Financial Times

The global crisis, tea and the Sri Lankan economy

By Sunil Karunanayake

As former US Federal Reserve Board Chief Alan Greenspan said it's a 'once-in-a-Century Credit tsunami' and its effects could be delirious. It’s no wonder that tea prices that hit an unprecedented $3-4 at the auction price levels too had to succumb. According to the statistics at the last week's auction prices came down drastically and large stocks of low grown teas had to be withdrawn. All these indicators seem to have dashed the hopes of the tea trade that was sitting pretty at US$ 0.9 billion at end August and looking at a record earnings for the year. While many theories could be attributed to this price decline, industry experts also believe that prices did hit a peak and staying at these levels were vulnerable. Our prices they say are still above most auction centres.

As one would have witnessed from the US and UK its inevitable that affected parties would seek government intervention. The leisure sector and the aparel sector at times have been benefitted by government support and its justifiable that the state offers a helping hand to the tea sector in its hour of need.

Tea as an agricultural export has been a strong pillar in the Sri Lankan economy and has weathered many storms over 150 years. It was only recently that the industry celebrated the 125th tea auction and Colombo is not only the largest but most important tea auction for global buyers. Within Sri Lanka its an highly integrated industry well linked to the society. Today over 60% of the tea is produced by small growers and it is this element that has provided revenue to the country. With unsold teas stock piling this sector is currently badly hit and financing would become a critical issue.

Picture shows unsold tea stocks which are piling up due to low export demands. This sector is currently badly hit and financing would become a critical issue in the future.

The crisis in US was not overnight; it was building over a period of time. Housing enjoyed a boom period and the demand for credit obviously expanded. When the sub prime bomb exploded bankers were in extreme difficulty and liquidity was highly under strain. We see some similarities in the local scenario too. Tea prices did improve over a period of time and reached an all time high of $3 to 4 per kg with added buoyancy coming from new-found wealth in Arab countries and CIS. Given the good demand there was also a rush by the producers to send their teas to the auction and in this process quality was a casualty.

Though a stringent process is in force for teas at the auction practical limitations do exist and poor teas affected the price levels and the "unsold element" too expanded.

The tea sector works in a very closely knit stakeholder relationship from the smallholder producer, broker to the shipper in a smooth cycle. Traditionally the broker also plays the role of the financier to the producer and regular advances are made to the producer on the strength of the stocks held for auctioning. If the teas are not sold or prices drop it is a critical issue for the broker to recover the debt. While this process goes on the broker's debt to the banking sector too will increase along with their own costs as well as curtailing borrowing capacity. This is no different to the "Sub prime"crisis. In the US instability moved from one sector to another embracing all parts of the economy, travelled across national boundaries including developing countries like ours at much risk to economic progress.

While the tea price decline was evident and the world financial markets were crashing, the Sri Lanka Rupee stood stable as it did for over the past 12 months period. It is rather surprising that with most of the major currencies depreciating this trend continued. At the same time the currency crisis developed in Russia, one of Sri Lanka's major markets, resulting in devaluation thus making imports expensive and still with Sri Lanka Rupee standing unchanged. Eventually the currency adjustment came far too late when fund withdrawals started and the reserves were affected. We seem to have paid a heavy price for this delayed action.

Within this background one sees the entry of the Tea Board playing the role of a buyer at the auction. At last week's auction they made this record breaking move for the first time in the history of this time tested auction process to purchase nearly 1 million kg to provide a cash inflow to the agitating producers. This purchase would result in these teas sitting in the brokers warehouses without a definite shipment plan adding more issues to logistics and quality. Whilst its being mentioned that these could be sold to markets like Iran and China the process would not be that smooth and one would hope the solution will not be another major crisis.

Declining reserves is a major concern and the Central Bank has now taken action to curtail at least the so-called non essential imports by imposing higher LC margins.

With withdrawals of foreign denominated bonds and the repayment of short term credit obligations the reserve situation appears to be grave and import of essential items too could be under threat reminding us of the queues and price controls. Sri Lanka did well to achieve an average growth rate of 6% in the last two years recovering from the Tsunami crisis, but today repeating the growth trend seems to be at risk

Another issue of concern is the sale of credit cards and the mounting debt and its consequence on the credit and financial stability.

Even in the US this is now being viewed as the next major threat to financial stability. The tsunami and its agony is still fresh in the minds of Sri Lankans and one would hope that what we seen is only a mild cyclone and not a credit tsunami as illustrated by Allan Greenspan.

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