Did green leaf subsidy destroy the tea market?
During the last Presidential election campaign the then opposition made an announcement that if they come to power that they would provide a price subsidy up to Rs. 80 per kg of green leaf to leaf suppliers.
In an article I published on Feb 5, 2015 in a local newspaper, I outlined a mechanism describing several possible ways that the government can implement the promised guaranteed price scheme (GPS) of tea green leaf for the suppliers and leaf producing smallholders in the country. In that article I explained possible benefits of the programme if properly implemented. I also outlined the grave consequences, if the programme was implemented in a wrong way to get advantages for vested interests. After several months of implementing the GPS of green leaf in the country today I would argue that more harm has been done to the tea industry by the GPS price subsidy for green leaf than benefits from it. This happened mainly due to the manner in which this price subsidy scheme had been implemented.
The price subsidy scheme was introduced during the period when Sri Lanka tea prices have been at the rock bottom. These low prices could be the lowest in 10 years or more and in nominal terms at least Rs. 100 to Rs. 150 per kg lower than tea prices of one year ago. Oil prices have also been lower, the Middle East volatile situation and Russian Rouble crisis and a strong dollar have contributed significantly to the present plight of the tea market of Sri Lanka. Another reason had been low quality of tea produced in the country. That was the reason for the Sri Lanka Tea Board to introduce the B-60 programme sometime in early 2014. The green leaf price subsidy was introduced while the B-60 programme was giving mixed results.
The green leaf price is determined based on fair price formula or roughly 2/3 of made tea value should go to the leaf supplier while the factory should get only the remaining 1/3. In other words, when the tea market is weak or made tea prices are low, leaf suppliers’ (including tea smallholders) income goes down. Auctioned tea prices came down to Rs. 420 per kg during the pre presidential election period (December 2014) tea smallholders were receiving about Rs. 65 per kg of green leaf against six months back they were receiving about Rs. 80 per kg of green leaf. That is why the then opposition promised to offer a guaranteed price system (GPS) for green leaf to protect smallholder leaf suppliers from falling incomes.
After the Presidential election the new (transition) government fulfilled what they promised and started providing subsidies to green leaf suppliers. However, this newly introduced price subsidy or GPS programme damaged the Sri Lankan tea economy in significant ways. The GPS did not have similar features of the case of the Paddy Marketing Board in olden days. The Plantation Ministry decided to implement this price subsidy via the existing tea factory network and the Tea Board was entrusted implementation of it. This article examines what really has gone wrong with this well meant green leaf subsidy programme.
First, what happened to the green
leaf supply side?
With all good intentions, perhaps more than that to save their own skin to show that the B-60 programme was a success, Tea Board officials connected the new price subsidy with the leaf quality standards as a way to pass the price subsidy to leaf suppliers. They said only factories that buy good green leaf (immature, un-damaged, two and half leaves, etc), 60 per cent or more were given Rs. 80 per kg and the factories that buy lower than 60 per cent, and lower than 50 per cent good leaf were given Rs. 75 and Rs. 73 per kg of green leaf they bought from leaf suppliers. Leaf suppliers were to receive somewhere around Rs. 65 per kg and suddenly started getting Rs. 80 to Rs.73 per kg according to the factory’s leaf quality standard. Not the leaf quality standards of the leaf supplier. Obviously when the leaf suppliers receive something more than the reasonable market price for green leaf the supply response was very positive.
Green leaf suppliers increased their supply and tea factories started getting large volumes of green leaf but quality was a secondary consideration even from day one. Leaf quality assurance was in the hands of Tea Board officials who thought the situation as a wonderful opportunity to extract rents from tea factories and leaf collectors. Suddenly very poor quality leaf receiving factories became the factories that processed best quality green leaf on paper overnight. This is a public secret that such miracle factories had to spend only few thousand rupees worth “Santhosam” to officials that made this difference. Even cash did not have to be handed over in person but keeping an envelope inside a tea book or some other record book or similar arrangements have improved the leaf quality standards with almost no time. So, smallholder farmers received some money, but Tea Board officials received enough and more money to fatten their accounts, expand their houses and buying new vehicles.
Starting from day one there again there was no certainty about the continuation of price subsidy. Everybody believed the price subsidy would not continue after parliamentary elections. If I am not mistaken even for August this price subsidy was not paid, so far. Most key players of this game behaved in an opportunistic way or highly entrepreneurial way so that maximum rent extracting was the objective. There were only very few who cared for genuine leaf quality improvement or high standards in tea processing. In fact there was a very simple way of checking whether a factory buys high quality leaf or not. For example, if a factory buys high quality green leaf, the factory’s net sale average (NSA) should be better than the poor quality leaf purchasing factories. But Tea Board officials did not want or did not bother to connect these two together. For example, there have been few such high quality green leaf buying factories and they often received very high tea prices at the auction. And also no high level Tea Board officer looked into leaf quality and NSA of the factory before transferring the money into those factories that became good leaf buying factories overnight.
What really happened was that poor quality leaf buying factories that could make quality monitoring officials “happy” made their way upward even though the tea market was moving downward rapidly. Those factories that genuinely made an effort to buy high quality leaf and improve the made tea prices (and tea quality) started losing their bought leaf market. In other words what the price subsidy did was to discourage good leaf buying factories and destroyed their leaf market and encouraged poor quality leaf buying factories through (i) vested interest, (ii) political power, and (iii) ability to buy off government officials.
If the government wishes to improve the tea sector in the country, and help green leaf supplying smallholders it must immediately change the price subsidy scheme in a way to improve smallholder incomes, enhance leaf quality, increase tea processing efficiency (price, quality, etc) and reduce the corruption at every level. If it is not changed I would argue that the green leaf subsidy or GPS introduced by the Yahapalana government has done more harm to the tea sector during this critical hour of the sector than good. Who gave this d-rope to the government is not a secret anymore and they have benefitted tremendously from low made tea prices for generations to flourish. I will analyse this issue in depth in a future article.
B-60 programme unsuccessful
Lack of labour for tea plucking, increasing cost of labour, introduction of colour sorter machines for cleaning or removing brown particles from made black tea, heavy and unhealthy competition among factory owners, and lack of awareness are some of the reasons for increasing poor quality green leaf production/supply/acceptance by tea factories. Subsequently the cost of production of made tea increased in Sri Lanka and made tea quality came down. International competition for Sri Lankan tea increased and our competitors took the advantage of this unfortunate situation. There was speculation that some of our tea producers import tea from Vietnam and blend it with Sri Lankan teas and submitted them to auction for sale. Some tea blenders and exporters also followed similar practices to enhance their volumes. One can argue that these reports are incorrect and this point cannot be considered as a reason for the present crisis in tea sector and I will leave that debate for another day.
In the middle of this situation the Tea Board introduced the B-60 programme with inadequate resources, weak monitoring capabilities and poor political will. For example, the programme was introduced during the previous government but some politicians from the same side made sure it was not implemented properly. Though the Minister then extended support and blessings to the B-60 programme, his officers did not implement it as expected. Local level or factory level corrupt Tea Board officials and other officials milked these cash cows as they pleased. A significant number of factory owners also took the easy path rather than collectively and genuinely trying to improve leaf quality.
What happened to the tea factories?
When the leaf subsidy or GPS was introduced some factories were on the verge of bankruptcy. Some could not attract bought leaf anymore since they could not pay a competitive price due to low NSA. General leaf quality was poor and further declining. B-60 was only a struggling initiative to show it was still alive. Economically weak factories produced poor or average quality made tea and at the auction they received only an average or low price.
Only very few factories, running with profits, bought good quality leaf and their volumes were not the highest. They paid a higher price for green leaf. They also gained higher prices at the auction. After subsidy, some of the poor quality green leaf bought factories were “transformed “into best green leaf bought leaf factories!. How this happened is known only to some Tea Board officials and factory managers/owners. Factory level leaf quality examination responsibility was given to Tea Board officials. This seems logical and who else can be better qualified? However, what truly happened was something else.
At the factory side, those who showed that they had high quality green leaf in the factory made through their way out. Whether they bought high quality green leaf was proven only on paper by Tea Board officials. If someone could not convince Tea Board officials they did not get the subsidy.
It was also decided to transfer money through tea factories but there was no share of subsidy to factory owners. They however, benefitted transferring cash from Tea Board to leaf suppliers.
The first subsidy was given in March 2015 and until to date it is in effect. Some factories complained that they did not get the subsidy, and some complained that they have received only Rs. 75 or Rs 73 per kg of green leaf instead of Rs. 80 per leaf kg. Some others claim that they did not receive in March or April or certain months and others say that they received continuously. The author of this article also owns a factory and he did not receive any price subsidy for his green leaf process in the factory at all. RPCs say that they do not get the subsidy since they are companies and not smallholders. There are many other exceptions and it is not the purpose of this analysis to find out who received the subsidy and who did not.
Way ahead
Finally, it might be worth to list down one or two ideas how tea smallholders can be supported without hurting the tea market. In my view, the tea smallholder subsidy must be given directly to the smallholder. It has to be a production (quantity) and quality improvement support where there will be direct benefits to the smallholder. Factories must follow the B-60 programme based on its own incentives and merits. Smallholders’ quality and quantity improvements can directly benefits the factories too. This is a market-based policy approach to improve the quantity and quality of Sri Lankan tea and thereby tea prices will also be improved in the world market. The government should play the role of being the facilitator and setting rules. No market based policy or even a market properly functions without solid legal, institutional and legislative environment. It is the duty of government to assure these. The factories must be kept out of implementing tea smallholder price subsidy scheme. As a norm, the government must keep its role only to setting up rules of the game rather than be a player of the game. This is very true in the domestic side and any intervention can come to international market side to protect, guide and guard the tea industry and to bring its glory back to Ceylon Tea.
Another way that the government can help the tea industry at this critical hour is to come up with a direct purchasing programme with a minimum price for tea by introducing a floor price scheme. This is of course direct involvement of government and it is somewhat similar to the ages old Paddy Marketing Board type approach. Since this is a floor price it is not exactly like a guaranteed price scheme. The proposed floor price scheme can be implemented in two ways: (i) direct purchasing and keeping the stocks until market improves and release when the price is higher enough to cover its cost, and (ii) to provide price support according to the tea volume sold in the auction and filling the difference directly through a cash support. Relatively, the second approach will be low cost but leaves much room for corruption. The first approach will be more expensive, and new storage facilities will have to be found for a successful implementation of it. Furthermore the government will be actively engaged in market operations and the private sector present buyers will not like it.
There will be major opposition from tea stock-holders for this approach. A short-lived such approach was implemented for a brief period few years back. But it had to be abandoned due to various pressures. In my view, a floor price programme can be a better approach than the leaf subsidy programme and it has the potential to serve leaf producers, factory owners, traders and final consumers all at once. However the government must keep Tea Board officials’ rent seeking behaviour under control if it is to be successful. Otherwise they will make sure it will also be a failure!