The Question of the Auction
Tea has been sold by open auction in Colombo since July 1883, allowing participants to benefit from price discovery in a free and open market. This allows both producers and exporters to transact at the best and fairest price. The Colombo Tea Auction has long held the position of being the largest single-origin tea auction centre in the world. However, the present economic uncertainty in Sri Lanka has given rise and lent an air of authenticity to the false belief that, the benefits of rupee depreciation have not been fairly passed down to the producer. This is a view primarily held by a small group of tea producers and supported by certain policymakers.
This notion is, however, easily refuted by even a cursory examination of recent price trends at the Colombo Tea Auction. Industry experts understand that this is a misconception far removed from the truth. Nevertheless, this notion is gaining traction in certain quarters, with some with vested interests standing to benefit from interfering in what has been a free and fair market for over a hundred years. Therefore, in this article, we will examine this claim and recent trends witnessed at the Colombo Tea Auction, to factually and irrefutably quell any authenticity that these ill-conceived ideas attempt to claim before they have a chance to destroy one of the last remaining bastions of Sri Lanka’s already battered economy.
An Untenable Proposition
The solution proposed by a segment of producers is to change the value currency of the Colombo Tea Auction from LKR to USD. However, such a move will not work to better compensate producers. Such a move would introduce unnecessary and time-consuming red tape, not to mention volatility, into a system that functions very smoothly as it is. It also has the potential of further exacerbating the foreign exchange crisis, as the industry would need to “dollarize” itself, meaning that fewer dollars will be available for import requirements, as they will be in circulation within the local economy.
Furthermore, there is the question of the other members of the supply chain, for example, smallholder tea growers and transporters. What happens if they too demand that they must be paid in USD? Such circumstances would only exacerbate the foreign exchange crisis, as more and more participants demand to be paid only in USD. There will also be other foreseen and unforeseen macro-economic challenges, as a result of such a move, with part of the industry denominating its transactions in USD and other parts in LKR. Furthermore, dollarization may restrict exporters’ ability to pay the fair price at auction, leading to a potential negative impact on the price of tea.
Dollarization has been suggested before in Sri Lanka and has been decided against, for good reason. However, the present crises have lent a certain authenticity to these ideas, which must be refuted at once. Dollarization has been implemented in countries like Kenya, but the move only resulted in small and medium buyers being wiped out, and large multinationals taking control. Sri Lanka’s tea industry largely remains diverse, locally owned and controlled, and such proposed dollarization of the industry could potentially lead to a loss of ownership and control to a homogenous monopoly made up of large foreign companies.
Numbers Do Not Lie
Supported by the sharp depreciation of the LKR against the USD and a shortage of tea in Q1 2022, auction prices soared in the last two months providing, in some cases, even more than the full benefit of the exchange rate movement to the local tea producer and grower. For the first time in history, average tea auction prices for all three elevations exceeded LKR 1,000 per kg in April 2022. Accordingly, the average price of tea sold at auction rose from LKR 708.00 per kg in January 2022 to Rs. 1,324.95 per kg by May 2022, an increase of 88%. At the same time, the Rupee depreciated by only about 75% from LKR 203.00 to LKR 356.00 per dollar. This alone is sufficient to empirically prove and make the case that the present system of tea auctioning is serving both exporters and producers equally and fairly.
However, it is possible to further demonstrate that the benefits are being passed down to the bottom of the supply chain if we consider the green leaf pricing formula. According to this formula, which is set and maintained by the Sri Lanka Tea Board, the apex governing authority for the industry, green leaf prices are set at a percentage of each factory’s tea sales average, computed based on monthly average tea auction prices. Thus, it is usually the practice that smallholders receive the price paid by the best factory in their area for their green leaf, sometimes even more. As a result, smallholder tea growers are now paid over LKR 200 per kg for green leaf, compared to Rs. 100/- 125/ per kg in the months before the rapid depreciation of the Rupee. These gains have also allowed many factories to provide increased compensation or relief packages to their staff, including labourers and other ancillary members of the supply chain.
Thus, teas are fetching prices far beyond fair value in many instances, giving a false impression that exporters are unfairly benefitting from the exchange rate volatility. The reality is, however, that the system of the open auction for tea in Sri Lanka, an established practice for over a century, is functioning well and exactly as it was designed to, fairly and openly distributing capital throughout the system, ensuring fair compensation to all members of the supply chain.
It is also necessary to bear in mind that tea exporters themselves have many costs over and above the tea itself. These include freight, packaging materials, tea flavours, agents’ commissions for foreign agents/distributors and marketing, all usually made in foreign currency, and none of these costs are passed on to growers or producers. With the present dollar shortage, most exporters are now required to make these payments in advance, even before receiving export proceeds, whereas these payments were made on credit terms in the past.
Understanding Reality & Gearing for the Future
Examining the figures and facts of the matter, it is impossible to draw any rational or reasonable conclusion other than that, the present system of tea auctions in Sri Lanka is working well and does not need any kind of meddling from any party, particularly policymakers. Much of the present economic disaster in Sri Lanka is a result of such meddling, so let us ask ourselves whether we would like to see one of the last remaining economic opportunities in Sri Lanka being destroyed for the benefit of a few.
If producers wish to benefit more than they already are from the currency depreciation, then Sri Lanka must look at increasing its annual tea production from 300 million kg to around 350 million kg, over the next 3 to 5 years, to meet global demand and benefit from increased revenues. This additional 50 million kg of produce could grow the nation’s export earnings by approximately USD 300 million each year.
Recent exchange rate movements have made Ceylon Tea and other products more attractive to overseas buyers and have even increased demand. However, Sri Lanka cannot benefit from this increased demand, without increasing production, and it certainly will not benefit in any way from parties with vested interests meddling with a system that has functioned well, created wealth and lifted generations out of poverty for over a century.