas on how the USG might be
able, with the UN and others, to assist with short- and longer-term
measures to address the child labor issue. End comment.
NORLAND