From Policy Paralysis To Policy Paroxysm – Analysis

By Kandaswami Subramanian

For months, critics have been attacking the government for failing to take decisions on important issues. Many western journalists and commentators have described the syndrome as ‘policy paralysis.’ As if to unsettle the critics, the Ministry of Commerce issued a notification on 5th March banning export of cotton from India. This has sent shock waves across the world and to howls of protests within the country. Is it an instance of policy paroxysm? Perhaps.

On all accounts, it is a major economic policy issue and one would have expected detailed examination within Ministries and also a decision at Cabinet level. What was bizarre was that even the Union Minister in charge of Agriculture and responsible for cotton cultivation and production was not consulted. States like Maharashtra and Gujarat for whom cotton cultivation is the life blood for millions of farmers were not involved in the decision making. Apparently, even ground realities of cotton trade in those states were not taken into account.

Within hours of the ban, Mr. Sharad Pawar, the Minister in charge of Agriculture entered a strong protest alleging he was not consulted before the decision was taken. The lame excuse given by an official was that Mr. Pawar was “not in town!” To make amends, the Prime Minister instantly referred the matter to an Empowered Group of Ministers (EGOM), the usual peg on which he hangs (no pun intended!) all troublesome issues. Leaving aside the requirements of inter-ministerial consultation procedures or mandates, one would have expected that, in a coalition government in which Mr. Pawar acts as lord protector of Maharashtra (read, the cotton lobby), common sense would have suggested prior consultation with him.

The circumstances leading to the ban are not known, nor made public. Yes, domestic price of cotton and yarn had gone up and spinners and mills were unable to get supplies at affordable prices. This would have thrown millions of workers, especially in the handloom sector, to destitution. The trends in exports were no doubt troublesome. Exports had touched 9.4 million bales (mb) by February against the estimated surplus of 8.4 mb and registrations for exports had hit 12 mb. There was the fear of a “tendency of hoarding in bonded warehouses abroad.” Lastly, there were reports of China buying cotton to build its cotton reserve and pushing up global prices.

The reasons given are not new. Rather, they have been endemic, impacting the longer term stability of the cotton market globally and in the country. Textiles have been the earliest sector to emerge in developing countries. The sector is highly labour intensive and it was inevitable that it came to be located in labour abundant countries with low wages. The economics of textile production led the early wave of gloabalisation and multinational corporations and retail giants began to source garments and apparels from developing countries.

China took the lead and others followed suit. The multifibre agreement (MFA), an unfair trading arrangement foisted on developing countries for three decades, ended in 2004. The ending of MFA with effect from 1st January 2005 opened the field for all and there was resurgence of textile industry in developing countries in varying degrees. However, there are continuing restrictions on textile exports directly or through devious means subsumed under competition issues. Despite these, the textile industry has been flourishing in emerging economies. Unfortunately, it has also tended to set them against each other and there are attempts to seize markets or deny them to rivals.

One of the vexing issues affecting the industry is the mismatch between availability of cotton, in particular its price and the growing demand from the industry. Not all countries produce cotton and many have to depend on imports from others. The changing patterns of supply/demand matches have been unpredictable. For instance, China has been a leading producer of cotton and also a leading exporter of cotton for some years. The phenomenal growth of textile industry in the years after it entered the WTO has altered the scenario. Though cotton production increased substantially, it began to lag behind the rapid development of the textile industry. From the early years of this century, China had to import cotton to meet the growing demands of the textile industry. China has turned into the foremost consumer and also the importer of cotton in the global market.

China’s problems, like India’s, are at two levels: one, at the level of cotton cultivation and the other, at the level of the textile industry. Chinese planners are acutely aware of the problems affecting both the sectors and deal with them in an integrated or holistic manner. As the Chairman of China’s Cotton Association explained in his keynote address [i] in 2007, “The cotton industry is a major industry in China, which is closely associated with national welfare and people’s livelihood. In China, 140 million laborers are involved in the cotton production, procurement, processing and trading in the cotton producing regions. Half of the farmers’ income is sourced from cotton.” He went on to say [ii], “Likewise, the textile industry plays a key role in promoting the development of the regional economy. The textile industry is a labor-intensive industry, and out of the 20 million textile workers, 13.5 million are peasant workers from rural China. The textile industry has performed an important role in resolving the employment problems for the surplus rural labors, increasing the income of farmers and supporting the development of the countrywide economy.” The data may have changed and the relative importance of textile industry may have declined somewhat. But the relationship between cotton cultivation vis-a-vis textile industry has turned more acute. It has become necessary for the Chinese authorities to maintain a balance between the two in order to ensure social stability and also economic development. They have been grappling these issues and conflicts with determination and forethought and planning. As many analysts observe, in recent years China has become the centre of the global cotton market. China can ill afford to remain passive when trade policy decisions of other countries, especially India, impact on its cotton supplies or availability.

The Indian side of the story is equally interesting. Its textile industry has grown in size and sophistication. However, India lags behind many of its rivals in East Asia. Its major weakness is the size of the textile units. A peculiar feature of India’s growth stems from the power loom and handloom sectors. Handlooms have been promoted as a measure of social policy, notwithstanding the criticism of latter day reformers who are opposed to the policy of reservation and promotion of small scale industries. The handloom sector depends heavily on yarn supplies from the textile units and mills are compelled to part with a part of their production to handloom weavers. The power loom sector is a hybrid and half way between mills and handlooms. Successive crises in textile mills and their battles with labour unions created this illegitimate offspring in the Indian textile sector. Many are owned by bigger mills and they buy back the cloth from them and sell the cloth under their brand names. It is a formidable force and leans on the organized textile mills for yarn. Not only availability, but price is a critical factor to ensure their survival. Indeed they are the cuddly vote banks for politicians.

A very significant development in India is that the country has turned from a net importer to an exporter of cotton Globally, India occupies the second position as cotton producer and also as an exporter. About 80 percent of India’s exports is to China. Part of the reason for increased supply of cotton facilitating exports is due to the introduction of the controversial Bt. Cotton. Though there have been campaigns against Bt. Cotton and reports of suicide rate going up, the issues are complex and run deeper. Much of it is due to the failure to compensate the farmer for the cotton crop, growing indebtedness of farmers, lack of credit facilities and the fluctuations attached to supplies and demand. Weather conditions do play havoc in some years.

The weakest link in the Indian chain is that between cotton cultivation (production) and the textile industry. Remunerative prices for farmers have been handled in an ad hoc way unlike China. Efforts have ranged from monopoly procurement to building buffer policy of building buffer stocks as reserves to meet shortages. However there has been the policy of minimum support prices (MSP). MSP has been the playground for politicians in cotton growing states like Maharashtra and Gujarat. Though there is the rationale to cover costs and create an incentive for cotton farmers, this has to be balanced against the countervailing power of mill owners who are unwilling to pay high prices for cotton. Moreover, MSP, if fixed at very high levels, could result in diversion food crops to lucrative commercial crops like cotton. This will affect adversely on food production and security programs. Though these factors were well known, in 2008, support prices were raised by 38 percent. This was criticized by many as having been done without an in-depth study of the costs of cultivation. In 2011 it was again raised by another 10 percent. Surprisingly, this increase did not impact the government or the mills, as support prices remained below international prices, except after the global financial crisis when all commodity prices crashed by more than 50 percent. During 2010-11 international cotton prices touched record highs and Indian farmers were able to sell cotton at double the support prices. Unfortunately, the government misread or misunderstood the market conditions. It disturbed the global market by a precipitate ban on cotton exports.

The global cotton market has been subject to high volatility since 2010 and many analysts and trade economists attribute this to the flip-flops in India’s trade policy affecting cotton exports from India. India banned cotton exports on 19th April 2010 citing ‘growing domestic prices’ and ‘shortage in global supplies’ as reasons. There were several modifications and changes from time to time and finally the ban was lifted in October, 2010. India’s policymakers did not cover themselves with glory by these changes and they created an adverse image for the country.

As the National Cotton Council, U.S.A., described in a report [iii],”India, the world’s second largest producer and processor of raw fiber, is a wildcard in the current cotton market. Over the past decade, increased production has allowed India to emerge as the 2nd largest exporter of cotton. However, since April, India’s use of various restrictions on cotton exports has greatly added to the volatility and uncertainty in the world cotton market.” The report went on to add how “India’s uncertain export regime has sharply reduced their presence in the world market and contributed to the rise in world cotton prices.” As one columnist explained [iv], “The ban also damages the competitiveness of textile mills in neighbouring Bangladesh, Pakistan and China.” He predicted, “The ban is not likely to last because India’s cotton crop consistently outpaces domestic demand. Traders expect the memory to linger longer and “it can lead to discounting of Indian prices in future because it will be perceived as high-risk cotton.”

The net result of the ban was to divert importing countries to seek supplies from other countries and much of it created additional export for the U.S., in particular from China. Early in 2010, global supply conditions were indeed tight. Around that period it was observed [v] that over the past several crop years, the amount of cotton consumed by Chinese spinning mills far exceeded the amount of cotton harvested in Chinese fields. As a result Chinese cotton stocks fell and import increased. “Due to the size of China’s cotton market and the volume of Chinese import demand, world cotton supplies have tightened alongside those in China. This tightening has been the driver of recent price increases.” Lower cotton prices relative to other crops created the supply squeeze as farmers corn and soybeans offering higher prices. Between 2005/2006 and 2009/10, the amount of cotton acreage harvested across the world fell 13% and world cotton production fell 17%. It was during these years that Chinese mill demand rebounded from recession. This led to a record production/consumption gap. USDA estimated the gap at 18.0 million balers and in 2010/11 it was estimated at 17.0 million bales. To ensure cotton supplies, Chinese authorities auctioned off 4.6 million bales from their reserves. By then, perhaps, China had exhausted its cotton reserve. The reserve had to be replenished and mills had to import cotton to meet orders. It was assessed that in 200/11, China would import 15.0 million bales which was 4.1 million bales more than imported in 2009/10. These led to tightened supplies across the world.

These market and price volatilities were further aggravated by India’s decision to ban cotton exports in 2010. As described by one commentator [vi] “Such has been the volatility in the cotton price that traders have dubbed it the ‘widow maker’, replacing natural gas which earned the moniker after big bets went wrong in the notoriously volatile commodity in the 2000s.” It led to huge losses for cotton exporters and global commodity merchants like Glencore, Noble, Olam and Cargil. Glencore was estimated to have lost $370 million like Cargill and Glencore is estimated to have lost $370 million. Cotton market did not stabilize even after India lifted its ban in October, 2010.

The outlook for 2012 as assessed by trade bodies and analysts was bearish. It was not expected that the market would repeat the volatility of the earlier two years. There were several reasons creating this somber or pessimistic mood in the trade circles. First was the drop in global growth rates as a result of the ongoing financial crisis. The second was the drought situation in the U.S. and estimated loss of acreage for cotton production. The third was the reduction in cotton acreage and production in China. The last and the most exaggerated threat arising from China’ cotton reserve policy. The National Cotton Council of America dealt with these in its Annual Economic Outlook. [vii]

It is unavoidable that demand for textiles (garments and apparels) should decline under conditions of continuing recession and with no prospects of recovery and growth. Advanced countries in Europe which generate higher demand for textiles face severe crisis, the so-called Eurozone crisis. The fall in demand for textiles should result in declining demand for cotton. Trade analysts estimated the demand drop was estimated at 9.3 mb (projected 119 mb minus 110 mb). There was an apparent surplus situation. Apart from the ongoing crisis, high prices for cotton had encouraged textile mills to switch over to synthetics. In recent years, cotton has to compete with synthetics and there is thus an upper limit beyond cotton prices cannot reach without losing the market to synthetics.

Several parts of the U.S., e.g. Texas, faced drought conditions resulting in reduction in acreage and production. US production was estimated at 15.67 mb for 2011. On the demand side USA was expected to use 3.4 mb which is down by 0.5 mb from 2010. Based on these estimates, U.S. exports were expected to reach 11.1 mb which was down by 3.3 mb from 2010. Apart from the drought conditions, a part of the reason for reduction in U.S. production is due to the shift in cotton/soybean and cotton/corn price ratios which made cotton production less remunerative.

The situation in China was somewhat similar to the U.S. Seed China News reported the results of a survey undertaken by the National Cotton Market Monitoring System. This survey was done in November 2011 and suggested that cotton planting area in China would decrease significantly in 2012, with planting intention down by 8.2 % in area year on year. It attributed this greatly to the depressed purchase price of unginned cotton and the rising planting cost. There was competition from corn and soybean which were more encouraged as a measure of food security. Total cotton production was estimated at 6.5 to 7.55 mb. As narrated earlier, this fall in production coupled with the rising demand for cotton by mills created an extra-ordinary situation for the Chinese authorities and they began to build up their cotton reserves.

China’s cotton reserve policy seems to be the most unsettling factor, especially for western traders. Almost every analyst refers to it with horror as the trouble maker. Cotton reserve is not new to China and they have been intervening in the market and holding reserves since 1990s. Its role would depend on the cotton prices in the local market and keep them remunerative to ensure crop production. The idea is also to insulate it against global fluctuations. Currently, there are estimates of China having built a reserve of at least 14 mb which represents 24-25% of global stocks. Farm Bureau of Georgia said,[viii] “The government of China is holding a lot of cotton in reserve, which has raised the price of cotton in China, but it is an artificial shortage created by government policy.” The same reports blames China’s reserve policy introducing a large source of uncertainty in the market. It may well be argued that China looks upon it as a measure of linking cotton production by ensuring remunerative prices with cotton demand by drawing on or stocking reserves. It makes senses from a longer term vision of ensuring social stability (employment, etc.) with growth. Of course, those wedded to the market will frown on such attempts as distortion. Sadly, China has the dominant position in the global market and others have to live with it.

To get back to our story. By the middle of 2011 it was clear that China would be facing an acute imbalance in the supply/demand situation for cotton and they had to step up purchases for the reserve. One part of the programme concerned local purchase and the other part related to imports. On local purchase, China decided to buy cotton from local producers $1.425 per pound. This was considered high in comparison to international prices. But, as narrated earlier, production costs had gone up and become unremunerative due to increased wages and the adverse price ratio for cotton/corn/soybean. Early in 2011 the government announced a scheme of local purchase which became effective from September 2011. Government purchased cotton at the prescribed price and added to reserve. Alongside, government began to buy massive amounts of cotton when the prices dropped below $1. On January 9 and 12, March price went below 945 cents and with each drop China bought tons of cotton. While some traders viewed it as a support for the sagging market price, others doubted its longer term sustainability.

The local purchase as announced was for one year and was to end by March 2012. However, early in March 2012, China’s National Development and Reform Commission (NDRC), an agency comparable to our Planning Commission, announced that purchasing domestic crop for the strategic reserve would continue for the next crop season and at a higher price of about $1.48 per pound. Traders were alarmed. As one analyst described, [ix] “These levels are substantially higher than international prices, with May 2012 cotton futures in New York hovering just below 90.00 US cents/lb. and recent import business into China taking place at prices ranging typically between 100.00 and 110.00 cents/lb., CF.” As he explained, China could lend support to the global market if it stuck to the domestic crop remnants of 2011/12 and imports, it could continue to support global prices at the then prevailing levels. “However, if Beijing decides to release stocks from the strategic reserve.. .. during the second and third quarters, then the full weight of abundant world stocks will be brought to bear on international cotton prices.”

March was the cruelest month for cotton price scenario. Western traders and trade analysts had created horror stories of China’s cotton purchases sending prices higher and higher. It was no doubt an uncertain market and a part of the price rise was contributed by commodity futures orchestrated by financial institutions, pension funds, etc. It was on 18th October 2011 that the Commodity Futures Trading Commission (CFTC) imposed position limits on speculative trading in commodity futures and commodity futures. However, many of the new limits are expected to be imposed in the coming years.

It is our assessment that the government of India decided to impose the ban on cotton exports based on such an assessment. It was ill judged and ill timed. They wanted to show that they were not suffering from policy paralysis and engaged in an act of policy paroxysm. It was knee jerk reaction to certain trends and the expectation in the market even around that time was that prices would come down. It was open to government to take other measures like cancelling registrations.

Perhaps, there was the hidden motive of denying the Chinese access to Indian cotton. If so, it would have been impolitic and uncalled for at a time when there are ongoing attempts to improve economic cooperation between the two countries. One report suggested that China did not import more than 1 million bales from India and the reason given for not purchasing higher quantity was that Indian cotton is not of good quality. The bank did hurt the interests of neighbouring countries like Bangladesh and they entered strong protests. China’s cotton industry association blasted the export ban. It said [x], “As a member of the international trading family, we hope the Indian government will rectify this market-disruption and mistaken policy in a timely fashion and comply with global trading rules..”

The ban caused more damage to the cotton market within India than abroad. As several papers reported, the ban on exports brought trade to a halt in Maharashtra, Andhra Pradesh, Gujarat and Karnataka leaving farmers in the lurch. There were no buyers and price crashed. They went down to Rs.3000 a quintal from Rs.4,200 a quintal. In some cases farmer sold even at Rs.2,500 a quintal. This led to protests from the Chief Ministers of the concerned states and also representation to the Prime Minister from Members of Parliament.

As in 2010, the biggest effect of India’s export ban was on its reputation as a reliable supplier. Most traders and commentators predicted that the ban would be lifted sooner than later. It is not surprising that it has been lifted even as this piece is being written today (12 March). It took two meetings of EGOMs and some convoluted recommendations on future guidelines and riders on policy to lift the ban on exports.

This episode is a sad reflection on the ability of the UPA-II to take major economic decisions. Though there are efforts to promote exports and to open up the economy, India is yet to build a socio-economic policy framework in which the buffeting from export trade fluctuations could be absorbed and people’s welfare could be protected. In this China seems to score over India even as India has withdrawn some of the earlier safeguards it had like building buffer stocks, commodity reserves, etc. It leaves much of these to private trade and the market in the name of ‘reforms’.

(The writer is a Former Joint Secretary, Ministry of Finance, Government of India)

[i] Drew Harris, China’s Cotton Association Calls for Global Cooperation, Cotton 24/7, August 2007 available at http://cotton247.com.ci/?storyid=471
[ii] Ibid i above.
[iii] National Cotton Council, Influence of India’s Export Restrictions on the World Cotton Market, October, 2010.
[iv] Gregory Mayer, Indian Cotton exports ban boosts US shippers, Financial Times, April 26, 2010.
[v] I draw this information from Cotton Incorporated Supply Chain, China: Center off the Cotton Market, January 2011 available at lifestylemonitor.cottoninc.com
[vi] James Fontella Khan, Cotton prices jump as India bans exports, Financial Times, March 6, 2012.
[vii] National Cotton Council, The Economic Outlook for U.S. Cotton 2012, February1012, 2012 available at http://www.cotton.org/econ/reports.annual-outlook,cfm?renderforprint=1&
[viii] AgWeb.com, China’s Large Cotton Reserves Worrisome, Georgia Farm Bureau, 1/27/2012 at http://www.gfb.org/gfbnews/GFBNew
[ix] Matt Robinson, Analysis: China holds sway over global cotton price outlook, March 2, 2012, available at http://ci.wtin.com/article/bT4xKIRGPfc/2012/03/12/analysis-xguna-holds-sway-over-glob
[x] Reuters, China association blasts Indian cotton export ban, March 9, 2012 available at http://in.reuters.com/asets/print?aid=INDEE82801U20120309