SL tea industry forecast

Overview

It’s been a roller coaster ride for Sri Lanka’s tea industry for the past 24 months. First there was an intense labor 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 labor issue cropped up again just 12 months later. This time there was speculation of political intervention between the government and the Ceylon Workers Congress party and the President himself directed 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 favorable 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 loosing 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 centers between late 2006 and September 2008.


OIL PRICES AVERAGE IN RECENT DECADES


2000 $27.39
2001 $23.00
2002 $22.81
2003 $27.69
2004 $37.66
2005 $50.04
2006 $58.30
2007 $64.20




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 bail-out 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 8Mkg to 277Mkg 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 Rs320 in September. However, a dramatic slide set in from thereon with the average price falling to below Rs200 by end of November 2008. The Low growns were the most dramatic, falling from a peak of Rs.398 in July to Rs206 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. Likewise, GDP growth in the coming year is likely to be between five and six per cent. However, the important point with the U.A.E is that it has exceptionally high foreign reserve levels. Therefore, rapid import growth will continue and as a result the demand for Sri Lankan tea will hold an adjusted but stable level. Moreover, the UAE by its self is a small tea market of only 4Mkg whilst shipments from all origins touch 85 – 90Mkg per annum. These are re-exported to neighboring countries which are all huge tea consuming nations. Despite pressure for the UAE to un-peg its currency from the US dollar particularly due to inflationary consequences from a falling dollar, the Dirham has remained pegged. With a single Gulf currency expected to be in force in 2010, the expectation is that this new currency will also be pegged to the greenback.

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. However, import growth is expected to be stable as the current account surplus is not likely to be threatened. Taking the current trend in energy prices, Russia could be looking at a current account surplus of around two per cent in 2010. The ruble which had been strengthening gradually for the past several years against the US dollar and stood at around 23 rubles to 1$ by July 2008 proceeded to depreciate to almost 29 rubles to the dollar, representing a twenty five per cent depreciation as a result of the financial crisis. This trend could well continue for some time. Such a scenario will not go down well for the tea trade in Russia. However, 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.

Syria: Syrian economic growth will slow in 2009 as investment from the oil rich Gulf states dries up in the wake of global financial crisis. A World Bank report suggests that GDP will slow to 2.5% in 2009 against the 4.2% recorded for 2008. Export earnings will also decline by about 13% due to fall in oil prices as well as easing agricultural prices. Tea imports to Syria are for both domestic market and re-exports to neighbouring countries. The liquidity & credit problems will have a negative impact on the import of tea to Syria. Trade sources expect a lower volume of imports at reduced prices for the first quarter of 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. Iran will be looking to increase oil and gas production in order to maintain its current account surplus despite OPEC production cuts that are likely to be enforced in 2009. Nevertheless, a GDP growth rate of between five and six per cent is expected in the financial years up to 2010. Moreover, whatever the global circumstances may be, Iran is bound to re-emerge as a strong buyer of Sri Lanka’s tea in 2009 due to its growing popularity. If any free trade agreements (FTA) is inked, this would be a bonus from Sri Lanka’s tea industry. Cross border trade will also play an important role in 2009. The Iranian Rial has been trading at between 9,254 and 9,328 Rials against the US dollar throughout 2008. The Riyal is not pegged to any currency and is determined by the market factors so exporters will need to monitor the forex market throughout 2009.

Turkey: The economy that has suffered during previous financial crisis’s 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. Cross border trade will also play a vital role for the tea supplies to Turkey since an import duty of 145 per cent is levied for direct shipments.

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 Aquaba will play a pivotal role on exports.
Sri Lanka teas will continue its sheer dominance in Jordan even in the New Year.

Iraq: Current oil prices will result in a balance of payments deficit in 2009 despite a surplus of $15 billion in 2008. Nevertheless, GDP growth is expected to reach five – six per cent as infrastructure spending will continue. It is also worth noting that the market has become increasingly price conscious and therefore Sri Lankan teas will need to work hard to maintain market share in 2009.

Japan: With negative GDP growth recorded in 2008 for the first time in ten years, 2009 will pose many challenges of the powerhouse economy. The Japanese currency which has been on a free float since 1971 strengthened over the past three months from 110 yen per 1US$ in August 2008 to 87 yen in December before easing up to 91 yen at the end of 2008. Despite the likelihood of the yen holding appreciated values in 2009, import growth might be tested. Whilst we expect the Japanese to buy only the bare minimum household necessities in 2009, exports of Sri Lankan tea to the ‘land of the rising sun’ will remain at normal levels since tea is an essential commodity for the health crazy Japanese consumers.



*Total exports = 254,823,175



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. Whilst OPEC will likely meet to cut production if prices look to fall further than the current four year lows, the global recession is likely to put enormous pressure on oil to adjust to pre-Gulf War II levels. Nevertheless, resilient GDP growth in India and China of around 7.5 and 8.5 respectively in 2009 will serve to maintain production levels.

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 4.9Mkg 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.


Global market shares

In terms of the composition of exports for local teas no major changes are expected but some recent trends are worth noting. In the first ten months of 2008, Kenyan exports to Pakistan lost 7.94 per cent. Similarly, Kenyan exports to Afganistan in the same period fell 29 per cent whilst exports to UK and Egypt rose by 24.00 and 40.00 respectively.

Therefore, continued interest from shippers to these destinations can be expected in 2009 but local teas will not have an opportunity to increase market share at the expense of Kenyan exports due to price and inadequate quantity of CTC tea available here. Conversely, there is a danger that Iran, the Netherlands and Poland who have increased their imports from Kenya, will continues to look to East Africa. Attempts to woo Egypt are yet to show an impact as they have increased their shipments of Kenyan tea in the first ten month of 2008 as compared to 2007.

However, given that the costs of transport and shipping are likely to fall in 2009, the feasibility for African markets to import from Sri Lanka despite the near proximity of Kenya and Uganda may work in Sri Lanka’s favor. This could only happen in the event of competitive prices which in turn is a function of Kenyan production levels.

On the other hand, both India and China have increased their tea exports during the first ten months of 2008. Sri Lanka will have to expect a close competition from these two nations in the coming years.


Currency

Sri Lankan exporters have intensified calls for a devaluation of the local currency in recent months. The entire exporter community is of the view that the rupee is over-valued by at least Rs.10 to Rs.15 against the dollar.

In view of the fact that a wave of countries, both developed and emerging, have recently devalued, the rationale for Sri Lanka to follow suit is a strong one. Moreover, the Central Banks’ policy of defending the rupee by spending its foreign currency holdings is unsustainable. This is due to the fact that the islands foreign currency earnings are any way under threat from falling foreign remittances that are anticipated in 2009. A slow-down in real estate development and other economic activity in the Gulf region for instance would pose a serious threat to foreign remittance earnings from migrant workers, the islands number one source of foreign exchange. If exports also have to compete in the world market with the disadvantage of an overvalued currency, it would expose many local industries to the possibility of loosing export markets. Regaining lost tea export markets would then be almost impossible. Egypt, Pakistan, UK and Yemen being typical cases in point. This would reduce the inflow of foreign currency into the island which in turn would constrain the Central Banks ability to spend dollars to defend the rupee.

Fore example, India’s strengthening rupee was a factor in the decline in competitiveness of its tea exports in 2007 and the early part of 2008. This phenomenon helped Sri Lanka to maintain the competitive edge over Indian export over this period. If the roles were reversed in 2009, the local tea industry would face a serious challenge from more competitive teas from other producers and exporters.

Since October 2008, the Central Bank has allowed the rupee to depreciate slightly and more so towards the end of 2008 representing a two percent drop against the dollar in two months. We do not expect any serious devaluation that can meet the demands of the exporter community during 2009. Whilst the Central Bank has shown some signs that it might let the market have a greater say in setting the rates, it is unlikely that the Rs.120 mark will be cleared during the first quarter of 2009.

We also expect the overall country situation to improve during the second and third quarter of 2009 and this will serve to strengthen the rupee. This could take place concurrently with a fading out of unnecessary imports resulting in a more favorable balance of payments position during the second half of 2009.





Supply-side factors


Production

Due to international market conditions, demand has the larger say in the global tea market as compared to other commodities like, for example, oil. Whereas OPEC can manipulate oil prices by implementing a joint production strategy, the international producers of tea are not close to this level of collaboration despite the obvious advantages of doing so.

Tea is comparatively price in-elastic as most consumers are habitually addicted to the beverage which has been increasing in popularity in recent times in comparison to its competitor beverages as a result of its health related benefits. Whilst some moves to bring together the world tea producers have been initiated this year, especially under the Food and Agricultural Organization (FAO) of United Nations, with the formation of International Tea Producer Forum (ITPF) no real progress is expected to take place in the short-term.

Consequently, production has to rapidly adjust to match the sudden fall in demand since September 2008. In the period January to October 2008 local production totaled 273.8Mkg which represents a gain of 28.35Mkg from the same period in 2007. However, the figure is a reflection of high production during the first two quarters that was spurred by high prices during that time. Since September, there has been a dramatic turn around and the factories have cut their production by drastic levels. Low grown teas have been hit the hardest resulting in small holders being directly affected with factories refusing to take in black tea leaf during much of the forth quarter of 2008. Fertilizer application was also at a bare minimum or almost a non entity.

For example, October’s production fell eight per cent as compared to October 2007 to just 23.9Mkg whilst exports fell to a four-year low of 25Mkg. It represents the second lowest October crop in over ten years. In November production recovered slightly to 24.6Mkg but remained well below the 27.2Mkg production in the same month of 2007, representing a low of 9.6 percent.

Elevation wise, the November crop represented a decrease of 22.75 percent for the low grown varieties whilst the mediums lost 14 percent. The high grown crops gained 28.5 percent as compared to 2007. The cumulative trend for the year to November shows an increase in the crop for all the agro-climatic district of 8.4 percent.



Likely scenario


Westerns: For the period January to October 2008, Westerns posted a crop output of 35.9Mkg representing an increase of 14.9 per cent from the same period in 2007. Apart from the Patana / Kotogola teas, all other varieties increased their crop. However, production in Q1 and Q2 of 2009 is likely to remain at constrained levels with a greater emphasis on quality than quantity. By the end of 2009, we expect the supply of Westerns to have adjusted upwards by a smaller margin of between five and eight per cent from 2008.

Mediums: The output of medium grown crops increased by 8.2 per cent up to 38.1Mkg during the first ten moths of 2008 as compared to 2007. All varieties apart form the Hunnasgiriya / Knuckles were up for the year. The largest contributor to this segment, Gampola / Nawalapitiya raised its output by 14.6 per cent. However, there are now reports that thousand upon thousands of workers in Gampola have been laid off since September. In this regard, the situation will not improve overnight as production is likely to re-adjust at a much slower pace than it wound-down.


Uda Pussellawa / Uvas: These varieties rose by 8.2 and 11.9 per cent in the period under review. However, the Ella / Namunukula teas fell by 36.3 per cent. The production of these teas in 2009 will be closely related to the quality related factors.

Low growns: This segment increased production to 138Mkg to October, representing an increase of 13.3 per cent. Again, the gain resent the surge in supply to meet strong demand during the first two quarters of 2008. The coming year is expected to witness a modest increase in the production of between five and seven percent as demand conditions ease.


Global Production

Kenya is expected to increase its production from the levels achieved in 2008 when the East African nation had to withstand severe political turmoil as well as unfavorable weather conditions. Across the Palk Straight, India has also been implementing programs to revive many tea planting areas and the impact on production of these initiatives might also come into play in 2009. Likewise, production in Bangladesh and Uganda have been on an upward trend in recent times.




Outlook and price forecast

Industry challenges

Whilst plantation stocks enjoyed excellent growth in the early part of 2008, recently the 19 listed companies have weakened as the Colombo Stock Exchange has continued on a downward trend. However, the local stocks are more affected by the conflict situation than international financial conditions and any improvement in this area in 2009 will witness a recovery in plantation stocks too. Whilst those plantation companies with diversified crops have spread their risk, the falling price of rubber will add further pressure on the large companies. Similarly, new taxes introduced in the Budget might hinder the industry’s ability to ride out the conditions. On the other hand, favorable policies like the fertilizer subsidy will serve to ensure the survival of tea small holders.

Taste trends

Despite the inevitable fall in consumption in the US and the West in 2009, one factor will continue to work in the favor of tea. Recent research has continued to reveal that tea is better for human health than any of its substitute drinks and green tea in particular is found to be having very strong medical properties that can cure many ailments. This has served to revive an increase in the consumption of tea in the West over recent years. Consequently, the fizzy drink market has suffered as young consumers too have become more health conscious and switched away from the unhealthy stuff. Therefore, we expect aggregate global demand for tea to continue on a positive incline despite the ongoing recession.

Ethical trading

Increasingly, consumers in the West and Japan in particular have been conducting their own research on the products that they consume. Consequently, there has been a massive increase in ‘Ethical Branding’ and ‘Fair Trade’ labeling for products which have largely focused on plantation crops like tea and coffee. Whilst some initiatives have been taken in Sri Lanka to market tea under the ethical label, a far greater potential remains with regard to this growing market segment.

Logistics

Shipping and logistical concerns for the Gulf region eased with the election Barak Obama to the White House but concern is again mounting since the Israeli aggression in Gaza. Thus, further conflict in the region involving more nations is not unthinkable. If some degree of peace does manage to prevail, the anticipated reduction in risk along with lower oil prices in 2009 should stifle the rising cost of transportation to some extent. Thus, it could be a good time to intensify attempts to penetrate market in Africa as the Kenyan proximity advantage will be reduced.




Price forecast

In our estimations we have taken the more optimistic scenario model, making the assumption that the overall positive trends in the global demand for tea will, to some extent, mitigate the impact of the global recession. We assume a notable market correction from the oil exporting countries while a more significant adjustment is likely from Europe, the USA and Japan.

We assume a positive impact from aggressive marketing overseas that will have an impact by the end of 2009. Some parts of the global economy will also start to recover by this stage.

Favorable weather conditions are also assumed in this forecast. Whilst there have been some concerns regarding acid rain and erratic weather patterns in Sri Lanka during 2008, it is not expected to have a significant impact on crop quality or output. However, in the long term a serious threat is brewing from environmental change and more funds need to be invested into research for this purpose.

Under the given assumptions, our overall average price forecast for the Colombo Auction in 2009 is an average price below Rs.300. We expect the price to edge upwards as the year progresses and even pass the Rs.300 mark as winter buying spurs the market. Beyond 2009, the market should improve.



Conclusion

The industry was caught off-guard in September 2008. Thinking was short-term and there was little market intelligence given the vulnerabilities in export destinations. Future survival will call for focus on long-term factors. This can enable consolidation of global market position by the end of 2009. Quality, ethical branding and aggressive marketing would pay dividends. Greater emphasis is needed on research and market intelligence in order to be better prepared for different scenarios.


KEY SOURCES: The Research Intelligence Unit / Sri Lanka Tea Board


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