Cotton prices, which have fallen by over 20 percent so far this year, could fall even further, if government policy changes in China are implemented as expected.
The Chinese government has reportedly stopped stockpiling, or buying cotton from farmers at target prices set by the government, effectively ending the program that has resulted in the accumulation of 50 million bales (11 million tons) of the commodity fiber, or more than half of the world warehouse supply of cotton. The purchase program, launched by the China National Development and Reform Commission (NDRC) in March 2011 in response to the price volatility of the 2010/2011 crop year, was implemented to stabilize both cotton acreage and domestic prices. China remains the largest cotton grower in the world, at almost 30 percent of the global harvest.
Because it set a guaranteed price that was considerably above historic averages, however, and given China’s position as the top cotton consumer in the world, representing 35 percent of global cotton usage, the policy ended up stimulating demand for cotton imports, thereby significantly impacting global cotton prices.
An end to the program could have just as dramatic an effect. Over the last few years, China has been the largest importer of cotton in the world, at an estimated 40 percent of total global imports, according to Cotton Incorporated. “With record stocks in China and outside of China, there is clearly a lot of cotton to weigh on prices,” Cotton Inc. Senior Economist Jon Devine noted.
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The Chinese government announced it will replace the direct purchase program with a pilot subsidy program for farmers in the northwest province of Xinjiang, where over 60 percent of the country’s cotton is grown. The initial price of 19,800 RMB per metric ton (about $1.45 per pound) was set, and is expected to rise over the next two years. Though more than double the U.S. spot price, it is about 3 percent lower than the price set under the direct purchase system. Cotton output in the eastern and inland parts of the country, where the subsidy is not being piloted, is expected to fall by about 25 percent in 2015, with acres planted with cotton already down by 12.5% this year.
Cotton Inc. estimates that the Chinese government has sold 11 million bales of cotton since January. According to China Cotton, the government plans to sell much more of its reserves, though the time frame in which this will happen is uncertain. The reserve auction price was reduced in April to 17,250 RMB, or $1.26 per pound, below the subsidy-supported price.
The release of cotton reserves at below-target prices has already had an impact on Chinese imports of cotton, which have fallen by over 40 percent, and are expected to total about 8 billion bales in the 2014-2015 season. Though higher than the WTO-required level of 6 billion bales, this is well below the average of 19 million bales per year imported into China over the last three years. Lower Chinese import demand would increase the amount of cotton held outside of China and put downward pressure on prices.
The decline in Chinese crops will be offset by an increase in harvest for the major exporting companies like the U.S. USDA estimates that world stocks will end the next season at a record level of over 100 million bales. According to Devine, “Due to consumer preference, lower prices and macroeconomic/demographic factors, cotton consumption could be expected to increase. However, due to the complex nature of the global supply chain, statistical evidence of a rebound in demand many take several months to fully emerge.”
Although the USDA and others have said they expect China to take a gradual approach to the drawing down of reserves, there remains considerable uncertainly around Chinese import levels, a major driver of global cotton prices. For now, futures prices are feeling downward pressure. How long that will last may depend a lot on what China does next.