Coffee economics

Coffee and Currency: The global impact on farmers

In the lead up to the November United States Presidential election, global headlines were regularly dominated by any news that would hint as to who would emerge to lead the American economy. With the US dollar staggering at record low levels, the election seemed especially important. As The Economist noted: “Every election tends to get billed as the most important for decades: but this one really is.” With the international price of coffee set in US dollars, a steady US economy and currency is important for producers the world over.  In the last year, many coffee farmers have seen their income steadily decline along with the American economy. Where currencies in many producing countries have appreciated, the effect has been magnified. The problem of currency evaluation is most exemplified in Colombia, explains Luis Fernando Samper, Chief Communications and Marketing Officer for the Colombian Coffee Growers Federation (FNC). Colombia currently has one of South America’s most appreciated currencies, with the government only recently (July) taking action to increase interest rates to address the problem. Since the beginning of 2012, to when Samper spoke to Global Coffee Review this past October, the Colombian peso was revalued by 7 – 8 per cent against the US dollar. Couple this with a 23 per cent drop in coffee prices, and the average Colombian grower has seen the price they receive for their coffee drop by almost a third. It’s a sad twist of fate, that Colombia’s success in boosting its economy has resulted in this unfortunate drawback for coffee farmers. “Colombia has changed a lot in the last 10 to 15 years, for the better of course,” says Samper. “We’ve seen increased security, which has created opportunities for people to invest, which has generated an influx in foreign investment. As the demand for the Colombian peso has increased, so has its value.” From a macro perspective, the fact that currencies like the Colombian peso can buy US dollars  for cheaper should lead to higher prices, explains Avtar Sandu of Phillip Futures in Singapore. Other market forces aside, he says a falling dollar is generally considered bullish for commodities. “In a market where there are no fundamentals driving the market, or are not considered a factor, a strong movement strengthening the dollar would be considered bearish for coffee,” says Sandu. While he notes it’s not a strong correlation, when the opposite happens and the dollar drops – as it is now – and it takes more dollars to buy coffee, then the price should rise. Prices in general are showing no sign of climbing any time soon. As of September 2012, the International Coffee Organisation composite price sat at 17.4 per cent lower than a year prior. This was on the back of tighter fundamentals, with production remaining roughly the same as the last coffee year, and consumption on the rise.  Carlos Brando, from coffee marketing firm P&A Marketing in Brazil, says one factor that may have helped keep coffee prices down has been Brazil’s recent moves to devalue its currency. Robustas have remained steady since last year, with Arabicas mostly to blame for dragging down the composite price. As Brazil is the world’s largest Arabica producer, devaluing the Brazilian Real against the US dollar should have helped keep prices down. “That may help explain why prices are not higher than they are now,” he says.  Indeed, Arabicas have dropped the most significantly since last year, when they peaked at over US$2.60 per pound. Brando says that currencies may have been partially responsible for last year’s record high prices, with 70 per cent of Arabica production taking place in countries with stronger currencies. As it took more US dollars to buy coffee in these countries, Brando says this may have contributed to the unprecedented price hike. Conversely, he points out that Robusta production is split roughly evenly between four countries: Vietnam and Uganda with depreciated currencies on one side, and Indonesia and Brazil with appreciated currencies on the other. As such, the currency effects on Robusta prices were more weighted-out, widening the price difference between Arabicas and Robustas that led to increased demand for Robusta, and decreased demand for Arabica. With less demand and lower prices, the compound effect is certainly being felt at the production level, Brando notes. “Coffee farmers are definitely less comfortable now than they were before,” he says. With prices and currency out of farmers’ hands, Brando says that farmers must look to increase their yields to increase their incomes. Lessons from Colombia 
Over in Colombia, leaf rust fungus and poor weather make increasing yields easier said than done. For its part, the FNC has invested in renovation programs that saw 74,000 hectares renovated already this year, having planted 2.1 billion trees since 2008 that has cost them close to US$1.4 billion. “Of course, we’re looking to adjust our productivity, it’s what we have been doing, but with this elevated currency our farmers continue to be pressed,” says the FNC’s Samper. With the FNC’s 540 purchase points, Samper says Colombian farmers are fortunate to receive around 95 per cent of the international coffee price, far above what most coffee producers receive. When that price drops, however, along with the US dollar, even at 95 per cent of market value, farmers are nevertheless prey to market forces. To help producers, the FNC has recently introduced a hedging instrument that will allow farmers to use those market forces to their advantage, or at least protect themselves against volatility. On 8 October, it announced a new Price Protection Contract (CPP) to help farmers insure their risk against currency and price fluctuations. The tool is quite innovative, as never before have small rural coffee growers had this kind of access to hedging and financial intruments.  The new financial instrument will allow the country’s coffee growers to buy contracts to set a load price for the second, third and fourth month after the date they purchase the instrument. One load equals 125 kilograms of parchment coffee, and farmers will be able to purchase up to 50 loads per month to protect their income when they decide to sell their harvest. “This way, we hope producers can not only optimise their productivity and costs through ongoing and successful plantation renovation programs, but take advantage of volatility and favourable price situations,” says Luis G. Muñoz, CEO of the FNC. “[This] can guarantee them a minimum income to be chosen individually by every coffee grower.”  The new tool will set a minimum income according to the market price of the day the farmer buys the contract, or to prices 10 per cent lower or higher. The cost of options will be published on a daily basis. Producers will be able to purchase the contracts from their farms, via their mobile phones, and deduct costs from their intelligent Coffee Grower ID Card.   As the CPP is designed to support the FNC’s goal in guaranteeing a minimum price, if the domestic price rises at the moment the producer sells the harvest, then the ‘put’ option is not exercised. When the domestic price falls, the producer will have the guaranteed minimum price as purchased.  “The best scenario for a producer is that prices climb and he [or she] can sell [for example] in January better than in November,” says Julian Medina, the FNC’s Chief Financial Officer. “It is worth a reminder that, as with every protection instrument, the ideal would be not to have to exercise it. But we buy it to have a guarantee and avoid the risks. With current volatility of markets, the risk of having unfavourable price situations at the moment of selling the harvest is not minor.”  Samper tells Global Coffee Review that the financial risk of the new instrument will be unloaded on market players, such as private finance companies and exchange operators.  “The philosophy behind this is that we’re focusing on a new factor in helping farmers,” says Samper. “The first variable is farm productivity, taking care of young coffee trees and so on. The second factor is to help them improve their coffee, so they can sell at higher prices, as specialty coffee through programs like Cup of Excellence. This third factor is now something new. We have to take a new angle and help farmers deal with the factors behind market volatility.” With the European Union joining the US in shaky economic times, Samper says this market volatility is likely to only increase. Investment companies the world over have proven their ability to take advantage of price volatility to their advantage, and Samper says this FNC program does the same for farmers in reducing their risk – to a certain extent. While the CPP may help buffer price changes, Samper points out that as long as coffee is priced as a commodity, farmers will continue to be prey to market forces. “I think the industry needs to get a grip on certain new things that the coffee producing world is facing,” he says. “Coffee continues to be a US dollar dominated product, and the dollar is not as strong as it used to be. Currencies in producing countries are rising, inflation and input costs are rising, and over time, these costs will transpire into prices… We have to convey the value of producing high quality coffee to consumers. It’s a costly activity, whether you value it in pesos, dong, or dollars.” GCR

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