CHAPTER 1

INTRODUCTION

1.1 Relevance of the study

Vietnam is characterized by the dominance of the agricultural sector. Over the last decades, Vietnam has obtained significant achievements in agricultural production, shifting from a food shortage to be a large exporter of some agricultural products such as rice, coffee, pepper, cashews and rubber in the world market. Among these commodities, coffee ranks second after rice in terms of export value (Duong Ngoc, 2002). Vietnam is now the second largest coffee exporter in the world, with a share of about 15%.

Vietnam is highly competitive as a coffee producer and exporter due to a favourable climate and environmental conditions and low labor costs. Over 90% of coffee output is exported to nearly 60 countries. However, Vietnam’s coffee fetches lower prices than those of the world average. This can be explained by lower quality due to poor processing, drying facilities and post-harvest technologies, manifested in high moisture content.

Moreover, in the context of trade liberalization, Vietnam’s economy is easily vulnerable to external shocks. The collapse of the world market prices in the some last years has lowered export earnings in spite of continuous expansion of Vietnam’s coffee export volumes. While a shock stabilising system is nearly absent or inefficiently operates, most of the risk is borne by the farmers. This situation of the coffee industry is worsened due to the practice of non-zoned production causing an imbalance between demand and supply. The large expansion of Vietnam’s coffee-farming area since 1994 partially explains the excess supply and the collapse of the world coffee prices in some last years. This is not the only for the coffee industry but also of some other agricultural products in the transitional period of Vietnam towards market economy such as pepper and cashews.   

The collapse of coffee prices in the world market seriously hampers coffee farmers’ profitability in Vietnam in general and DakLak province in particular, which accounts for 53% of Vietnam’s coffee volume. However, information regarding the impact on living standards in the affected regions is very scarce. In this study, impact of fluctuations in coffee prices on farmers is assessed by considering a case of coffee farmers in DakLak province.

1.2 Focus and scope of the study

Focus of the study:

Theoretical works which are related to price fluctuations of agricultural commodity

Movements of the world as well as Vietnam’s coffee market and relationships between world and domestic prices

Structure of Vietnam’s coffee industry, paying attention to the change in 1999, where export activities were released to private sector

Impact of price fluctuations on farmers, including direct impact on their earnings and secondary effect on indebtness and investment behaviour, however the former will be paid more attention

Effects of some outstanding policies on coffee farmers and policy recommendations for Vietnam 

Scope of the study:

The term “price fluctuations” may imply many kinds of price risk, including risk of input prices, complements prices and substitutes prices. It is too wide to be covered in the thesis. This thesis focuses on the impact of fluctuations in coffee price on coffee growers only, referring to the case of DakLak province.

1.3 Research questions.

Central question raised for this study:

How do price fluctuations affect coffee farmers?

For clarity, sub-questions are as follows:

What are the movements of the world and domestic coffee markets and relationships between world and domestic prices?

How does Vietnam’s coffee industry structure affect distribution of export income and price risk to the actors in coffee channel?

How do price fluctuations affect coffee farmers’ earnings, indebtness and investment behaviour?

What are recommendations for Vietnam to deal with coffee price fluctuations?

1.4 Research methodology

This thesis adopts both descriptive and quantitative approaches. The simulation exercises and the case study method are used to analyse impacts of price fluctuations on farmers. Econometric models are used to estimate export demand for Vietnam’s coffee and explore determinants of coffee production in DakLak province.

1.5 Data sources and limitation

Data employed in this research ear derived from both sources: primary and secondary data. Primary data come from a survey on Evaluating impacts of policies on coffee farmers’ profitability in DakLak province, conducted by ICARD of MARD in the early 2002. The survey covered 178 coffee households in Cumga, Buon Don and Lak districts of DakLak. Secondary are collected mainly from databases of ICO, FAO and VICOFA.

The study would be more interesting if poverty incidence could be estimated, which permit a further analysis of changes in living standards based on poverty incidence estimates in the period of coffee price fluctuations. Unfortunately, poverty incidence could not be estimated due to unavailability of information of production costs of all production activities of households in the survey.

Secondary data used in the thesis were collected from various sources and thus statistical difference occurred. Therefore, despite the efforts to find most reliable data and information, the research still suffered from several problems with data and information.

1.6 Structure of the thesis

This study contains six chapters. Chapter 1 introduces overview of the study. Chapter 2 reviews theoretical issues of price fluctuations of agricultural commodities and particularly, coffee. Chapter 3 highlights movements of the world and domestic coffee markets and focusing on analysis of coffee price volatility and the relationship between world and domestic prices. Chapter 4 presents structure of Vietnam’s coffee industry, which affects to distribution of export income as well as price risk. Chapter 5, the core chapter of the thesis, considers impacts of price fluctuations on coffee farmers in DakLak province. Finally, chapter 6 reaches a conclusion and makes recommendations.

CHAPTER 2

THEORETICAL FRAMEWORK

2.1 Agricultural market and commodity price fluctuations

A problem raised for exporting countries of primary products is wide fluctuations in export prices of these products. This can be explained by both inelastic and unstable demand and supply. Inelasticity and instability in demand is caused by the small proportion of this commodity in total consumption spending of individuals and business cycle fluctuations in developed countries. Inelasticity and instability of supply is sourced from the rigidities and inflexibility in resource uses in most primary commodity production and changes in weather conditions. With inelastic demand and supply curves, any shift of demand or/ and supply can lead to wide fluctuations in the world prices. The volatility in the world prices, in turn, transmits to export prices of producing countries, then producer prices and their income.

2.2 Agricultural marketing system in developing countries

Agriculture marketing includes all activities that are involved in transforming, storing, transporting, and promoting agricultural products to the domestic consumers or foreign buyers (Elz, 1987, p.5). Structure of an agricultural marketing system affect pattern of income distribution of exports to actors in the system, namely producers, assemblers, processors and exporters, so influences risk sharing of price fluctuations of exported commodities.

In the context of wide fluctuations of agricultural commodities, income of producers seems to be most volatile.  Governments’ intervention into primary markets by defining who does and who does not participate in the markets, setting of rules of inclusion, assisting participants to achieve these standards and monitoring their performance, which aiming at stablizing prices, maintaining food security, protecting farmers from local traders, controlling exports, was applied by most governments during most of the 20^th century. The intervention had only limited successes. The parastatals found themselves financially strained. The lack of transparency in the management of government-controlled systems mattered. Steady productivity gains in agriculture, transportation, and communication began eroding the efficiency of intervention instruments. Economists and policy makers increasingly turned to market-based approach.

The commodity market reforms towards to reduce the state’s involvement that began in the late 1980s made changes in structure of agricultural marketing systems of many countries, by which changed pattern of income and price risk distribution between the involved groups. Following the reforms, prices for farmers as a percentage of export price increased, however, the farmers are likely to face increased price volatility due to a larger link between domestic and world prices, which are established after the reforms

2.3 How do commodity price fluctuations affect farmers’ incomes?

Changes in price of a single commodity, obviously, lead changes in revenue of this crop and total crop income. However, impact of the price risk may vary across farms depending on the level of specialization in that commodity, which measured by proportion of farming land allocated to, number of labourers devoted to that commodity production or contribution of this crop to farm income. A higher level of specialization in a commodity reflects larger dependence of farmer’s total income on earning from that commodity, so farmers that highly specialize in a commodity are mostly affected by fluctuations in price of that commodity. In contrary, highly diversified farmers need not experience much revenue loss because of their farm revenue should be relatively insulated against single price changes. In fact, commercial farmers are typically more specialized than smallholders, so they are mostly affected by fluctuations of a single commodity price. This is can be cited by some studies of UNDP in 1989[1] of impact of agricultural price instability in 1980s at farm level, including cases of palm oil in Indonesia, cocoa in Malaysia, sugar in Philippine, tea in Sri Lank and cassava in Thailand, which exposed that the price fluctuations affect mostly on large farmers rather than small farmer. An exception for case of Jute in Bangladesh, which also presented in the series of UNDP’s studies, showed that small jute farmers are mostly affected owning to a fact that they devoted most of their land to jute. Perhaps, small farmers are highly susceptible in any cases. The welfare consequences of even a small drop in income for smallholders might be dire. A large commercial farmer may be able to absorb a huge drop in annual revenue, while a small subsistence farmer may starve as a result of a little drop in revenue. Moreover, agricultural price fluctuations may affect not only farm revenues but also the price that farmers pay for the products they consume, therefore, if farmers do not produce enough for their own consumption, they do not enjoy benefit from any increase in the world price of the commodity they produce  (Fafchamps, 1992). The poor farmers are mostly venerable in any cases.

2.4 How to deal with commodity price fluctuations?

2.4.1 Farmers have developed a variety of ways to mitigate the effect of commodity price risk on their well-being.

Alderman and Paxson (1992) classify farmers’ strategies in two categories, risk management and risk coping. The first category refers to ex-ante adjustments to production and resources used before the occurrence of crop revenue shock.  It can occur before or during the production season. The second set of strategies consists of ex-post responses or actions taken after a shock has already occurred, aiming at minimizing impact of production shortfall on revenue, then consumption. Risk management includes strategies like crop and field diversification, non-farm employment. Risk coping strategies are divided into intertemporal smoothing of consumption though precautionary saving behaviour, and consumption smoothing across households through sharing risk.

2.4.2 Government’s intervention and the role of agricultural market in dealing with price risk

· Governments establish buffer stock schemes to moderate price and supply fluctuations. “A buffer stock is an organization aiming to stabilize a commodity market. It buys when the price is low and sells when the price is high” (Begg et al, 1991).

· Governments establish stabilization funds, which sometimes accompanied by marketing boards and/or state trading enterprises. A domestic stabilization fund compensates producers when prices fall below a predetermined floor or price band, and accumulates reserves when prices increase above the fixed price or band.

Both buffer stocks and stabilization funds need to be very large, which are very costly. Otherwise, they suffer the risk of running out of funds, which happen very quickly. When these schemes are administered in conjunction with a marketing board or state trading enterprises, these institutions risk bankruptcy themselves. Under these domestic schemes, the risks of international price fluctuations are transferred from the producers to the government, which often finds it too costly to finance the schemes.

· Internationally, price stabilization has been attempted via international commodity agreements by imposing export quotas on participating countries or establishing international cartels.  In order to keep the world prices within a price range agreed by members, the cartel control supply for export in the world market by distributing export quotas to member exporting countries.  However, commodity price cycles tend to be asymmetric (Gilbert, 1999), meaning that schemes, which set out to stabilize prices about a supposedly known trend, face intractable problems when the long-term relative prices change. Moreover, once prices rise in the short term, some producers are encouraged to break away and sell above their quotas of exports, so discipline of the cartel may be violated. Furthermore, competition from non-members makes more difficulties for cartel to obtain the goal of price stabilization.

· As a result of the repeated failures of domestic and international attempts at stabilizing commodity prices, efforts are now being made towards setting up schemes that aim at dealing with commodity price volatility in developing countries based on market approach. The available market based tools such as futures and options are widely used in developed countries, are inaccessible (or very difficult) for small agricultural producers in developing countries. This can be explained for several reasons as follows: (i) sizes of contracts traded on organized exchanges far exceeds the annual value of production of individual small producers, (ii) Small producers as well as many market intermediaries in developing countries are lack of knowledge of such insurance instruments and (iii) the sellers of such instruments, generally international trading firms are often unwilling to engage with new and unfamiliar customers with a small value contracts.

It is required to carry out a strategy for developing countries to overcome these obstacles, thereby making risk management instruments more widely available to producers in developing countries. Experiences of some countries such as Costa Rica and Mexico in shifting problems related to accessibility through institutional development can be lessons for Vietnam. Coffee growers in Costa Rica through the organization of cooperatives and cotton, corn, sorghum, soybeans and wheat growers in Mexico through the government have indirectly and regularly used these instruments by hedging their position in a definite price in exchange for a fixed fee.

CHAPTER 3

AN OVERVIEW OF COFFEE MARKET

3.1 Coffee as a commodity

Coffee is now cultivated in over 70 countries in the world, mainly in South America, Africa and Asian with tropical and sub-tropical weather being suitable for coffee growing. Coffee is the second largest global commodity export after oil, with a 1999-2000 value of $9 bil. employing more than 25 mil. people on more than 5 mil. farms. Revenue from coffee exports is an important source of export earnings for many developing countries. Coffee is regularly consumed by more than 40 percent of the world’s population (Rotzoll and Henniges, 2000).

There are between 25 to 100 different species of coffee, but almost commercial coffee comes from either arabica or robusta. Robusta beans are offered at a lower price due to inferior taste to arabica

3.2 The world coffee market

3.2.1 Supply and demand

Coffee cultivation is restricted to the tropics and invariably also developing countries due to the organic demand of the coffee trees. Coffee producers of the world are South American, Asian and African developing economies. The largest coffee exporters in the world in the period of 1990-2001 are Brazil, Colombia, Mexico Guatemala, Cote d’Ivoire, Costa Rica  (South America), Uganda (Africa), Vietnam, Indonesia, India (Asia) in which Brazil always rank first in the list of largest exporters with the market share of around 25%. Colombia used to rank second in this list for a long time, however, since 2000, this position has been occupied by Vietnam, a new entrant in the world coffee market. The world coffee production was growing at 3.7% per annum in the period of 1991-2000.

While coffee is planted in developing countries, most of world consumption of coffee takes place in industrial countries. Large markets for coffee consumption are Europe, USA and Japan. Europe market with annual consumption of around 2m tonnes accounts for over 40 percent of total global demand. The US accounted for 24 percent of total consumption and Japan for over 10 percent.

In contrary to large coffee consumption in the industrial countries, coffee consumption in exporting countries only explains for above 20% of world demand. A half of the 20% come from domestic consumption of Brazil, where domestic consumption account for 40% of its production.

Demand is slowly growing at 1.5% per annum only, a lag behind supply. While Coffee consumption grew rapidly outside of Europe and USA at annual rates of nine percent in 1990s (Fitter and Kaplinsky, 2001), consumption in the traditional importing countries is showing of plunge. The slow growth of coffee consumption in the context of the expansion in coffee production has caused very low coffee prices in some last years.

3.2.3 Coffee price movements since 1960s

A disturbing characteristic of world coffee market is the prevalence of high degree of price instability. The variability also takes place from year to year, within each year, even each month. One measure of price volatility, coefficient of variation[2], shows a high inter-year variability of 48.6% in the ICO composite indicator price in the period 1965-2001. The intra-year variability is averagely 10.6% in the same period. The intra-month of July 2002 is 3%.

It is well known that the high volatility in coffee price is primarily caused by supply shocks rather than demand factors. Historical evidences showed that wide changes in coffee price were occasionally related to frosts and droughts in Brazil, the largest coffee exporters in the world. The most significance was the frost in 1975, drought in 1985 and frost in 1994 severely marked upward pressure on the world coffee price.

In contrary to driving-up-price impacts of these negative shocks, production hikes are matched by price falls in the world market. Changes in the world price as a result of supply shocks are in opposite direction to changes in world production. The transfer of supply shocks to price shocks is immediately, however supply response to price can take place with some delay. High price expectations can lead to higher production from existing trees by better attending only, while the new plantation is related to a long gestation period of three to five years. Therefore, it takes several years for supply to response to high prices. This is also inferred by positive correlation indices of evolution of the world production and international coffee prices lagged. These indices are 0.53, 0.57, 0.61, 0.63 and 0.63 respect to prices lagged by one to five years. The three latter is rather higher implying larger price response of supply in long term than short term.

Downward trend of world price is another characteristic of the price movement. Except for some occasional price-rising events resulting from both human-made and environmental interventions, there has been a systematic long-term decline in coffee’s terms of trade. Supply is going at 3.7% per annum, consumption is only going at 1.5%. The oversupply has led to long-term pressures on coffee prices. Although the combined prices of the four main categories of traded coffee grew from about 40 US cents/lb in the mid 1960s to around 45 US cents/lb in 2001, real coffee prices in terms of trade (adjusted by inflation) as pointed out in Kaplinsky (2001) fell sharply, to a level of around half that of the mid 1960s (and around 20 percent of peak market values in 1977). Seriously, the coffee price of 2001 did not cover total costs of producers.

3.3 The Vietnam’s coffee market

3.3. 1 Vietnam’s coffee production

Coffee trees firstly were introduced into Vietnam by the French missionaries in 1857. Till 1975, areas for coffee farming in Vietnam reached to 14,000 ha. Production of coffee significantly increased since the re-unification in 1975, expanding to 150,000 ha in 1994. However, the areas rapidly increased in the late 1990s due to the sudden price surge in the world coffee market, caused by a severe frost in Brazil in 1994. Areas for coffee farming reached to 516,700 ha in the year 2000  (of which DakLak, the biggest coffee-specialised region in the country, accounted for 260,000 ha, around 50%).

Expansion in farming areas added by growth of yield (annual growth of 8.3% over 1990s) resulted in an annual increase in coffee production of 32% over 1990s, reaching a record of 802,000 ton in 2000 (of which DakLak explained for 53% of national output) from 92,000 ton in 1990.

3.3.2 Vietnam’s coffee export

As a result of rapid increase in production capacity, coffee has become one of Vietnam’s key export commodities, ranking second after rice in terms of export revenue. Vietnam now exports coffee to 59 countries, mainly Switzerland, the United State, Germany, Singapore, England, the Netherlands. With rapid increases in export volume over 1990s, Vietnam has become a large exporter in the world coffee market. Since 2000, Vietnam has been the second largest coffee exporter after Brazil and the largest exporter of robusta coffee. Along with rapid growth in export quantity, there was an upward trend of export value in the 1990-1998 period with annual growth of 36%. However, export revenue has fallen due to low price since 1999 despite of growth in export volumes.

Vietnam as a large exporter in the world coffee market since 1994, have affected the world coffee price as well as Vietnam’s export price by changes in export volumes. Estimation of export demand for Vietnam’s coffee, which is based on quarterly coffee export data for 1994-2002 period released by Vicofa, adjusted by seasonal factors significantly indicates a negative relationship between Vietnam’s coffee export volumes (Q) and prices (P):

Coefficients are significant at 5% level. Tests of autocorrelation, heteroscedasticity and normality are passed.  Regression results and tests are reported in detail in Appendix 8 of the thesis.

From the estimated demand function, we can compute the elasticity of export demand for Vietnam’s coffee with respect to its prices, in turn suggest about optimal quantity, that is revenue maximizing volume, which occurs at the point of unitary elastic demand. The calculation shows that the optimal point occurs at the export volume of 104,198 tons quarterly or 416,789 tons annually and price of US$ 1,473/ton, totalling a revenue of US$ 614 mil. In comparison to the export volume of 713,735 in 2002, it is clearly current volume was much higher than the optimal point, exceeding the optimal point about 300,000 tons or 42%. This suggests that Vietnam should to reduce its coffee plantation area by 42%, holding other else unchanged (given world demand and supply for coffee in other producers.). However, owning to instability in the world coffee supply, the estimate may be not very realistic.

3.3.3 Relationships between the world and Vietnam’s export prices

With over 90% of Vietnam’s coffee output exported, the Vietnamese coffee sector has become closely linked with the international coffee trade. Price changes in the world market will be transmitted and translated to domestic price. A high correlation coefficient of 0.98 was obtained between the world and Vietnam’s export coffee prices for the period of 1990-2001.

But it is not the entire story of the relationship between the international and Vietnam’s coffee prices. There is a fact that Vietnam coffee fetches a lower price in the international market. The low price of Vietnam’s coffee can be explained by following reasons:

· The relatively low quality of coffee exported, which attributes for the practice of strip harvesting which mixes of the ripe and unripe cherries and inadequate primary processing at both farm and post-farm levels, mainly uses dry processing method. 

· Incompatibility to international standards of grading coffee has made reputation of Vietnam’s coffee industry in the world market undermined and suspected.

· The monopoly of state exporters prior to 1999 was responsible for lowering Vietnam’s reputation in the international market as the SOEs, in charges of coffee export, had not fulfilled their side in the contract.

· Poor marketing services also lower Vietnam’s bargaining power in the international market, especially in the event of adverse price movement

CHAPTER 4

STRUCTURE OF VIETNAM'S COFFEE INDUSTRY

4.1 Structure of Vietnam coffee industry before 1999

At the present, coffee is grown under a wide range of production systems, including small farms of less than one hectare and state farms of more than 1,000 ha. Around 85-90% of coffee area is cultivated by small farmers.

The coffee channel before 1999 depicted in Figure 10 of the thesis. For the case of small farmers, coffee after preliminarily processing step on the farm, is mostly sold to private assemblers, which at the end of 1998, were licensed by state owned processors or exporters. This monopsonist position of the assemblers would suggested that the assemblers were able to keep the farm-gate prices low and to pass the risks of export price fluctuations to small growers. The assemblers then deliver the coffee beans to processors. Both private processors and state owned processors were in the market, however, the relative size of the private processors was quite small. The production from the state-owned farms bypassed the assemblers and was delivered directly to the state processors. At the processing factories, a further processing step takes place - the green coffee beans are cleaned, sorted and graded.

Before 1999, however, the liberalization in coffee industry took place just in fields of production and processing only, coffee-exporting activity in Vietnam was confined to state owned enterprises (SOEs).  

4.2 Structure of Vietnam’s coffee industry since 1999

Since 1999, private firms have been permitted to engage in coffee exports. Assemblers can take part into coffee market without the license of the SOEs.

4.3 Impact of structural change on distribution of income and price risk

With the liberalization of export marketing, the structure of the market is currently rather fluid. And it is expected that share of growers in export price would be larger as what we can see from reforms in cacao sectors of Cameroon and Nigeria since the mid-1980 and coffee sector in Uganda in 1990s mentioned in Chapter 2.

However, a time series of farm-gate prices as a percentage of export prices in the period 1996 – 2001 seem not support for this argument. Shares of farm-gate prices in export prices have even declined since 1999 in contrast to what were expected. This can be explained by the downward trend of export price since 1999, by which farmers bear most of the risk, distorting impact of the recent liberalization on the small growers, therefore the impact of the liberalization is unclear.

A below consideration of cost structure of the coffee channel will make clear how farmers bear the price risk.

Table 1 presents cost structure of DakLak’s coffee channel in 2001. Farm-gate price for coffee beans, as seen from this table, was about VND 4,000/kg in 2001, a too low price in relation to production cost. With the low price, farmers suffered such serious loss from coffee plantation. Assemblers, processors and exporters could still gain in doing coffee business.  

Table 1. Cost structure of DakLak’s coffee channel in 2001

Source: Estimates from data of Survey in DakLak, 2002

Return to a survey conducted by MARD in DakLak in 1997. The survey reported farm-gate, assembler and export prices in 1996 in DakLak were VND 10,322.6/kg, VND 14,562/ kg and VND 20,983/kg respectively. With these prices, the farmers could earn a profit of around VND 2,000/kg (or 10% of export price) in comparison with profits of over VND 4,000/kg (or over 20% of export price) for the assemblers and of VND 699/kg (or 4.4% of export price) for exporters  (Anh, 1999). However, the very modest profit of VND 699/kg, which was reported by the exporters, could be distorted. If using cost structure in the survey in 2002, added by payment for 5% revenue tax[3], exporters’ profit in 1996 could be roughly VND 5,000/kg (or approximately 24% of export price).

By looking at available data of two years 1996 (a year of high price) and 2001 (a year of low price), it is clear that farmers were bearing most of price risk. While farmers could earn a profit of about VND 2,000/kg in the year of high price, they were bearing a serious loss in the year of low price. The situation for other actors of marketing channel is rather different. Assemblers, processors and exporters still earn significant profits even in the low price year. In order to maintain high profit margins, they tended to transfer most of price risk to farmers. In this situation, it is understandable why the shares of farm-gate prices have not become better after the liberalization.

In the context of the sharp drop in the world coffee price, partially explained by expansion of Vietnam’s coffee area, the Vietnamese government decided to buy 150,000 tonnes of Robusta coffee beans for reserve (60,000 tonnes at November 2000 and 90,000 tonnes in February 2001). However, the government’s attempt to stabilise coffee prices by stockpiling was ineffective.

CHAPTER 5