What Would a Change in Chinese Cotton Policy Mean?

For several years, cotton producers from around the globe have kept one eye on China’s massive cotton reserve program that has propped up cotton prices and simultaneously threatened to send the market into a free fall. Now some, including Joe Nicosia, executive vice president of Louis Dreyfus Commodities, say the Chinese could finally be on the verge of changing that policy – for better or for worse.

Speaking to a room full of cotton industry professionals at the Mid-South Farm and Gin Show, Nicosia said 2014/15 could be the year the Chinese government begins the process of reducing its 57 million bales of reserve cotton stocks onto the market. Drawing down those 57 million bales represents an enormous task – and that number doesn’t include the bales that are currently being stored in mills and on farms around the country. And, Nicosia says, China was still importing cotton at least through the end of March.

But there is no doubt that China is looking for a way out of its currently bloated cotton reserve policy.

“They have new leadership in China,” Nicosia said. “They realize what they’ve done has created some kind of dislocations, and they have to step forward with a new policy in 2014/15.

“So China has finally come to the table and said ‘Alright, it’s time for us to do something different.’”

The Chinese studied many of the policies previously employed by the United States to determine how they should move forward, according to Nicosia.

“They seem to have settled on some form of target price or direct subsidy program going to their growers so as to try and free up their stocks instead of having everything go into their reserve programs, which is what is currently happening,” Nicosia said.

In the past, China had supported its farmers by buying the cotton directly from them at advanced prices – often as much as $1.20 per pound, before placing that cotton into its domestic reserve. Nicosia noted that this shift in policy was not finalized, but the government was at least considering a change.

Of course, the ramifications from such a policy shift would be felt around the globe. For U.S. cotton producers, the most apparent effect from this change would be a reduction in exports to China. By lowering its premiums paid to domestic farmers, the Chinese government would open the door for Chinese mills to begin to source their cotton domestically – reducing the need for cheaper, imported cotton from America. This would have an immediate bearish impact on cotton prices in the U.S. But, Nicosia said, this is a necessary growing pain for the cotton market.

“Ultimately, this is the beginning of the process of what has to happen for us to start to work through a 100-million-bale carryover,” Nicosia said, referencing global carryover stocks in 2013/2014 – a figure for which China accounts for over half.

Silver Linings

Although a Chinese policy shift would have negative short term impacts on the U.S. cotton market, there are potential positive implications as well.

For starters, without a lofty support price, fewer Chinese growers would plant cotton in the coming year. Nicosia estimates the country’s production could drop to as low as 30.5 million bales in 2014/15. Paired with increasing Chinese consumption of 38 million bales in a year, the country could end 2014/15 with a net cotton deficit of around 7.5 million bales.

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