Cocoa Dinner 1999

Response to Chairman's Speech by Mr John McIntire, Principal Economist at the World Bank,

Abidjan Ministers, Baroness, Your Excellencies, the Chairman and Members of the Cocoa Association of London, distinguished representatives of the national and international cocoa associations, ladies and gentlemen. I begin by thanking the Chairman and Members of the CAL for inviting the World Bank to address this distinguished group. I will say of course that we are honored by this invitation.

I must also concede that your Chairman has asked me to explain, with reference to Cote d'Ivoire, why radical changes are seemingly forced through without first establishing the private sector structures that are necessary to avoid market disruption. So, in my remarks tonight I shall try to meet this challenge.

At the outset, I concede that we sometimes have failed to honor our obligation, as a public international institution, to explain our views to the public as well as we must if our work is to remain credible and if it is to contribute to the Bank Group's goals of promoting economic growth and reducing poverty in our member countries.

So let me begin to meet this obligation to you this evening by responding to Your Chairman's call to explain and to defend our position about the reforms in the major origin countries, especially in Cote d'Ivoire.

As you are of course aware the government of CI, with the active support of the World Bank Group, the International Monetary Fund, the European Union, and the African Development Bank has, over the past decade, progressively changed the regulatory framework governing coffee and cocoa exports. This gradual process, which began with the crash of cocoa prices in the late 1980s, has recently been completed for coffee. Coffee export was liberalized in January 1999 and cocoa export will be liberalized in October of this year.

An opinion is sometimes voiced, admittedly less so concerning cocoa than with respect to at least one annual crop on which we give advice and financial assistance -- that the Bank is "dogmatic" or "ideological" or "inflexible". There are doubtless occasions when such opinions have been valid; some of us may in future give you reason to think so again. But in the cocoa market, I believe that we have thought carefully through the sequence of reforms, in consultation with many of you here tonight or with your representatives, both in Cote d'Ivoire and in Ghana, so that they are well considered, have good prospect of success, and are accompanied by appropriate measures that will ease the transition to a modern and, I must add, more equitable, system of export marketing in the world's major cocoa growing country.

What are the reforms of the cocoa sector in Cote d'Ivoire? The reforms are that Cote d'Ivoire will no longer sell cocoa forward officially, although private traders can do so; it will not require prior authorization of cocoa exports; it will not enforce official marketing or freight rates; it will not set official export or farm prices; it will not fix marketing costs and margins. The reforms mean, in sum, that the cocoa business in Cote d'Ivoire will become much more like the wheat business in Kansas or the dairy trade in New Zealand than it has ever been.

Why are these reforms necessary? The essential reason is that the regulated system - or système stabilisé, as it is known in Cote d'Ivoire - failed to reward farmers sufficiently for their labor. The Ivorian farmer, sometimes cultivating one-half hectare of land, often producing less than 2 tons of cocoa, always feeding a wealthy international industry, was paid but a fraction of the international price. Much of the difference between international prices - what those of you who are traders and processors pay - and the Ivorian price did not go to growers. It went to the public sector and to intermediaries. Hence, the growers, the foundation of cocoa's wealth, were often miserably poor. You can understand the social importance of this problem in Cote d'Ivoire, where cocoa and coffee are more than 40 percent of exports and about one-sixth of Gross Domestic Product.

A second reason is that the regulated system was expensive. Ivorian trading costs at all levels - handling, transport, finance, shipping - are high. Greater cost competitiveness is needed if the Ivorian origin is to defend its share of cocoa's wealth. But this competitiveness could not be achieved with the regulated system despite years of partial and, it must be said, often half-hearted measures to tinker with the stabilized system. Experience throughout the rich and poor world alike, with many farm goods, has shown that it is very difficult and often impossible to minimize marketing costs under a regulated monopoly because of collusion between the governing agency and the regulated firms. More vigorous reform is needed to reduce trading costs and cocoa in Cote d'Ivoire is not an exception to this rule.

A third reason is that the stabilized system was imperfectly governed. The regulated system was opaque. It was discretionary. It required personal access. It was known to discourage private investment, foreign and domestic alike. The reforms will make the new system clearer, more objective, and more accessible. The reforms - if they are not undermined - will allow a smaller and less intrusive public agency and I think you will agree that this is in the general interest of your industry. In discussions within the World Bank, and inside the IMF, with whom we work very closely, many stress the symbolic importance of this reform - it is needed to give a clear signal that it is no longer "business as usual".

A fourth reason is financial stability. The stabilized system was not, in fact, very stable. By setting rigid prices and costs, it made the government of Cote d'Ivoire a financier of last resort, as we have seen, to disastrous effect, yet again this season. The stabilized system also exposed the banks to concentrated risks at the same time as it prevented those same banks from diversifying their risks or even from refusing to bear some of the more dubious ones at all.

A fifth reason is fiscal stability. The stabilized system has been at the root of persistent fiscal troubles in Cote d'Ivoire. It became so because it guaranteed all prices and costs to exporters, while failing, at the same time, to fully enforce the contract performance of those exporters. The inevitable result during a slump - and there are perhaps some in the audience who know this from personal experience - was that some exporters would default. Caistab and the government of Cote d'Ivoire would then have to intervene, often at some high fiscal cost to Cote d'Ivoire. This could not go on.

What do the reforms hope to achieve ? The reforms - if they are allowed to succeed as there are certainly many interests who would like to go back to the old opaque system - will benefit some and harm others. We expect that they will benefit producers and international buyers. The former will benefit because they will receive a higher share of the world price. But they will also benefit from greater economic liberty - to contract, to associate, to trade, to invest, and to grow. These new liberties will contribute much to the economic and social development of CI. We also expect that international buyers will benefit from having direct access to the Ivorian origin without the intermediation of the Caistab and without a series of complex and sometimes opaque rules of trade.

We have never hidden our view that these reforms will harm certain interests. Intermediaries within Cote d'Ivoire will suffer lower incomes, and so may some in the public sector. But the net benefit to the economy, and to the general climate for trade and investment, will be positive. In recognition of this fact, the government has pushed forward with these reforms, despite the current difficulties in the markets, with, as I have said, the support of its international partners.

How is the Bank assisting the reforms ? The Bank assists the reforms in many ways. First, we provide substantial balance of payments support on very concessional terms to Cote d'Ivoire - and, I must add, to Ghana and Cameroon - so that they may maintain essential public spending programs at times of low world prices for their chief exports. At the same time, we assist Cote d'Ivoire and the others with the restructuring of their commercial and public multilateral debt, so that debt service is less burdensome to their development prospects.

Second, we provide advice - on trade, on privatization, on its investment and labor codes, and on the whole sequence of measures necessary to make these market reforms succeed.

Third, we support projects that assist the private sector in Cote d'Ivoire, and in all the major origins of cocoa and tropical crops, to become stronger against international competition. Important among such projects are ones that help growers' organizations to develop so that they may receive more of the benefits produced by their industry.

The Chairman of the CAL has asked that I speak on risk and risk management in the new trading environment of Cote d'Ivoire. I have said that the historical role of the Caistab in Cote d'Ivoire was not always one of stabilization; in fact, it was often destabilizing, as we have seen in the current season. We believe that risks and instability will in fact decrease, and that whatever their level they will be more objectively measured and borne by private agents, not by governments, in the new system.

Some of our critics argue the contrary - that the end of CAISTAB's system will cause risks to rise. We believe this to be untrue. One reason is that external risks remain the same. World prices of cocoa and other agricultural commodities will always vary - for reasons of climate, demand shocks in the consuming countries, supply shocks in competing origins and, through the activities of market agents, because of the use of commodities as a financial instrument. The liberalization of Cote d'Ivoire's marketing arrangements changes none of the things that make world prices risky.

An important source of risk and instability that will change with liberalization is the degree of moral hazard in the Ivorian origin. As I have adverted to a minute ago, the guaranteed contracts issued by the Caistab were often not enforced if prices fell. Because sanctions were sometimes not applied against defaulting exporters, some were tempted to speculate with what amounted to a very cheap option. Liberalization, by stopping the issuance of guaranteed contracts that had the possibility of being unhedged, eliminates a powerful source of instability emanating from the Ivorian origin.

It would be false to say that there are no remaining origin risks. Contract performance remains an important risk. The immediate tool to manage contract performance risk will be to shorten the period of risk - in other words, it is likely that most of the forward sales from Cote d'Ivoire will disappear and the market will become much more of a spot market.

A second tool will be to extend the marketing season with Cote d'Ivoire. As you know, the season historically began by presidential decree fixing the producer price and marketing costs. This limited the duration of the season and made cocoa unavailable at certain times, while squeezing excess supply on the markets at other times. With the elimination of the official marketing season, cocoa will enter the market more regularly, with, we believe a stabilizing effect.

Third, new financial mechanisms will emerge to replace CAISTAB's forward sales. We expect external trade finance, linked to futures contracts, performance bonds and other private guarantees, will allow buyers to reduce counterpart risk from the origin. Over time, these instruments should become more prevalent and permit longer periods of coverage even after the end of the historical Caistab structure.

Fourth, there will probably be more vertical integration between users through international traders to domestic purchasers to growers. While it is unlikely, and even undesirable, that this integration take the form of large-scale plantations owner by purchasers or processors, there may well emerge some nucleus estates of some types that will serve as local and regional purchasing centers. The presence of such centers will constitute the basis of year-round supply and attenuate counterpart risk.

How is the Bank Group assisting this evolution? The Bank is assisting this evolution through: (i) assistance to the banking and private export sector in Cote d'Ivoire, notably through promoting stricter prudential regulations and bank restructuring. The Ivorian financial system is highly exposed to systemic risks in coffee and cocoa finance and we are working with the government and regional banking authorities on a new regulatory framework that will reduce such exposure; (ii) encouraging the liquidation of CAISTAB's debts, so that the domestic export sector is financially healthy when it confronts the new and more intense international competition ; (iii) financing technical assistance to producers organizations, in the areas of price and cost information, risk management and marketing, financial management; (iv) financing a guarantee fund for loans made to producers' organizations that cannot access private bank credits; (v) financing investments in rural infrastructure, notably roads and telecommunications, so that domestic marketing costs fall and that price information is more rapidly and cheaply transmitted within Cote d'Ivoire and with the exterior; and (vi) advising the government on the liberalization of coffee exports (which began this year) so as to avoid mistakes in cocoa.

We do not pretend that these changes will occur by the end of the current season or even by the end of the 1999/2000 season, or that the full benefits of cocoa liberalization in Cote d'Ivoire will have been reaped in the next 18 months. We do say that these changes will be beneficial to Ivorian producers, and to the national economy as a whole, and to the world's cocoa economy if the reforms are pursued vigorously.

Thank you.