With the state no longer controlling cotton prices and production levels, Beijing has few tools to correct supply imbalances that are re-emerging.
Supply imbalances are re-emerging in China’s cotton market, three years after the sector’s partial liberalisation. Combined with signs of declining growth prospects in the closely related textiles and apparel sector, the possibility of renewed crop surpluses and falling prices may further depress farm incomes in cotton- producing regions.
Since the reform of the cotton sector in 1999, the state has no longer directly controlled cotton prices and production levels, as it still does with staple food grains such as rice and wheat. Apart from making nonbinding recommendations to farmers, Beijing’s only remaining tool for influencing production decisions is its control over large cotton stocks. Like stockpiles of other farm goods – notably corn, which China exported heavily in 2000 – cotton stocks have been reduced substantially in recent years through export subsidies and import restrictions, in preparation for the country’s entry into the World Trade Organisation.
Surge in import levels
China is the world’s largest consumer and producer of cotton. However, there are signs that World Trade Organisation rules are already constraining the sell-off of China’s cotton surplus (see charts). Cotton imports, which were squeezed after 1998 in an effort to dispose of stocks, are believed to have roughly tripled in the past year, to around 150,000 tons. The WTO accession agreement requires Beijing to levy a tariff of only 1 per cent on cotton imports up to a fixed quota – set to rise to 894,000 tons by 2004 and to be abolished entirely in the following year. This drastically improved market access for foreign cotton has only taken effect in the past several months, so the most recent rise in imports may be only the tip of the iceberg.
Meanwhile, efforts to limit domestic output and to subsidise exports have had only limited success. The cultivated area devoted to cotton in China is believed to have fallen since the mid-1990s. In May this year, Xinhua reported that 1.4m acres would be taken out of production in seven major cotton-producing provinces, including Hebei, Anhui and Xinjiang. The nationwide year-on-year fall for 2002 is estimated at 14 per cent.
However, despite such a reduction, output has risen slightly in recent years, reflecting higher farm productivity. At the same time, Beijing has scaled back the use of export subsidies to dispose of ‘old’ stockpiled cotton produced in Xinjiang autonomous region, which grows as much as 35 per cent of the country’s cotton. According to estimates published by the US Department of Agriculture, export subsidies fell from around Yn2,700 per ton in 2000 to just Yn1,000 per ton in 2001, and they are expected to disappear completely this year in line with Beijing’s WTO commitments.
In principle, strong growth in China’s textile and apparel industries might be expected to absorb growth in both domestic production and imports. Garment production is virtually the only sector in which WTO accession will force China’s trading partners to make major concessions on market access: both the US and the EU will abolish quotas on apparel imports in January 2005, and China is already benefiting from gradual increases in quotas before then.
However, it appears that at least before 2005, growth in China’s apparel sector will not be fast enough to restore balance to the cotton market. China Daily reported on February 19 that textile exports were expected to reach US$55bn in 2002, compared with US$53.28bn in the previous year. This estimate implies growth of just 3.2 per cent, suggesting that the export market remains highly constrained. (Pressure from the US and European textile lobbies has ensured that nearly all liberalisation in the sector will be ‘back-loaded’, meaning that changes will not take effect until the day all quotas are repealed.)
Decline in profitability
There are also worrying signs of backsliding in one of China’s most important industrial reforms of recent years: the return to profitability of the textile industry, which moved back into the black in 1999 after laying off 1.2m surplus workers. Unlike many other sectors, the state-owned textile industry seems to have made real gains in efficiency since the start of Premier Zhu Rongji’s enterprise reforms.
However, that accomplishment may be short-lived. Aggregate profits for the sector fell by 11.6 per cent year-on-year in 2001, to Yn22.1bn, indicating that state-owned mills have again begun to expand capacity too quickly and drive margins lower. China’s imports of spinning machinery rose by an astonishing 93 per cent in 2000, a clear sign of over-investment.
Given the industry’s strong growth prospects, any imbalances in the textile sector may well work themselves out soon after 2005. The World Bank expects China’s share of the world apparel market to reach 45 per cent within a few years after rich-country quotas disappear, compared with just 16 per cent in 1999. For Chinese cotton farmers, however, this may do little to improve crop prices. Market observers expect this year’s US farm subsidy legislation to keep world prices for cotton weak in the foreseeable future, which means that any increase in demand from Chinese mills will likely be filled by imports.