During the cotton marketing season, the race to procure white gold usually does not start too early, driven by a host of factors such as crop outlook, world prices, export orders, and carryover inventory. Historically, inventory building by the textile industry picks up in late October, peaking in December. Over the last 10 years, local cotton sold to textile industry by end of September averaged at 2.4 million bales, with cotton procurement by record procurement of 3.3 million bales in 2021. The same fiscal year (FY2021-22), Pakistan’s textile export earnings grew by 25 percent, reaching record $20 billion.
If correlations are everything, then industry watchers should be in for a surprise. According to data from Pakistan Cotton Ginners Association (PCGA), ginning factories in the country had sold up to 4.2 million bales of cotton to textile industry by the end of September 2023, the highest figure for at least all of last decade (and quite possibly, in country’s history)!
Aggressive inventory building by textile industry so early into the cotton marketing season can usually mean two things, first of which has already been discussed in this space last week. For more, read: “Cotton crop: over-estimated”, published by BR Research on October 20th, 2023). Quick recap: climate change and monsoon flooding has been gradually shifting cotton picking months earlier into the calendar year, and higher business volume during the Jul – Sep period is more likely reflective of early harvest, and not necessarily cotton crop performance breaking all records.
The second explanation? Low carryover inventory from the previous year, and heavy export order interests – just like 2021 – is leading to aggressive inventory building by textile industry early into the season, which explains the very high volume sold, as reported by PCGA. This would be great news for both industry and the economy, since 2021-22 turned out not only to be a good year for cotton crop, but also for record export performance.
But another thing happened that year. Aggressive and early buying by the industry drove the market mad, with cotton prices increasing by nearly Rs10,000 per maund or 71 percent between June 2021 and March 2022. Note that while the currency had remained remarkably stable during this period - range bound around Rs155 – world cotton prices also rose by nearly a dollar per kg (or 46 percent), led by post-lockdown commodity markets exuberance. That trend is now in reverse, with cotton prices plateauing in the global markets for much of the calendar year 2023 and declining in local currency terms.
So, why has aggressive buying by the industry not led to a rise in prices in the local market? Are farmers struggling to offload their bumper crop, and the mills taking advantage? Or has a slowdown in global prices turned local cotton into a buyers’ market? To understand what’s going on, we look towards trends in banking credit offtake for financing of cotton procurement.
According to BR Research’s estimates based on SBP datasets of loans classified by nature of securities, procurement of indigenous cotton during the current marketing season (by end September 2023) financed by bank loans is perfectly in line with historic trends, and show no upward trend or deviation from historic buying patterns. Based on market prices as reported by Karachi Cotton Association (used by most commercial banks to mark-to-market value of cotton under their pledge) and loan value against pledge of indigenous cotton, procurement financed by banks by September end historically averaged at 2.2 million bales (excluding any margin held), which is in line with cotton volume sold to textile mills by Sep end, historically (as reported by PCGA). For the past two seasons, this figure dropped to 1.84 million bales. For September 2023 end, the same has landed below 1.83 million bales. Which is only 40 percent of total cotton volume sold to mills by Sep end, as per PCGA.
That bank lending for cotton procurement would not increase drastically at a time when markup rates on short term borrowing are averaging close to 25 percent makes perfect sense. But this only raises more questions about the financing of aggressive buying (as reported by PCGA)? Are buying houses financing cotton procurement through own cash? Or are ginning factories offering market credit to large textile houses due to indications of bumper crop? Or, is the peak procurement season past us – in which case – why has the needle not moved on market prices?
But most importantly, if the early peaking prospect as advanced by BR Research last week makes sense, why are the ginning factories not holding on to inventory to sell later into the year? In a forex strapped economy, buying houses can threaten local ginners with the prospect of cheap imported cotton for only so long, before import LCs have to be cancelled again in case IMF conditions are not met. Or has the needle not moved on bank credit because actual buying prices are significantly lower than the rate reported by KCA?
Whatever the explanation, the subject deserves more attention of market watchers and commentators. If industry and textile buying houses are so flush with cash that they no longer require banking credit to finance raw material procurement, what does it truly say about the efficacy of the ongoing monetary tightening cycle? So many questions, so little clarity.