An interview with Karachi Cotton Association Chairman Khawaja Muhammad Zubair 'Poor seed quality poses an existential threat to domestic cotton'

Khawaja Muhammad Zubair is a leading name in cotton trading, known for his long-term association with cotton inspection business. He is the CEO Baltic Control’s Pakistan office, a global inspection, verification, testing and certification company with headquarters in Denmark.

In October last year, Zubair was elected chairman Karachi Cotton Association for marketing year 2019-2020. This is his second stint as chairman KCA. He has previously served as KCA’s boss in 2014, in addition to representation in association’s executive committee in various capacities as senior vice chairman, vice chairman, and member for many years.

As domestic cotton crop is set to witness a record-low production season, BR Research sat down with chairman KCA to understand his views on challenges surrounding the sector, with focus on trade policy, price-setting, derivatives market, seed quality, data reporting, and outlook for coming season. Below are the edited excerpts of the conversation:

BR Research: News reports indicate that cotton crop is set to record its worst performance in several decades, leading to fears that agricultural GDP growth rate may itself take a hit. Do you believe these fears are misplaced?

Khawaja Muhammad Zubair: This season is the first in recallable memory when crop target was revised down by 30 percent in the very first CCAC’s meeting, held in mid-September. This is significant because Cotton Crop Assessment Committee (CCAC) is a national forum which notifies a consensus estimate after exhaustive stakeholder consultations. These include public sector bodies such as Pakistan Central Cotton Committee, Federal Seed Certification & Registration Dept., Department of Plant Protection, provincial crop departments, various grower associations and industry bodies such as PCGA, KCA, and APTMA.

Historically, major revision in crop estimate is usually announced in the second CCAC meeting held before calendar year-end. By that time, more than eighty percent of harvest is already completed. Because cotton crop target has now been missed for several seasons, the December estimate is usually much lower than the first.

This year, low-base effect of the first CCAC estimate led to sombre projections by some market players that the final output may be as low as 7.5 - 8 million bales. KCA’s market intelligence places it a little under 9 million bales; however, CCAC meeting held in third week of December arrived at a consensus estimate of 9.45 million bales.

This is lowest in at least 20 years, but unsurprising. Reports suggest that apart from Rahim Yar Khan region, most cotton-growing areas have recorded a multi-year low yield. In the past, low yield was usually attributed to pest attacks, water stress, and poor-quality seeds, which was exacerbated by unexpected extreme temperatures in this season.

BRR: Other than vested interests, what explains the conflicting estimates presented by various stakeholders? Which sources are relied upon for data collection by industry associations such as KCA?

KMZ: To date, the only reliable barometer of domestic crop production is the seed cotton arrivals in ginneries, tracked by Pakistan Cotton Ginners Association (PCGA). As PCGA member firms process over 90 percent of total domestic output, its estimate is considered a close proxy. The information is monitored and made public on fortnightly basis, ensuring its timeliness.

Additional input is provided by various growers’ associations, arhtis, and brokers, but much of this is based on anecdotal evidence. Some KCA-member traders have made a practice of commissioning market intelligence surveys that help cross-check validity of PCGA estimate.

Provincial Extension departments conduct two crop surveys, first in June, followed by another in November that feed into provisional estimates of MNFS&R. Third official survey is conducted by Revenue departments in February, following which final meeting of CCAC takes place in the same month.

BRR: Is the imposition of sales tax on ginning output in the current fiscal playing into under-reporting of seed cotton arrivals?

KMZ: Conversations with market players indicate that incidence of under-reporting is slightly higher than in previous years, but it is hard to place a number on its extent. For purposes of estimating total crop position, the quantum of under-reporting may be no more than 0.8 to 1 million bales for the entire season.

In fact, KCA’s estimate of 9 million bales of ginned cotton is inclusive of the under-reported portion, which means that PCGA’s official number may be no more than 7.5 to 8 million bales.

BRR: Decline in cotton output is often attributed to shifting of traditional cotton sowing areas to competing crops. Do you agree?

KMZ: Average acreage under cotton has lost over half a million hectares since peak production level of 14 million bales, achieved in FY05. Competing crops such as sugarcane and maize have gained these bonus acres, which is reflected in higher output of these commodities.

Having said that, acreage was not of primary concern in the current season. Had yield levels been maintained between 750 – 800 kg/ha, output could have been higher by at least 25 percent.

BRR: Yield is a function of variety of factors such as suboptimal application of inputs, unfavourable weather and pest-attacks. In your opinion, which of these factors has played a pre-dominant role in the ongoing season?

KMZ: Market reports do not indicate a substantive decline in fertilizer or pesticide application. Similarly, water availability was on the higher side compared to previous season. Incidence of pest-attacks was also no greater than usual.

While unexpected extreme temperatures have been reported, it is symptomatic of an underlying problem. Cotton plantation has increasingly become reliant on unaccredited poor-quality seeds, which in turn fail to fend off against volatility in weather patterns or virus attacks.

Moreover, if quality of available seed varieties is subpar to begin with, their vigour will only decline in subsequent generations. This means that even if current acreage level is maintained, yield in the next season may be worse. This should be a cause of great concern to policymakers.

BRR: Has lower yield due to poor seed quality forced growers to shift to competing crops? Are stakeholders targeting the wrong symptom by focusing only on acreage?

KMZ: No. Because if traditional sowing regions such as South Punjab were dedicated to cotton, it would incentivize private sector to invest in its production.

Similarly, if large tracts of uncultivated government-owned lands were leased to private sector with stipulated purpose of cotton sowing, it will lead to renewed efforts for research and development of quality seeds by biotech companies. This has been a longstanding demand of the industry but has gone unheeded by policymakers.

BRR: But there were no dedicated cotton areas fifteen years ago when crop production was at its peak. How exactly has the government policy changed since then?

KMZ: Raw cotton is no longer a freely traded commodity. Back when free trade regime was introduced three decades ago, it ensured that growers receive prices at international parity, which encouraged competition and investment in inputs.

In the past ten years, inconsistent policy has played the greatest role in damaging cotton’s potential. For example, tax and duties applied at the beginning of sowing season to protect local producers and ginners distort competitiveness.

BRR: In absence of duty, local producers will be exposed to competition from higher quality imported cotton. The problem may become exacerbated when international price is on the lower side as seen in recent times. Will that not further dissuade growers from investment in cotton?

KMZ: Government support to any sector should not come at the expense of other industries. Current policy favours the upstream industry at a loss to spinners and traders. Instead, support to growers should be extended in the form of input subsidy, such as lower priced electricity, fertilizer and pesticides.

If the purpose is to improve quality and yield, policy focus needs to shift towards productivity maximizing solutions such as mechanization, technical support, and improved irrigation methods.

These subjects remain ignored, as subsequent governments have followed a zero-sum approach of ‘taking from one and giving to another’. Even this principle has been applied inconsistently based on which vested interest holds more sway at any given time.

BRR: Agriculture became a provincial subject under 18^th amendment. Does the issue of quality seed availability results from lack of R&D capacity in provincial departments?

KMZ: Pakistan Central Cotton Committee (PCCC) is the national forum for approval of seed varieties for commercial purposes. Public sector research institutes that conduct national trials such as Central Cotton Research Institutes (CCRIs) in Multan and Sakrand also report into PCCC.

Although provincial bodies also conduct basic level research, for all intents and purposes policymaking for cotton seed varieties falls under federal purview through PCCC. While PCCC is legislatively empowered, it faces multi-faceted challenges of governance and finance.

First, it has remained unclear whether PCCC is to function as an autonomous body that may draw on talent pool of private sector professionals. Lack of consistency in this regard has affected its administrative effectiveness.

Second, while cotton cess is ostensibly collected to fund research, it is spent on establishment and salaries of PCCC and its reporting organizations. This is evident from the fact that no new cotton variety has been approved for commercial purposes in the last three years.

BRR: Does KCA oppose any measures to introduce a minimum price guarantee for growers?

KMZ: Yes, because indicative/support price focuses on only one aspect - returns to farmers. It ignores other factors such as fibre quality, strength, and trash percentage etc which have increased competition from better quality imports.

In any business, if the revenue is pre-determined due to price guarantees, return maximization can only take place by minimizing costs. This leads growers to cut back on investment by spending less on inputs. At a time when domestic cotton is already beset with challenges of poor quality, introduction of support price may worsen the problem.

BRR: Has the high level of fragmentation in ginning industry contributed to lack of capex investment in productivity improvement, leading to poor quality output? Is there a need for consolidation in ginning sector?

KMZ: It will be impossible to achieve, simply because the market is extremely saturated. PCGA alone has over 1,400 members, of which about 1,200 are operational. Seeking large scale investment in ginning is also difficult because it is a seasonal business, which means the ROI on capex is unattractive.

Having said that, if the momentum around production gets going, it will inevitably lead to investment by major textile players looking for backward integration. Such large-scale investment will eventually drive out smaller players. Investment needs scale; it will not happen unless national output reaches 20 million bales.

BRR: Does the same reason explain lack of corporate farming initiatives for cotton?

KMZ: Yes, but even more important is lack of quality seeds availability. Already, progressive farmers are shifting to competing crops due to repeated incidence of cotton crop failure. Why would corporate farms enter the fray knowing that available inputs such as seeds are of questionable quality and lack traction in international market.

BRR: Do you believe unabated mushrooming of small seed firms is responsible for low quality cotton seeds?

KMZ: I disagree. There are small seed firms whose applications for fresh seed approvals have been stifled by regulators despite best efforts at R&D. Therefore, size of seed firm is not relevant.

Blame lays with those firms whose poor-quality seeds have flooded the market and are sold under misleading labelling and marketing claims. Regulators who approved such varieties are equally to blame, as are those who fail to take any action against these varieties and their sellers.

BRR: The last time cotton crop recorded such a major shortfall from target was during the 2011 flood year. At that time, average cotton price in the international market short up to $3,500 per ton. Now that import duty is removed beginning January, do you foresee a major uptick in international price?

KMZ: Commodity prices are forward-looking. Between April and August last year, global cotton prices fell to a three-year low depressed by US-China trade war. Since then, the expected shortfall in Pakistan’s production has already been priced in international rate, which saw an upward trend during the last quarter.

Moreover, most buyers in domestic market have already entered long contracts that will soon begin shipment. Therefore, a drastic increase in international cotton price is not very likely. However, there are two caveats.

First, if the trade war eases and Chinese firms enter buying, price could see a major shift upwards. Second, the revised FTA with China has also kicked in from January. Higher demand for local yarn from Chinese firms could create demand pressures, which may trickle into raw cotton prices.

BRR: What is KCA’s official position on establishment of a derivatives market for cotton trading? Why has there been no development in this direction?

KMZ: KCA has a very consistent and strong position in favour of futures trading for cotton. Derivatives, particularly trading in options, will aid in price-discovery, provide liquidity, and reduce ginner’s dependence on market credit.

The lint market is currently dominated by five or six large buyers, who consume almost fifty percent of total domestic output. These act as price-setters and dictate terms of credit to ginners. Derivatives market is strongly opposed by such players whose buying power allows them to ‘hedge without a hedge’.

BRR: Various categories of textile products require different grades of cotton. Which textile products can be most easily produced using only domestic cotton?

KMZ: Domestic cotton feeds into manufacturing of towels, denim, knitwear and greige cloth, using yarn of ten and twenty coarse counts. Fine count bedwear, suiting, and apparel requires extra-long staple (ELS) cotton which is not produced locally. As a result, ELS represents a small but inelastic share in imported cotton volume.

BRR: Globally, value-added textile has seen a shift towards higher use of man-made fibre as raw material. Given that domestic cotton is beset with quality defects amid falling crop production, why has MMF failed to substitute demand for cotton by local mills?

KMZ: Man-made fibre (MMF) has various inherent issues that cotton is not vulnerable to. One major difference between MMF and cotton is of price disparity. Every time MMF price increases, demand for cotton increases due to substitution effect.

MMF market may have expanded its share but its demand is primarily driven by its lower price. MMF-based products are usually considered inferior in quality compared to textile made of hundred percent cotton. If the price differential between the two is bridged, the threat from MMF will diminish, as buyers will be less inclined toward MMF-based products.