Dawn McLaren, Manager, Fiber Economics, Cotton Incorporated

The big story in the global economy last year was the Asian currency crisis. The Thai Baht depreciated sharply after it was moved to a floating exchange rate and soon the rest of the Southeast Asian currencies were involved. The only country not experiencing a depreciation in its currency was China, causing China's exports to become more expensive comparatively and therefore less competitive to its Asian neighbors. This has sparked some debate as to whether the Chinese government will depreciate the value of its currency in the near future. Thus far, the government of China has undertaken the task of eliminating unnecessary expenditures in its own budget in order to stay fiscally stable. Although the immediate effect of the Asian currency crisis was not as dramatic as some expected because of various forms of financial help from the IMF and the governments of the U.S., Japan and Australia, the aftershocks are likely to be felt for some time.

In the cotton market, both the 1996 and 1997 crop years were relatively stable fundamentally. Worldwide, and production dropped off by less than one percent and consumption remained steady at 88.6 million bales. Due to a number of factors, a regional shift in demand occurred: in Indonesia, a slowdown to about 30% capacity utilization in textile production after the Rupiah was pulled into the currency crisis and, in Brazil, a warm winter reduced the demand for value-added cotton products. In Japan, where structural change in the spinning industry has been occurring for some time and a recession threatens the economy, consumption dropped by 10.7% between 1996 and 1997. Offsetting the decrease was consumption in Mexico, which rose by 32.3% to reach 2.1 million bales. Because of these factors, world ending stocks rose slightly and the stocks-to-use ratio, excluding China, moved from 31.3% to 32.5%.

World trade in raw cotton has remained steady over the last seven years, with the U.S. and Uzbekistan accounting for 42% to 51% of exports. A falloff of imports into Japan and Indonesia, both major cotton consumers and importers, was offset by an increase in imports into Mexico, mostly from the United States. The USDA forecasts 1997/98 exports for the U.S. and Uzbekistan at 7.5 million bales and 4.3 million bales respectively.

The African Franc Zone and Australia also remained strong suppliers of exportable cotton this year. Australia, in an effort to compete for Asian business, offered in April to guarantee US$250 million worth of trade credit specifically for cotton going to Asia, with Indonesia as the main destination. Generally, over 90% of Australia's cotton production ends up on the export market with one third of that amount going to Indonesia and only 10% going to non-Asian destinations.

Appearing on the export market for the first time in three years was China, with two separate offers. In early April, 1.4 million bales of cotton, excluding any from the western province of Xinjiang, were offered. Most of that cotton was apparently sold to a U.S. merchant. At the end of May, a second tender offer was circulated; this time for 1.2 million bales of new crop cotton from the Xinjiang province, with delivery during the 1998/99 season.

China has a vast inventory of raw cotton, amounting to about 40% of total world cotton stock. When China previously held such a large amount of cotton in stock, it soon appeared as a major exporter of cotton. In 1985, for example, China exported 2.8 million bales and in 1986 exported 3.2 million bales. The USDA attaché is currently estimating that 1.1 million bales of cotton will be exported this year. This is 900,000 bales more than the USDA's latest official estimate and reflects cotton from the original tender offer.

So what does the 1998/99 crop year look like? First of all, world planted acreage is expected to be lower than this year by between 1% and 5%. Although a small percentage, the decreases are mostly seen in exporters and major producers such as the U.S., China, Argentina, India, the African Franc Zone and Brazil, likely affecting those dependent upon imported raw cotton.

China is the world's largest producer and consumer of cotton, but due to the Chinese government's lowering of the price paid to farmers for cotton, a shift in acreage away from cotton has been occurring and is likely going towards more vegetable production. Argentina experienced major problems with weather and therefore yield during this year's harvest, which may account for why forecasts are for lower planted acreage in 1998, but it is still very early to tell what is likely to happen. In Uzbekistan, the second largest exporter of cotton, planted acreage is expected to remain at about 3.7 million acres in 1998 according to the USDA. Pakistan's planted acreage is also expected to remain similar to last year. Mexico, which has emerged as a major consumer and importer of cotton over the last three years, is expected to plant more acres in cotton, but the increase is insignificant compared to their increased needs.

World planted acreage has remained fairly steady, averaging 82 million acres over the last twenty years. About half of the change in planted acreage can be explained by changes in the 'A' Index, a proxy for world price, during the harvest period of the previous crop year, while government programs, participation in the export market, and other factors each influence the level of planted acreage to a lesser extent. As planted acreage usually decreases as the 'A' Index falls, planted acreage is expected to decline slightly.

World cotton yields have leveled out over the last few years. The last significant technological change that affected yield was the introduction of pyrethroid chemistry in the late nineteen seventies. At first, the increase in yield was dramatic, but since 1984, world yield has averaged 500 pounds per acre. The last three years have seen minute increases of less than one percent, indicating that, unless new technology affects yield, it is likely to remain level. The ICAC forecasts world yield for 1998/99 as the same as this year, 512 pounds per acre. Yield problems in the major producing countries are responsible for the immobility of overall world yield. In China, weather and pest problems caused lower yields while leaf curl virus reduced yields in Pakistan. Yields in Uzbekistan may recover now that the disruption in input supply caused by the breakup of the Soviet Union is no longer an issue. It is also notable that world yield has tended to fall in the years following an El Niño event. The average yield during those periods is about 3% below years in which no El Niño occurred.

Given an expected drop in planted acreage and about 3% lower yield, world cotton production could fall to between 84 and 87 million bales in 1998. The ICAC is forecasting 1998/99 world cotton production at 87.1 million bales, a four percent decrease from this year. Until recent declines in world prices for cotton, the ICAC had been forecasting less than a one percent decrease in world production. The USDA is forecasting 86.5 million bales in cotton production, a 2.4% drop from this year.

Over the last twelve years, production has fallen to a low of 70.6 million bales in 1986/87 crop year and risen to a high of 95.7 million bales in 1991/92. The 1986 crop year had the lowest planted acreage in the past twenty years and the 1991/92 crop year had acreage similar to the last two years. Whether production ends up to the low side of the forecasts or to the high side, not much change is expected in world production as a whole, but as most of the drop is expected in regions with heavy participation in the export market, cotton available for export may fall.

World cotton consumption has remained steady over the past decade. The USDA is forecasting consumption of 90 million bales in the 1998/99 crop year. This compares to the ICAC forecast of 89.5 million bales. Both show that, although consumption in Asia may have slowed, cotton consumption worldwide is expected to remain strong. The decrease in raw cotton consumption in Asia has been offset somewhat by increased consumption in Mexico. Mexico is now a major consumer of raw cotton with consumption having risen by two and a half times the level attained in 1993. The U.S. is a driver for increased yarn, fabric and apparel production in Mexico as it provides a lucrative retail market at close proximity. It is likely that by late 1999, barring any further problems such as an extended recession in Japan, the world economy will have recovered somewhat from the currency crisis.

An important indicator to watch over the next few months is the level of value-added exports from Asian origins; Asian currency exchange rates have steadied. Textile exports from Indonesia, the most troubled of the Southeast Asian countries, were reported as 86% higher in January 1998 than one year earlier, but overall exports are lower. Exports of goods from Thailand, Malaysia, and Taiwan have fallen since last year, while exports from South Korea, the Philippines, and China have increased. Asia has been an important source of goods in the U.S. and worldwide, but individual companies' liquidity and ability to continue operations are of concern. This is perhaps what is causing exports from the troubled regions to fall despite the favorable exchange rate for buyers.

 In the 1997/98 crop year, Mexico offset decreases in imports of raw cotton by Asian countries, importing 1.6 million bales, a 77.8% increase over last year. As new textile mills open and existing mills increase production in Mexico, the need for raw cotton imports should remain strong.

Indonesia, the second largest importer of raw cotton in 1997, has experienced problems because of the currency crisis. Export-oriented companies in Indonesia have had a comparative advantage as their products became relatively cheap due to the devalued Rupiah. Companies focusing on domestic consumption have encountered more difficulty in continuing their operations as unemployment rose and personal consumption expenditures slumped. Recently, energy prices were hiked by 60% in order to cover the higher cost of imported inputs only to be reduced later because of the violence that ensued. Indonesia has developed the production capacity to become a net exporter of polyester within the next year while raw cotton needs to be imported. The amount of cotton imported by Indonesia is expected to fall significantly during the 1998/99 crop year.

Until recently, China has been a major importer of cotton, but began to reverse in position several months ago. At first, an incentive program encouraging Chinese mills to use Chinese cotton was instituted. Then, China began to enforce an import quota policy that stopped state-owned mills from importing cotton. Lastly, China appeared as a cotton exporter when it offered a tender of 1.4 million bales in early April and one for 1.2 million bales in late May.

China's actions are particularly important as they have been determined to have an effect on world price. The ICAC proposes that a 100,000 bale change in China's net imports has a 2 cent per pound effect on the 'A' Index. China's participation on the import/export market may be responsible for as much as 44% of the change in the 'A' Index. As previously mentioned, changes in the 'A' Index likely account for half of the change in planted acreage. Therefore, if China's net imports fall in 1998 as expected, planted acreage in 1999 may be even lower than this year and, unless some technological change to boost yields occurs, the recent downward trend established in world cotton production is likely to continue.

Consensus forecasts of Gross Domestic Product (GDP) worldwide show a picture not as severe as some cast. Other than the recession seen in Indonesia, the slowest growth in GDP for 1998 is forecast for Japan, where growth is expected at less than one percent. This has important implications as Japan serves as a major export destination for Southeast Asia and is likely to be a crucial determinant of recovery in the area. The threat of recession in Japan has caused property values to drop and a decrease in consumer expenditures. It also appears that the government's debt situation may be more severe than previously reported, causing concern as to how far the government can go towards assisting in the economy's recovery. Brazil is also expected to see growth at under 2%, with some increase in 1999. The only countries for which higher growth in 1998 compared to 1997 is forecast are in Europe.

So where does this leave us in the 1998/99 crop year. First of all, production is forecast at 86.5 million bales by the USDA and consumption at 90 million bales. This will reduce ending stocks and cause the world stocks-to-use ratio, excluding China, to fall to about 27% compared to this years' 32.5%, indicating a tightening in the world cotton market. The outcome in the world cotton market next year hinges upon the ability of the Asian economies to recover. At this point, raw cotton consumption of 90 million bales may be optimistic. If consumption is lower the tightening in the market may not be as severe, but pressure on supply is still likely to be more intense than over the past four years.