Tea industry recovering from setback and lessons learnt

Dr. M. T. Ziyad Mohamed Director, CIC Tea Advisory Services (Pvt) Ltd.

The decision of the Government to supply tea fertilizer at a subsidized rate of Rs. 1,000 per 50 kg bag of fertilizer should be appreciated.

After experiencing record prices during the first three quarters of last year, the industry took a nose dive during the last quarter, with prices falling below cost of production (COP) and to the levels experienced in year 2006.

The global recession and the sharp drop in oil prices have been contributing factors identified, to this downturn.

As a result, of the price decline the bought leaf factories, processing mainly small holder leaf, suffered huge trading losses with substantial quantities of teas unsold.

The latter resulted in serious cash flow problems, which prompted a handful of factories to close down with some factories resorting to taking less (limited) quantity of leaf, just to keep the COP within a reasonable limit. This action precipitated lack of demand for smallholder leaf, a far cry from the extraordinary competition, when the market was strong.

Artificial market

The artificial market conditions experienced during the first three quarters of the year, exacerbated malpractices, especially in the form of accepting, poor quality leaf, with the intention of producing larger volumes - as anything was selling at very attractive prices. Such quantities of poor quality too had resulted in more supply and hence contributed to declining prices, to some extent.

The notable feature out of this setback was that the producers who concentrated on producing good quality leaf survived, while the producers aiming at quantity were hit very badly, resulting in serious cash flow issues.

Lack of demand for green leaf, resulted in most of the bought leaf factories demanding only good leaf, since the secondary as well as off grades was not selling. This could be cited as a blessing in disguise. Declining tea prices also resulted in lack of demand for refuse tea. It is common knowledge that re-processing of refuse tea is a thriving business, enabling one to make exorbitant profits. Unfortunately, some refuse tea, after re-processing enters the auction and this had contributed to low demand for secondary and off grades.

As a result of poor prices for refuse tea, many large producers decided to denature the refuse tea and add same to the field to increase soil organic matter contents.

The indirect impact of this methodology was better prices anticipated for the secondary and off grades during the sales in first quarter of the New Year.

Cost of production and green leaf price

A rough estimate would indicate, that the cost of production of green leaf is in the region of Rs 30 - 40 in the small holder sector.

With the crisis situation developing, the green leaf price which was averaging about Rs 50 - 60 in low country, dropped to nearly 30- 40 per kg. With such low prices for green leaf, it was cost prohibitive to manufacture tea, both for the smallholders and the factory owners. Hence the small holders resorted to;

i..pruning their tea fields, on advice from certain officials - although it is not advisable to prune tea bushes into dry weather, as it would take a long time to recover and also might result in casualties.

ii. adopting cost cutting methods - the first item to be curtailed was the application of fertilizer, which contributes to about Rs 5 - 6 per kg of green leaf (with the earlier price of fertilizer). Scientific research had proven beyond doubt that, curtailment of fertilizer would result in overall yield loss and also result in weakening of the bush.

Along with these limitations, long dry spells lasting over 2 -3 months had exposed the bush to severe stress conditions. As a result the production had dropped by nearly 18% in January 2009 and making the quality of leaf too, not very suitable for processing.

The drop in production and non application of fertilizer created panic among the buyers, and speculation is that the demand created in January was, as a result of anticipated less crop during the first quarter of year 2009.

Lessons learnt

Although there is renewed hope and also a sigh of relief, with the market picking up in the New Year (as seen from the first four sales), indications are visible of a drop in leaf standard to enhance volumes. In short, even after going through a crisis situation, it seems that the industry had not learnt the simple lesson of concentrating on quality. This is an alarming development.

As highlighted above, the industry is recovering as evidenced by prices realized at the auctions in January. However, for the smallholders the benefit has not percolated as of such a situation, they do not have adequate crop, mainly arising from non - application of fertilizer, coupled with poor weather conditions.

The industry should benefit from these lessons and take preventive measures to avoid such situations in the future. The need to improve the soil organic matter has to be emphasized, to improve productivity and reap the beneficial effects of applied fertilizer.

Looking at inputs, fertilizer remains the single important input in agriculture, be it tea or any other crop. Application of appropriate amount of fertilizer would result in increased yield with attendant reductions in the cost of production. Fertilizer is also highest cost component of cultivation next to wages.

In this regard, the decision of the Government to supply tea fertilizer at a subsidized rate of Rs. 1,000 per 50 kg bag of fertilizer should be appreciated.

From the time, this subsidy was recommended there seem to be, some interest created to apply the required fertilizer quantity to tea fields, as cost to the produced leaf would be between Rs. 1.50 - 2.00 per kg of green leaf. Although it is a welcome move, whether the state and the country could afford to continue with such a scheme is questionable.

Therefore, prudence demands a few policy recommendations:.,

i. whether the subsidy could be given to the entire industry or only the smallholder sector - if it is for both sectors, should it be in equal proportion or different.

ii. a mechanism to ensure that the fertilizer reaches the tea fields, as there could be temptation to sell the fertilizer and make money out of it - as found in the paddy sector

iii. to establish a separate fund generated from the industry, to ensure adequate supply or distribution of fertilizer, to protect this all important industry on the long run.

The industry might argue that they have been already overtaxed - but in this scenario, the tax will have to be directly channelled to the growers.

Establishing a separate fund to cover fertilizer costs

One of the options available is to collect Rs 3.50 or more from the sale averages through the tea brokers. This would imply that an amount of nearly Rs 900 million will be available to the industry. There should be proper mechanism to ensure, accountability as well as assurance that the collection reaches the producers and not to any other sector.

Assumptions

An approximate calculation would indicate that about 14 kg of green leaf (or nearly 3 kg of made tea) could be produced from one kg of fertilizer. Therefore, the requirement of the industry is about 100,000 metric tons.

Option 1: Assuming that the subsidy is available for both sectors,

100,000,000 kg to produce 300,000,000 kg of tea cost of fertilizer would be 1 kg of fertilizer could produce only 3 kg of made tea. At Rs. 1,000 per 50 kg bag fertilizer, cost of fertilizer would be Rs. 20 per kg - 300 million kg tea cost of fertilizer would be - Rs 600 million.

Option 2: Assuming that the subsidy is available only for the small- holder sector,

Production by the small holders (70% of the total) - Rs. 210 million Amount to be recovered @ Rs 3.5 /= per kg- Rs 735 million

Fertilizer requirement - 210/3 = 70 million kg

(1 kg of fertilizer could produce only 3 kg of made tea)

Cost of fertilizer would be Rs 1400 million for the entire small holder sector (At Rs. 1,000 per 50 kg bag - cost of fertilizer would be Rs 20 per kg)

Recommendation

From the above, the amount collected will cover only 50 per cent of the total cost of fertilizer. Therefore, the recommendation is, to issue 1 kg of fertilizer for 28 kg of green leaf supplied i.e to meet 50 per cent of the requirement virtually issued “free” by the factory accepting green leaf. The balance 50 per cent to be bought at the subsidized price of Rs. 1000 per 50 kg bag.

Such arrangement would ensure at least 50 per cent of the fertilizer being applied, in the entire smallholder sector.

There would not be much resistance from the smallholder, as he must be under the impression that he is getting the fertilizer almost free.

On the other hand, the factory owner too will not object, since he is contributing only 32 per cent of Rs. 3.50 and indirectly he is benefiting by attracting (having) more bought leaf.

More resistance could be anticipated from the corporate sector, as they might not be convinced with the real benefit.

Therefore, we must concentrate only on smallholder sector initially. If such a scheme is to be introduced, the impact of the same on other stake holders (such as fertilizer dealers) too, need to be carefully, addressed.

(The writer is a former Director of the Tea Research Institute of Sri Lanka, during the period 2003 - 2006).