Market Reports

ICO economic report: Threat of a different kind

The economic sustainability of the coffee sector has been the focus of debate among a large group of coffee stakeholders in the last two years. In September 2018, it was widely called into question when international coffee prices fell to their lowest level since October 2006. Prices have remained subdued, averaging 102.21 US cents per pound since September 2018, 28 per cent lower than the average of the previous 10 years.

In response to this prolonged period of low prices, the International Coffee Organization (ICO) has been examining the economic sustainability of the sector through economic analysis to assess the key determinants of low prices and volatility, publishing a new economic flagship publication of the ICO, “Growing for Prosperity: Economic viability as the catalyst for a sustainable coffee sector”. This work was guided by an unprecedented consultation process. It mobilised all coffee public and private stakeholders, NGOs, academia, and development partners that lead to the historic industry-led London Declaration and the call by the ICO Member governments to establish a Coffee Public-Private Task Force with one of the goals to take concrete actions on price levels and volatility.

In this context of low prices already threatening the long-term economic health of the coffee industry, the COVID-19 (coronavirus) pandemic provides an additional challenge to the industry, bringing an even greater sense of urgency to the issue of economic sustainability for the sector, from farmers to consumers.

By the end of January 2020 when the World Health Organization stated that the coronavirus pandemic was a public health emergency of international concern, much of the harvest for the 2019-20 crop for October-September producers was nearing completion. Global output in 2019-20 is estimated 1 per cent lower at around 168.9 million 60-kilogram bags, as a result of lower prices as well as Brazil being in the off-year of its biennial Arabica cycle rather than any impact from the coronavirus. Given the more limited supply this year, short-term deficits in the international market are helping to prop up washed Arabica prices, but this may be a temporary phenomenon.

In the March 2020 interim report of its economic outlook, the Organisation for Economic Co-operation and Development (OECD) adjusted its global growth forecast downwards to 2.4 per cent for 2020 in its baseline scenario. However, it was noted that the situation was rapidly evolving and the potential for a more significant downturn increased as the virus spreads.

Coffee farmers around the world were already in a vulnerable situation as some producers were operating at a loss compared to the prevailing low prices. Given their lack of ability to access price risk management tools, such as hedging in the futures market, smallholders are heavily exposed to fluctuating prices. Several producing countries had already observed the negative impact low prices have had not just on future coffee production, but also on broader socio-economic indicators such as income and food security.

Given the economic vulnerability already faced by producers because of this prolonged period of low prices, the ICO analysed the long-term relationship between ICO indicator prices and global economic growth using a quantitative model, covering a 29-year period, from 1990 to 2018. The model explores the relationship of prices with GDP from leading world economies, which also represent significant importers of coffee and the traditional consumer markets. These economies include the United States, Japan, Germany, Italy, France, and the United Kingdom. According to the World Bank’s World Development Indicators (WDI), the combined Gross Domestic Product (GDP) of these six countries has represented an average of 52 per cent of the world’s GDP during the 29-year period under consideration.  In addition, these six countries import 42 per cent of all green coffee shipments and are responsible for an estimated 33 per cent of the total global coffee consumption. Figure 1 plots coffee prices against the GDP of these six economies for the last 29 years. A first indication is a positive relationship of coffee prices with global economic growth.

The model also includes the inventories of green coffee in those six markets, as a control for market fundamentals on the demand side. Figure 2 shows a graphical representation of the relationship of prices and inventories, indicating that the larger the inventories of green coffee in importing markets, the lower the international price of green coffee.

An additional model was tested using prices, GDP, and inventories in three specific markets – US, Germany, and France – which are the three import markets for the ICO indicator prices. This second model uses a more robust quantitative technique, Market-Fixed-Effects, that controls for the particular characteristics of each of these markets.

The results of the quantitative models indicate that there is a positive and statistically significant relationship between GDP growth and green coffee prices. Specifically, a 1 per cent increase in GDP is associated with a 1.6 per cent increase in coffee price. In terms of inventories, a significant negative relationship was found, in which a 1 per cent increase in green coffee inventories is associated with a 0.54 per cent decrease in green coffee prices.

In its November 2019 outlook, the economic growth for 2020 of the six economies considered was 1.3 per cent. The OECD revised these figures as a result of the impact of the coronavirus in early March 2020, projecting GDP growth -0.2 percentage points lower, at 1.1 per cent for 2020. Using ICO prices in 2019, the GDP effect of these economies, assuming all other things being equal, would have caused coffee prices to increase by 2.1 per cent to 102.6 US cents per pound in 2020. However, due to the coronavirus, this effect would now be lowered to 1.8 per cent. While the effect might look small, for coffee farmers in some of the poorest areas of the world as well as farmers that face higher production costs, this reduction in price can create a real difference in income at the farm level.

This analysis of the impact of a slowdown in the global economy on coffee sector prices is the initial step to understanding the full impact coronavirus may have on the coffee sector. In the coming months, more information will become available to provide a clearer picture. In particular, the ICO will be looking at the impact on both demand and supply across the value chain.

Regarding supply, harvesting should be starting soon for producers with a crop year commencing in April, which includes Brazil and Indonesia. Further, the upcoming crop is an on-year for Brazil’s Arabica production, and this season’s weather indicates that Brazil should have a sizeable, though not record-breaking, crop. The expectation of a large upcoming Brazil crop has limited a sustained rise in prices. However, if the virus becomes widespread in these producing countries and containment measures limit the availability of on-farm labour and raw materials, there is the potential for a reduced harvest. This would have a noticeable effect on the availability of coffee in late summer, when supplies from producers with a October-September crop year start to dwindle.

Disruptions to the supply chain may be another source of shock on the supply side. Coffee is widely traded, with over 90 per cent of production shipped from origin as unprocessed coffee, a portion of which is shipped to additional destinations after processing. However, transporting the coffee to its destinations is showing some signs of difficulty. Given the reduced output from China, a major global manufacturing hub, fewer shipping containers are available, and some cargo lines are cutting back on the number of stops they make.

Data through January 2020 shows that total coffee exports reached 10.3 million bags, compared to 11.1 million bags in January 2019 and 10.5 million bags in 2018. However, the lower volume remains within market expectations due to the lower output this season. Additionally, farmers that were unable make sales in December 2019, when prices surged, have held on to their coffee waiting for another rise in prices. Further reductions in shipments, particularly if prices remain elevated could suggest ongoing issues with logistics.

On the demand side, inventory and import data can provide indications about the impact on overall demand, particularly in the two largest import markets, the United States and Europe. Typically, inventories in these markets are drawn down in the fourth quarter of the year with minimal change in the first quarter. Then during the second quarter, stocks tend to be replenished. Data through November 2019 demonstrate a similar drawdown of around 7 per cent for inventories in the United States and Europe. Given the disruptions to the supply chain that may occur in the next few months, the typical rebuilding may be delayed or reduced, which in turn could create shortages of certain qualities in the market in the near-term. The market is closely watching for an expected drawdown of the ICE certified stocks under the C contract, signalling that supplies remain tight for Arabica Milds.

Imports by the large consuming markets declined by 3.5 per cent in the first two months of coffee year 2019-20. This follows two quarters of significantly higher volumes and precedes the pandemic. However, if imports continue to remain dampened over the next few months, this may be an indication of reduced demand.

While early reports have indicated a sharp fall in out-of-home consumption, stockpiling of consumer goods is likely to have resulted in increased retail sales of coffee. Over time, though, continued strain on the supply chain may impact at-home consumption as well, particularly in emerging markets where coffee is not considered a staple good.

Looking beyond the next few months, containment measures across the world have resulted in a global decline in commercial activity as COVID-19 has rapidly developed into a global health emergency. This could have knock-on supply- and demand-side effects on the coffee sector over the medium term.

We may expect to see output contractions in processed coffee, a fall in new processing units as a result of decreased investment flows, decreased public spending on agriculture as government incomes decline and are directed to health care, as well as an impact on prices due to fluctuations in currencies of major coffee producers.

The ICO has already started a dialogue across the coffee sector in the face of low coffee prices. However, with the current situation both in the short- and medium-term, it is more urgent now than ever to continue this dialogue on identifying and implementing solutions for the health of the industry.

This article was written by Rebecca Pandolph (top), Chief, Statistics Section, and Marcela Umana (bottom), Economist at the International Coffee Organization (ICO).

The ICO is the main intergovernmental organisation for coffee, bringing together exporting and importing governments to tackle the challenges facing the world coffee sector through international cooperation. Its Member Governments represent 98 per cent of world coffee production and 67 per cent of world consumption.

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