The Fonds de Lissage for the Cotton Sector in Burkina Faso,
A Pertinent Initiative to Fight Price Volatility
In a context of widespread decline of the cotton industry in French-speaking Africa, the Agence Française pour le Développement (AFD)––the French Agency for Development––launched its Fonds de Lissage, or smoothening fund, in April 2008 to manage price volatility and safeguard lucrative revenues for producers. This smoothening fund is grounded on an old rationale already tried out in the 1970’s with the “European Monetary Snake”, that is to say a “price spread” hinged on a trendline price set forth by large homogenous geographical zones that defines the field of intervention by public authorities in case of high volatility.
The AFD initiative gets the credit for clarifying the factual operation of this type of attractive and efficient system. It is meeting some success at the local level1, but involves, at a wider level, some limitations that justified its disuse in the past. These are precisely the limitations that momagri strives to overcome.
The goal of the AFD Fonds de Lissage is to manage the risks associated with short-term highly volatile cotton prices through a matching contribution and withdrawal system. The principle is as follows: free fluctuation of prices within margins set by a trend line price and initiation of an intervention beyond, when prices break the ceiling price as well as fall through the bottom price.
The range of recorded price shocks justifies this intervention. Because, “like all economic agents, all the more so because of the very unpredictable nature of their activity, farmers are receptive to any technique that allows them to better master their climatic, social or economic environment” notes José Tissier, who is in charge of the Fonds de Lissage at the AFD.
Yet, in the case of agricultural markets, “there are events regarded as shocks external to either countries or industries by the international community that can eventually lead to the phasing out of the sector” adds the Project Manager. “Neither players, through their inter-annual2smoothening tools, nor the market through derivatives, can face up to such situations [of price hyper-volatility]. Confronted to what is commonly called market lapses, governments are faced with the following options: either they do not intervene and take the risk to see the sector collapse––with related societal as well as economic and fiscal damages, which can be more or less drastic depending on the weight of the sector in the national economy––or governments decide to intervene. The mechanism of the fonds de lissage allows them to do it preventively since, as soon as a trendline price is set, it is possible to determine if the announcement of an excessively low production price may discourage producers and may lead to a brutal neglect of cotton production”.
Indeed, the mechanism implemented by AFD jointly with local players in the cotton industry in Burkina Faso offers the advantage that “prices do not rely on annual negotiations between producers and one or several cotton companies. Prices are now subject to the evolution of global prices (…) which is determined every year based on a mathematical formula that evaluates what is commonly called the trendline price”. It consists in a centered and sliding average3 calculated on the basis of the two more recent harvests and on forecast prices for the next harvests.
• For the previous two harvests (N-2 and N-1 years), the calculation refers to the value of daily averages of the A Cotlook Far East FOB index (the standard index published by the financial data provider Cotton Outlook); The trendline price is also adjusted according to the base rate of exchange.
• For the current harvest (N year), the calculation refers to the A Forward Cotlook forecast index if it is available, and, in its absence, to the A index of the latest World Bank publication for the N-2 year4;
• For the two up-coming harvests (N+1 and N+2 years), the computation refers to the World Bank November/December forecast for the N-2 year.
Boundaries of the smoothening spread are calculated on the basis of this trendline price, the lower boundary (or bottom price) representing 95 percent of the trendline price while the upper boundary accounts for 101 percent.
The bottom price is set no later than every April 15 for the following year. In the case of the Burkinabe fonds de lissage, it is equal to the guaranteed purchase price of cottonseed from the producer; it is automatically paid to each producer a few days following the filing of his request for payment.
Alternatively, when the cotton fiber average sale price in the current harvest is higher than the spread ceiling, cotton producers and cotton companies must pay a portion of resulting gains according to a complex and progressive matching contribution formula.
The Fonds de Lissage is managed by the Association du Fonds de Lissage (AFDL) established in April 2008 at the charter general assembly of the Burkinabe cotton trade association, which includes producers and cotton companies. A local bank, selected by public tender, has been given the mandate to manage the mechanism and the fund to ensure transparency, fairness and security of the fund’s resources.
With regards to the initial matching contribution of the Fonds de Lissage, AFD earmarked €15 million in the form of a Prêt Très Concessionnel Contra Cyclique (PTCC)––or highly concessional contra-cyclical loan. A €3 million public subsidy will be added to the €15 million loan.
The effective implementation of the Burkinabe fonds de lissage is in line with a broader regional outlook for an integrated management program for price risks. Its implementation should thus permit to reopen the debate initiated in 2007 regarding the creation of a regional entity to refinance, if need be, the eligible national fonds de lissage to stabilize Western African regional markets as a whole.
The fonds de lissage, designed at the initiative of the AFD to respond to the lingering sharp decline in cotton prices, is proof that constructive decisions exist and continue to be instigated to bring about solutions to price volatility, which disturbs all agricultural activities. If this kind of mechanism is totally feasible at the local and national levels, it quickly meets its limitations on a larger––regional or international––scale.
Borrowing from systems already put in practice in the past, such mechanism in fact presents a major downside on the regional or international scale, in as much as it tends to stimulate overproduction. With the assurance of being able to sell their products at a set price (the bottom price), producers are encouraged to produce more than what the market can handle. What is bearable at the local level has a different impact at the regional level. In the latter case, the system tends to feed its own deficit since the overproduction marshals such commodity volumes that they influence actual prices downward. As a result, global prices tend to remain low over the long term, a situation that curtails the opportunities for public authorities to balance their accounts when prices exceed the ceiling price.
This is why the European Union, through its 1984 and 1988 reforms, gradually did away with intervention prices in the CAP and established production control mechanisms (quotas, compulsory fallows, etc...); this is also the reason which led, in the 2000 Cotonou Agreement, to the disuse of the STABEX, the financial compensation system instituted by the Lomé Agreement between the European Union and the ACP5 countries to stabilize the latter’s export earnings6.
This mechanism is thus far from being flawless; however, its reinstatement by the AFD for the Burkina Faso cotton market shows the extent to which it stands as a solution for fragile economic sectors. The price hyper-volatility that qualifies agricultural markets remains the major risk confronting farmers, and indirectly their governments (national food security, staying power of some industries, etc…). Until very recently, governments often opted to take the risk of overproduction rather than leave agriculture in the free market arena and in the hyper-volatility it provokes. And the fond de lissage implemented in Burkina Faso proves that, in crisis situations such as that experienced by the cotton industry in Western Africa, the price intervention system is again the preferred solution.
by Paul-Florent Montfort, Analyst, momagri
1 Please read our July 7, 2009 article “Since the 2006-2007 Harvest, the System Works”, an interview with André Pouillès-Duplaix, Deputy Director of the AFD Operational Technical Divison.
2 For many years, the cotton trade in Burkina Faso operated on the basis of prices negotiated between cotton companies and producers. However, such system––established without any benchmark to international markets or production costs in the industry––was bound to eventually collapse.
3 i.e. an average that can be adjusted on a continuous basis.
4 Source: Global Economic Outlook, Commodities Forecast.
5 The ACP countries, or African, Caribbean and Pacific Rim countries, are nations that signed the Lomé and Cotonou agreements. The Lomé Convention is a cooperation program between the 27 members of the European Union and 79 countries in Africa, the Caribbean Basin and the Pacific Rim. It mainly sets up tariff preferences that provide these countries access to European markets as well as special funds to guarantee price stability for purchases of agricultural or mining products.
6 Mechanisms in which prices are set par the state: producers are therefore assured that their products will sell at a given price.