Plunging prices leave Burkina Faso’s cotton companies in a difficult situation
AS the global economic crisis cut demand for textiles and depressed cotton prices, Burkina Faso’s cotton farmers at first were insulated from the worst effects of the commodity price shock. A new producer price mechanism helped put cotton sector finances on a sounder footing. But as the crisis escalates, cotton companies face a choice between selling or stocking during an extended slide in the world cotton price.
Cotton accounts for about 60 percent of exports in Burkina Faso, sub-Saharan Africa’s biggest cotton producer. The cotton sector provides about 700,000 jobs, employing about 17 percent of the population, and many more people benefit indirectly. In several rural areas, where poverty is high, the sale of cotton seed is the main or even only source of cash revenue. The expansion of cotton growing has stimulated production of cereals, mainly because fertilizer financed with cotton credit can also be used for other crops. As a result, poverty has been reduced by one-quarter in cotton-growing areas.
Cotton sector reforms
Although the past few years have been difficult for Burkina Faso’s cotton production, the sector was about to recover when the global economic crisis started. Ginning companies, which separate the cotton fiber from seeds and stalks, sell at world prices and incurred sizable financial losses during 2005–07, partly because of an inflexible pricing mechanism that prevented the pass-through of lower cotton prices to producers. In 2007, Burkina Faso’s cotton production declined by more than 40 percent because of late rainfall and low international cotton prices.
Several institutional and policy reforms followed.
A market-based producer price mechanism was established. It sets producer prices, based on a five-year centered average of world prices, at the beginning of each growing season.
A smoothing fund was created to support the price mechanism for producers and compensate ginning companies should world market prices fall below producer prices.
Big ginning company losses required a recapitalization of the largest, SOFITEX, in 2007, which increased government ownership of the company from 35 percent to more than 60 percent.
The crisis and cotton
The global economic crisis affects the four main stakeholders in the cotton sector in different ways.
Sources: DataStream; and IMF staff estimates.
Producers. The new producer price mechanism gave farmers certainty about sale prices at the beginning of the 2008 season, isolating them from the price decline later in the year. Cotton production in 2008 was thus not affected by the plunge—down about 40 percent from the March peak—in cotton prices during the year (see chart). In fact, cotton production exceeded expectations, reaching more than 500,000 tons because of good weather conditions. But producers will be affected directly if crisis-related demand continues to depress cotton prices in coming years.
Ginning companies. They protected part of their income by selling about one-third of their production forward when the average cotton price was still relatively high. For their unhedged production, the companies now face a difficult choice: sell at current spot prices or stock ginned cotton in the hope that international prices recover. However, postponing sales carries the risk that prices may decline further. Moreover, sales contracts are needed to finance the rest of the current season, because banks take them as guarantees.
Banking sector. Local and international banks provide financing for the cotton sector, and local banks have important exposure to the crop. A reduction in credit or higher borrowing costs would jeopardize the equilibrium of the sector.
Government. Although the government plans to gradually withdraw from the cotton sector, it is having difficulty identifying a strategic partner for SOFITEX. If cotton prices continue to decline, a drying up of the smoothing fund could eventually lead to calls for government support. Although the cotton sector in Burkina Faso has so far managed to weather the global storm, its fortunes depend on the outcome of the current season, international cotton prices, and financing conditions. That is why reforming the sector to improve productivity is more important than ever. Burkina Faso is currently experimenting with genetically modified cotton, which promises a productivity gain of about 30 percent. It may also explore the scope for more cooperation with cotton producers in other West African countries.
Isabell Adenauer, Norbert Funke, and Charles Amo Yartey are, respectively, Resident Representative, Mission Chief, and Economist for Burkina Faso in the IMF’s African Department.