Modest increase in tea production expected in 2009

It's been a roller coaster ride for Sri Lanka's tea industry for the past 24 months. First there was an intense labour dispute at the end of 2006 that halted production and led to a serious crop shortage at the start of 2007.

Whilst the dispute was settled with an upward revision of wages the labour issue cropped up again just 12 months later.

This time there was speculation of political interference between the government and the Ceylon Workers Congress party and the President himself intervened to bring about a settlement that witnessed a further increase in plantation worker wages on the grounds of rising costs of living. Nevertheless, 2007 witnessed tea export revenues topping $1 billion for the first time in history despite the lower production levels.

Needless to note that it was the favourable demand conditions experienced in Sri Lanka's export destinations that was the driving factor in the record breaking performance where many teas fetched all-time high prices. Essentially, sustained increases in the price of oil resulted in a massive hike in foreign reserves in oil exporting nations which also resulted in an increase in consumer spending. Particular reference could be made to the Middle East / Gulf region, North Africa and Russia along with the CIS which together absorbs some 75 per cent of total tea exports from Sri Lanka.

As luck would have it, the popularity of Sri Lanka's teas amongst oil rich nations had been on an incline despite losing market share to Kenya in the heavy tea consuming destinations of UK, Pakistan and Egypt in recent times. Therefore, Sri Lankan tea was in a much better position to gain from the global economic conditions characterized by high oil prices between 2004-2008 than any other tea exporting country. Prices at the Colombo auction far outpaced all other auction centres between late 2006 and September 2008.

Consequently, 2008 too started out well with the price of oil sustaining it's upward trend whilst tea prices at the Colombo auction also gained. However, trouble was brewing and there were ominous signs of trouble ahead though few took heed. The only warning sign that did surface was the momentum building in the US sub-prime mortgage crisis that started in 2006 which then spread out to all parts of the US economy.

Few if indeed any were able to foresee the monumental collapse in the US finance sector in September 2008. Moreover, the impact it had on the entire global finance sector was even more staggering as multinational banks fell, one after another with thousands upon thousands of jobs lost overnight. Attempts to mitigate these trends with government bailout plans and interest rate cuts have been introduced in most of the leading developed and emerging economies and time will tell on their effectiveness. For the current time period, few deny that Sri Lanka's exports will be hit significantly in 2009 by the downturn in the global economy that has had an impact on all commodities across the board.

Given that 2008 has witnessed a significant shift in fortunes for the island's tea industry, the challenge will be to ride out the current crisis and focus on costs in order to survive during the adjustment period. This report attempts to forecast the short to medium term scenarios for the tea industry with reference to available information and intelligence on the demand conditions in the international markets, expected production in Sri Lanka and in other exporting nations, shipping and logistical factors as well as the impact of government policy and innovation in the industry. The impact of changing trends in taste are also considered.

Demand-side factors

Background Exports in the first eleven months of 2008 have risen by 8 m kg. to 277 m kg. as compared with the same period in 2007. Likewise, the average price is higher and as a result the value of exports are up substantially by 26 per cent or Rs. 25 billion. However, there are incidents of some overseas clients refusing to pay or demanding refunds for shipments currently in transit. Consequently, many players in the industry are undergoing difficult times.

The strong demand experienced at the Colombo auction during the first three quarters of 2008 is best illustrated with reference to the steady price gains. The average price of a kilo at the auction rose from around Rs. 330 in January to a peak level of some Rs. 342 in July before easing off a little to Rs. 320 in September. However, a dramatic slide set in from thereon with the average price falling to below Rs. 200 by end of November 2008.

The Low growns were the most dramatic, falling from a peak of Rs. 398 in July to Rs. 206 by late November. With most low growns reaching the oil exporting nations in the Middle East, a clear and direct correlation can be seen from when the oil prices reached an all time high of $145.15 per barrel in July to their current low levels of below $40 per barrel.

With 2009 expected to witness further downward pressure on oil prices due to stifled demand amidst an environment of political uncertainty in the Middle East, the likely impacts of these trends on the islands tea export destinations is a difficult question to address accurately. Herein we seek to analyze each overseas market segment as a separate entity.

Key export destinations

U.A.E: Whilst export earning have driven the economy in the past few years, earnings are likely to be a whole lot less in the latter quarters of 2008 and 2009. An export earnings rise of 20 per cent might be optimistic for 2009.

Russia: The economy was hit somewhat severely by the global finance crisis.

Consequently, GDP growth is set to slow to around 5.5 per cent in 2009 and 2010. Sri Lanka's tea has earned top spot in popularity amongst Russian consumers and therefore we expect renewed interest from this large customer base in 2009.

Iran: The likelihood of military conflict is now much less likely than it has been for several years during the Bush administration. However, economic sanctions will test the economy that has an inflation rate of around 25 per cent.

Sri Lanka's tea in 2009 due to its growing popularity.

Turkey: The economy that has suffered during previous financial crisis' is currently in good shape despite political uncertainties. Despite high inflation and interest rates GDP growth is expected to top four-five per cent in 2009. Additionally, Sri Lanka's tea is in heavy demand amongst Turkish consumers. Hence, they are expected to return forcefully to purchase teas from Sri Lanka this year.

Jordan: With heavy reliance on grants and aid, the economy has a trade deficit along with high inflation and interest rates. Therefore, GDP will be hard pressed to reach five per cent in 2009 and import growth might ease. Additionally, so long as Iraq experiences political and economic instability, the port of Aqueba will play a pivotal role on exports.

Iraq: Current oil prices will result in a balance of payments deficit in 2009 despite a surplus of $15 billion in 2008.

Japan: With negative GDP growth recorded in 2008 for the first time in ten years, 2009 will pose many challenges of the powerhouse economy.

Likely scenario

With the IMF and other pundits predicting lower global oil demand in 2009, the price of oil is not likely to pick up significantly in the next 12 months.

Consequently, the demand for low-grown teas are likely to adjust somewhat with market correction setting an average price of somewhere between Rs. 250 and Rs. 275 for these varieties during 2009. A more optimistic forecast might even hope for a return to Rs. 300 as the year progresses.

However, we expect the impact on high grown teas that are popular in the Western markets to be more significant as the financial crisis has hit the USA and Europe more severely as compared to other key tea importing regions. For example, Germany who imported 4.9 mkg. of Sri Lankan tea in the first ten months of 2008, is already in recession. Similarly, the UK which imported some 2.1 million kilos in the same period is also facing a recession in 2009 along with Japan who imported 8.36 million kilos.

Additionally, the demand for the high grown tea's in 2009 are likely to be strongly conditional to the quality levels. Therefore, only the best varieties will maintain their prices whilst many of the plainer high growns will adjust downward from the 2008 average. An average price of between Rs. 225 and Rs. 250 for the first half of 2009 might be realistic.

To be continued

The Research Intelligence Unit and the Sri Lanka Tea Board