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February, 2009

Oriental Leaf

By C. Hasan Umur

A recap of the 2008 year in lands of Oriental tobacco.

2008 was an eventful year in Turkey, both on the political and economic fronts. The first half of the year was dominated by the political uncertainty surrounding the court case for the closure of the ruling Justice and Development Party (“AKP”) and the last six months witnessed the acceleration of the global economic crisis and the anticipation of its effects on the Turkish economy.

In March 2008, the Chief Public Prosecutor opened a case against the AKP at the Constitutional Court, demanding that the party be closed on claims that it was carrying out anti-secular policies. AKP had won a landslide victory in the general elections in July 2007 and holds a comfortable majority in Turkey’s single-house Parliament. The legal process then took four months and the Court finally ruled the case out in July, but the country suffered once again from political rhetoric, which is always costly on the economic side. As a result of the Court’s decision, the Government of Prime Minister Recep Tayyip Erdogan looks set to remain in power at least for the remainder of this parliamentary term which ends in 2011.

In October, the global credit crunch took a new shape with insolvencies in the global banking sector. The Turkish financial sector was not as badly affected as the Western World, mainly due to a lack of appetite for the “sophisticated” financial instruments as relatively high returns were already available in the country thanks to the high real interest rates. However, the major consequence of the credit crunch will be on Turkey’s real sector in the shape of reduced credit to finance ambitious growth rates.

In the six year period from 2002 to 2007, Turkey benefited from the globalization of the world economy, “globeconomics,” in that high growth rates were financed by inflows of foreign capital, attracted to the country by the high real interest rates, and exports rose on strong global demand. As a result, Turkey became the sixth largest economy in Europe, and the chronic inflation rates were reduced to single digits. All this was under the auspices of a stand-by agreement with the IMF which expired in May 2008.

We argued in these pages exactly one year ago, that “the problem with globeconomics lies in its irreversibility. When world trends become unfavorable, it is almost impossible to control the national economy by macroeconomic policy alone, and previous gains can easily be lost.”

The prophesy is coming true in the advent of the global economic crisis. Turkish businesses are having to pay higher interest rates on their loans, and still, credit is generally scarce. Long-term financing for green-field projects is virtually non-existent while exports are suffering from reduced global demand. As the effect of the crisis on developing countries is more accentuated on the real sector, 2009 is likely to be a worse year than 2008.

The Central Bank of Turkey has, on its part, been proactive in dealing with the crisis by introducing a series of unexpected rate cuts, amidst criticism that such cuts may be pre-mature, especially as inflation targets are still far from being met. However, the cuts were necessary for easing liquidity. The major economic policy decision facing the economy now is whether or not to revert to the support of the IMF, and if so, at what level. When the stand-by agreement expired in May 2008, the government had hoped to continue the relationship on much looser terms, but it is now becoming more and more evident that the IMF will play an important part again in facilitating Turkey’s financing.

The global events of October 2008 did trigger a “correction” for the much overvalued Turkish Lira, which was until then, adversely effecting the competitiveness of traditional exports such as leaf tobacco.

However, the devaluation of the Lira is not likely to give a boost to exports before global demand begins to pick up. Imports are also likely to decrease as domestic demand is depressed, bringing about a general fall in trade volumes. As a result, the current account deficit, which increased alarmingly over the last six years is likely to stabilize, but will still need to be financed, in an environment where financing is a totally different proposition compared to the pre-sub-prime days.

In 2008, exports rose by 29.1% while imports increased by 18.7%, and the resulting trade deficit was the largest in the country’s history. Turkey relies on tourism and foreign capital inflows to finance its trade deficit, but the prospects for neither are very strong for 2009.

The Turkish Tobacco Situation
The historically short crop of 2007 raised many concerns regarding the sustainability of Turkish tobacco production, especially of the Izmir variety. At 38,557 tons, the Izmir 2007 Crop was the smallest and most expensive in living memory. The total Turkish Oriental Crop came down by 23.7% from 93,240 tons in 2006 to 71,156 tons in 2007, and most of the reduction was caused by the fall in the Izmir crop, which is traditionally the locomotive for Turkish tobacco exports.

True, there were some mitigating circumstances: the Izmir 2007 Crop was produced under the worst drought conditions in over two decades. Furthermore, export prices were driven up by the artificially strong Turkish Lira. However, the tobacco industry had been hearing the same broadcast from Turkey since the onset of the 2006 Crop, and at face value, the outlook was not so bright for the 2008 Crop.

The privatization of TEKEL’s cigarette manufacturing assets in 2008 was the final step in a series of changes in the functioning of tobacco markets in Turkey, basically aimed at reducing state involvement in the sector. The century-old government support for leaf tobacco production was lifted with the passing of a new tobacco law back in 2001 which essentially restricted TEKEL to purchase tobaccos only for its own usage in cigarette production, and no longer to support the leaf market. At the same time, tobacco cultivation was placed under a contract system. In the interim period, TEKEL contracted with farmers for its own requirements, and some support can be said to have been present in that contracted volumes, especially in the East and South-East reflected long durations for TEKEL. During this period, TEKEL sold its excess stocks, mainly for export, to the rest of the industry and continued to serve a quasi-buffer function.

Against this background, TEKEL’s cigarette industry was finally privatized in 2008. In February, B.A.T. was the highest bidder for TEKEL’s cigarette assets at a public auction with a bid of USD 1.72 bn and the sale was completed in June. The privatization was in the form of an asset sale, and even though the name “TEKEL” is now used by BAT, the State Company continues to exist as an entity, encompassing the former Leaf Tobacco Division of TEKEL, which is now called “T.T.A.”

As the privatization was not yet completed at the time of contracting for the 2008 Crop, TEKEL contracted with farmers for the crop, seemingly for the last time. The tobaccos produced under those contracts will be bought for the State by T.T.A. for later sale. There is some speculation that T.T.A. may again contract some quantity from the 2009 Crop, but this would only be for socio-political reasons unless there is a total reversal in the Government’s reduced support policy for agriculture, an unlikely event in the current circumstances.

In line with the State’s reduced involvement in the tobacco sector, the Government passed a decree in December, promising to pay farmers in the growing regions of Eastern and South-Eastern Turkey, the sum of 1,080 TL per hectare not planted with tobacco and instead used for alternative crops. The payment applies to farmers who had planted tobacco in the 2008 Crop, and decide to take the option. The value received by the farmers will be approximately 10% to 20% of the value of the tobacco that could have been planted on the de-coupled land.

The 2008 Crop
The onset of the Turkish 2008 Crop was thus a turning point on two fronts: For the Classical Export Varieties of Izmir, Samsun, and Basma, sustainability and price competitiveness were under threat. For the so-called “semi-oriental” varieties of Adiyaman, Yayladag, and Sark, which together make up the Eastern and South-Eastern production, the future of the crops were questionable in the absence of TEKEL.

Furthermore, with the further reduction of the State’s involvement in tobacco, the responsibility to match the supply with demand promised to fall more on the leaf industry.

For the Classical varieties, especially Izmir, the leaf tobacco industry made a concerted effort to bring production volumes in line with the perceived demand. Advances were paid soon after the signing of the contracts to compensate for the loss in revenue resulting from the drought in the 2007 Crop and to help the farmers with their cash-flow for the production of the 2008 Crop.

Alternative crops also had a dismal year in 2007, and tobacco was the only crop that gave a reasonable return to the farming community, with unit prices increasing at least in line with inflation, despite the drought growing conditions. The farmers in turn responded by increasing the plantation area in Izmir, from 97,258 hectares in the 2007 Crop to 103,031 hectares in the 2008 Crop.

As a result, the 2008 Crop tobacco production in Turkey is expected to materialize at 94,000 tons, representing an increase of 32.1% from the previous year. The reversal in the trend of declining production, amidst all adversity, is a strong indicator of the continued sustainability of the crop in the medium term. At the same time, the slide in the value of the Turkish Lira will help the economics of the crop and increase the competitiveness.

All in all, the 2008 Crop represents a distinct turn for the better for the Turkish tobacco crop. Turkey supplies the desired volumes with no subsidies or premiums, and as such, continues to be the most reliable and sustainable Classical Oriental producer in the world.

The Izmir 2008 Crop is expected at 60,500 tons, up 56.9% from the 2007 Crop. Even though the reasons behind the shortfall in the 2007 Crop were mostly weather-related, such a reversal in the production volume is a strong re-assurance that the Aegean Region of Turkey can and will produce a crop with good critical mass and continue to lead the country’s exports of tobacco.

The overall quality of the crop is good, with ripe and bodied top stalk. The law stalk is more mixed, but in line with average quality.

The market for the 2008 Crop started on 28 January 2009, and purchases are expected to be completed in mid-March. Processing will start in the second half of April.

Black Sea
The Black Sea Region in North-Eastern Turkey produces the two other main export varieties, Samsun and Basma. The production is fairly stable and reflects the demand levels.

The quality of the 2008 Crop is good in the top stalks, but below average in the first pickings due to sustained rains following transplantation. The lower stalk is expected to be weak and thin.

Adiyaman, Yayladag and Sark are the three varieties that make up the semi-oriental group. The expected quantities for these varieties in the 2008 Crop are as follows:

Adiyaman: 5,700 tons
Yayladag: 3,500 tons
Sark: 10,800 tons
Total: 20,000 tons

The Turkish semi-orientals had hitherto been purchased mostly by TEKEL. In the absence of the State contracting for these tobaccos, the future of the three varieties depends on the industry’s ability to create a demand for them in the international market. Until now, the price-quality match-up was not sufficient to kindle demand. However, the area has experienced tobacco farmers producing a sizeable quantity, and many alternative opportunities may be found for the usage of these tobaccos.

Tobacco International - February, 2009


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