After the last two years of escalating returns to India's tobacco farmers as prices soared to record highs - and then continued to climb - its hardly surprising that India is recording its largest tobacco crop ever in 2010.
It is estimated that this year Indian tobacco farmers will produce 420 million kg of tobacco - of which flue-cured Virginia will account for about 350 million kg. Burley production ranks second, followed by other air-cured and sun-cured varieties and around 5 million kg of oriental tobacco.
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The sun-cured crop is more than burley production this season. Around 10% of the Mysore crop and between 10-15% of the Andhra Pradesh crop is unauthorized, meaning over what was authorised by the Tobacco Board prior to planting.
Despite the higher prices being paid today - as of early March, 2010, farmers were earning an average of US$2.2/kg for flue cured Virginia tobacco, the general feeling pervading the industry is "if the market is there, then this level of production is sustainable, If not, the farmers will grow something else," in spite of some dire warnings in 2009 of the possible consequences of rampant price increases and how these could affect some international buyers' disposition towards Indian tobacco.
Affordable prices?
In fact, the current prices are apparently affordable for buyers, and the market has seen some stability return, a dynamic that was often seen to be lacking in previous year's frenzied auctions and bewildering speculative bias.
"The price seems to have levelled out," according to Maddi Lakshmaiah, whose two tobacco processing plants handle around 50 million kg of Indian tobacco annually. "It is the buyer's choice and evaluation that will ultimately determine the sustainability of Indian tobacco. They either choose to select or not to select it."
However, Lakshmaiah believes that for some international buyers, it would become "unpalatable" if the price was to go up any further.
India is the only country still ramping up tobacco production for export," he said, "but prices are not coming down - buyers may expect that as more is produced the prices would come down. But this isn't happening. Prices should be balanced between buyers and growers," he concluded, adding that he believed that current price structures "are a bit unstable."
Exchange rates are another big factor affecting the returns on tobacco sales for both farmers and traders. Despite its relatively stronger banking system and a fundamentally more stable economy, India's rupee has lost around 10% of its value compared to the strengthening US dollar over the last year.
Exporters are not particularly comfortable with the current dynamic, although most agree that if the prices remain where they are, the Indian tobacco will remain a sustainable export crop. But any further escalation is a scary proposition for many, who believe that unless their customers support them, a further rise in prices could hurt exports, causing first the exporters and ultimately the farmers to suffer.
But history may offer some clues as to how things might play out. In 2009, in spite of all the fluctuations in the prices, by the end of the season only some low grade was left over, so traders were ultimately satisfied.
This after a season where different grades were often bundled together by farmers as pretty much the same prices were being paid for different grades by speculators anxious to ensure they had sufficient product to "play" with.
"As of now, some sense has descended into the market, the mad buying is over," according to S. Janardhan Reddy, ITC-ILTD chief executive. "Different grades now attract obviously different prices, and prices are based on standard and quality. Secondly, because of increased costs the number of speculators on the auction floors is coming down, only serious players are active in the marketplace at the moment. The number of "cowboys" on the auction floors driving up prices is certainly decreasing."
According to Reddy, it seems as though major cigarette manufacturers are "fairly comfortable with their inventories - there is no fire-fighting exercise apparent."
Consistency and stability
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The keys to Indian tobacco's survival are typically identified as consistency and stability. Insofar as there is little fluctuation in production, we can regard productivity as being consistent, and overall the quality of Indian tobacco is also consistent - some would argue that it is consistently improving in fact. This has much to do with the work of the Tobacco Board of India performs. Its support is critical. It doesn't interfere in market processes overmuch and it is a well-respected institution at all levels of the industry. The Tobacco Board is a core player in India's tobacco sector, partly as it operates the auction system, which handles all flue-cured Virginia tobacco produced in India, and partly through the support and advice they offer to traders as well as farmers.
However, in 2010, the way the signs and expectations are coming across, farmers seem to be demanding more for the tobacco they produce, and this is a worry with regards to sustainability.
By March of this year, Mysore tobacco grades saw prices taking off after sales of around 65 million kg. The high prices saw regular traders reducing their purchases as most exporters are not prepared to speculate at these prices, uncertain of demand at the prices being asked. When Mysore hit Rs30/kg (US$0.66/kg), way back in 1970's, not so many buyers indicated a willingness to participate. Ultimately, they intimated reduced volumes. But then suddenly the demand seemed to increase, with purchasing for the domestic market reaching an estimated 75% of sales. So clearly the exporters took a back seat.
As one trader remarked in early March, "auction prices seem to be fairly predictable, the increases are reasonably predictable, but no one can say with any certainty what the buyers are prepared to pay, and accordingly what volumes they will ultimately procure."
ITC-ILTD is by far the largest player in Indian leaf tobacco. It purchases around 50% of the crop, of which it uses around 50% for its own domestic production and exports around 50%.
According to Reddy, the challenges facing Indian tobacco growers and exporters have changed over recent years.
"Over the last 10 years there has been a huge gap in prices between India and the rest of the world," Reddy told Tobacco Asia. "Over the last two years, that gap has been bridged. Now India needs to plan properly to remain a quality tobacco supplier at a competitive price. Now the gap has gone, the huge price competitiveness is no longer there, and India is like any other tobacco supplier. So we have to work hard to ensure that customers see a clear value advantage to buying Indian tobacco in the future. The challenge is to make the customers see the quality and value benefits."
For Indian tobacco to remain competitive with buyers, and profitable for traders and farmers, ITC-ILTD believes that the way forward is for tobacco production to increase on a per acre basis rather than by adding more tobacco-growing acreage.
"For farmers, tobacco is more remunerative compared to other crop options," Reddy noted. "As far as the future is concerned, depending on export demand, ITC-ILTD's plan is to develop vertically: not to expand the land base, but to keep existing land usage as it is by introducing hybrids alongside contemporary agricultural techniques to increase productivity by at least 20% compared to existing levels over the next three years, with quality enhancement of the crops."
Legitimate customers only
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India is not regarded as a source of counterfeit cigarettes, and its tobacco is not knowingly sold to any importer that cannot vouch for the integrity of its operation. Most exports from India are through merchants, direct exports are very rare - there is some manufacturer to manufacturer trade, but valid documentation is always in place.
"I never heard of one kilogram going from India to a counterfeiter," said Lakshmaiah, whose company is engaged in a successful joint venture with Premium Tobacco. "We have effective export restrictions and strong government oversight on tobacco exported out of India, so it is unlikely that much, if any, Indian tobacco is used in illicit production, he said, adding that: "Most of our customers have been with us for the last 50 years. Banks monitor all tobacco transactions, and financial discipline is very good in India."
"So long as ITC-ILTD has information that tobacco is being used illegally by a prospective purchaser, we will not supply," agreed Reddy. "We do not want to be associated in any way with illicit trade. ITC-ILTD tries to verify the credentials of all new potential buyers. So as far as we are concerned, we are taking the appropriate steps to ensure the tobacco we supply does not enter the illicit market knowingly."
Age of machines
Indian tobacco farmers have now seen what an increase in tobacco prices can do for them. A degree of previously unobtainable wealth has touched farming communities, but there are still many challenges to be overcome for the influx of cash to be translated into a sustainable income.
Principal among these is the continuing drain on available as the burgeoning development and infrastructure projects being undertaken by India's cities attracts more and more rural workers with the promise of higher wages and a better life style. Crops can be left to rot in the field when there is no one available to harvest, and skilled workers are vital to ensure tobacco is handled properly after harvesting.
Efforts to mechanize many of the processes involved in farming and harvesting tobacco in the Indian context are well underway, with ITC leading the pack.
"As labor shortages and rising labor prices bite, ITC is encouraging mechanization in nursery management, transplantation, harvesting and stitching," Reddy told Tobacco Asia. "How do we mechanize these operations and reduce labor requirements? This is the challenge we have undertaken. Now, as far as nursery management, is concerned, micro-sprinklers are used widely instead of manual watering. We are currently testing some prototype machines we have developed for main field operations such as transplantation, harvesting stitching. Depending on the feasibility and operational efficiency of these machines, the plan is to extend that to the farmer by 2011. To complete the process it will take 4-5 years to reach a significant level of mechanization as tobacco farms are generally smallholdings. But in the end mechanization should offer similar cost but minimize wastage, ensure efficient and timely crop processing. So the future should see a stabilized production scenario developing as mechanization will minimize waste generation." Enditem
