Global Tea Markets Relationships And Price Analysis In Developing Countries: Modelling Tea Prices By Use Of Current And Novel Econometric Methods

The genesis of this study was a realization that most of the research on tea is mainly about how to improve yields and productivity with very little input on the marketing aspects. The most fundamental and rational thinking and concern of most farmers and Agribusiness firms in tea producing countries is whether there exists a market for their produce and fluctuations of prices in international tea markets. In most countries, tea is exported to international markets apart from the populous countries of India and China where most of the tea is consumed domestically. Good tea prices in the international market will only benefit tea farmers if the price increases are transmitted to domestic markets and when domestic demand is high enough for realization of better price. Farmers contribute immensely to funding of research on tea in their respective producing countries through a levy on tea which is deducted from their tea deliveries at the factory.Through this funding better yielding varieties have been developed in the respective national research centres.The yields of tea have been increasing following farmers adoption of research recommendations leading to high production and persistent situation of oversupply on the international market caused by fierce competition among producing countries for market share.But it is the price of tea in the market that determines whether the farmers and other market participants will continue with in the tea farming business in the future periods. Generally speaking there has been more emphasis on improvement in production without considering marketing and more specifically the behavior of the tea markets. Tea takes about four to five years from planting for the bushes to reach economic harvesting levels; likewise the economic productivity of tea bushes takes over fifty years before the harvested yields start to decrease. At farm level, cultivation requires continued financing to pay for inputs and labour. This means that the farmers’decision to plant tea is very crucial and he or she must weigh the cost and benefits before making any decision go into tea farming. Price of tea during planting up to the time of harvesting will not be static but will keep changing depending on the supply and demand, polices in place, global politics,shifts in tastes and preferences by consumers, substitutability to other beverages, weather and climate change, pests and diseases among many other factors. Before embarking on the study the author realized that frameworks that have been employed to study agricultural markets in developing have been seriously wanting in terms of the relationship between conclusions and results obtained. The fundamental weakness of much of the existing research on commodity price transmission in developing countries context where most of the tea is grown in the world is that they attempt to inference just a subset of relevant factors yet actual market relationships are hazy and complex. A close look at models that have been used to study agricultural markets indicates that there has been an attempt to tailor their analytical frameworks to the perfect competition model, yet the invisible hand theory or the perfect competition models in the Marshallian tradition assumptions underscored by Adam Smith in his studies hardly hold in developing countries. While tea is produced in several countries across the world, the status and health of the tea sector for many developing countries has major macro-economic implications in terms of economic development. In fact the increase in export earnings from 2006 to 2012 so far at the global level, is positively affecting rural incomes in all tea producing countries. Tea farming is a high fixed investment at production and processing levels, and requires large economies of scale in factory operations. Green leaf crop after plucking is also highly perishable and bulky and therefore a short-time span is required between harvesting and processing. At farm level, cultivation requires continued financing to pay for inputs and labour. The production structures of tea, therefore, require heavy investments in tea plantations and factories for processing. Within the tea sector, the small-holders’ sub-sector is an important segment world-wide. From the point of view of the smallholder, tea cultivation provides work and income throughout the year in tea growing regions. The Governments of most developing countries have long recognized the importance of the tea industry in economic development as source of export earnings, job creation, rural infrastructure and income generation for rural population. Furthermore the tea factories located in rural areas have also contributed to control of youth migration to urban areas for looking of employment. Depending on the tea farming environment, a good price of tea creates opportunities for better wellbeing of farmers. Small changes in the tea prices can therefore impact the lives and economic wellbeing of millions of growers worldwide. Price of tea has been in long-term decline while production costs have risen, putting downward pressure on farmers’ incomes. The author utilizes various econometric models to model global tea prices. The first part of the thesis is a study on global tea price relationships and implications whereby prices at world tea auctions are interlinked across different tea markets. This study applied the cointergration approach using Engle- Granger two stage estimation procedures to examine the extent to which these markets are linked. The author analyzed the relationships between monthly average tea auction price data from seven selected markets from Africa and Asia and discovered that markets are defined more from the type of manufacture. Black tea markets seem segmented between orthodox types of tea mainly exported by Sri Lanka and Cut-Tear-Curl (CTC) type traded in Mombasa, Kenya. Cointergation results showed that agribusiness firms can benefit by simultaneously adopting both modes of manufacture. The author recommends that tea boards in the respective countries should promote diversification of products into other segments of the market while at the same time control quality of tea which by default will curb over supply. This analysis was followed by econometric modeling of price transmission to small holder tea prices in Africa through tracing the tea from smallholder farmer’s garden to the international markets.This was achieved by testing for price transmission (Law of one price) to confirm whether smallholder farmers in the developing counties are gaining from the recent good price of tea in history. The results indicated that there is price transmission from world market prices (Kenya) to export prices and tea markets in Malawi are integrated.It was additionally found that prices tend to be supply driven rather than demand driven. However, there was insufficient evidence to show that FAO composite tea price index, the reference price for tea is used by tea markets in Africa in making decisions on pricing in the long run. Results also suggested that smallholder farmers can benefit more from good tea prices if they own the processing facilities. Based on the results the author recommends that for effective and sustainable empowerment of the smallholder tea growers, it is important that respective tea producing countries re-look into small holder tea sector policies that will enable smallholder farmers own processing factories or ownership of shares in the existing processing factories while at the same time encourage and promote participation of small holders in value addition. Likewise governments in developing countries should also strive to increase investment in the agricultural sector so as to improve marketing and transport infrastructure. The author further applied non-linear models on the global tea markets through the use of the most current and attractive novel methods of assessing asymmetric market behaviors in agricultural commodities. Threshold Autoregressive model(TAR), Momentum Threshold Autoregressive model (M-TAR) were tested on tea prices of three major producers of tea, Sri Lanka, Kenya, and India. This study employed novel methods to determine firstly whether the prices of various types of tea are co-integrated. In the spirit of Stigler’s arbitrage definition of the market, an attempt was made to test whether all the prices co-integrate in pairs, implying that there is a single market for tea. This test for co-integration was carried out using non-linear approaches and compared with earlier used linear approach. The finding demonstrates that the conclusions drawn from the linear and non-linear tests maybe drastically different. While applying the momentum-threshold autoregressive (M-TAR) model due to Enders and Granger Unit root tests and asymmetric adjustment with an example using the term structure of interest rates based on Journal of Business and Economic Statistics,16(3), pp. 304-311), relationships between the various prices of tea quoted at different market auction centres in international tea market were examined. We find evidence of M-TAR asymmetric adjustments of tea prices, indicating that price signals within export markets are transmitted over time in an asymmetric manner. Finally on the application of novel methods the author conducted an examination of the price relationships of different qualities of tea and how prices adjust over time in relation to each other with the aim to test for the presence of cointegration in the presence of asymmetric adjustment. The results conclude that the nature of asymmetry is captured less by TAR and more by M-TAR models which suggests that the path of adjustment to the long run equilibrium relation is relatively faster when the price differential is decreasing as opposed to the case when it is increasing. Further, the results indicate that either prices adjust to any deviation only when they are increasing or decreasing, or that a rise in the price of a high quality tea found in Sri Lanka and Kenya might lead to a slower rise in the price of a relatively lower quality tea, while a decline in higher quality tea prices might trigger a relatively rapid fall in lower quality prices tea mainly from India. The paper concludes by providing an explanation to this asymmetric price adjusting behavior. On existence of market integration and asymmetric adjustments in tea markets results interestingly showed that using threshold models, the tea market may be considered to be highly integrated than earlier thought from standard cointegration methods. In the last part of econometric modeling, tea price dynamics were estimated to capture price evolution and volatility at the key auction markets around the world from January 2003 to 2009. Cointergation results of prices from 2003 to 2009 show that tea markets are less integrated with FAO composite price. There is an indication that volatility in Sri Lanka granger causes most world tea markets. The author is concerned that the prevailing good prices of tea are likely to trigger producers to incorporate current world price information into planting decisions. This together with increased capacity among producers in Asia exemplified by China creates significant challenges whose implications will probably be felt from the year 2014 onwards if world consumption of tea does not improve in tandem with anticipated production. The study also showed that the markets are affected by regional trading blocs, global and regional politics and country specific conditions and policies. Trade barriers and bilateral trade agreements seemed to play major roles in tea exports, while quality, tastes and preferences among consumers in different importing countries tend to dictate the mode of processing in exporting countries. The results offer important policy implication. Notwithstanding the attention paid to tea yield improvement, there has been surprisingly less attention on studies targeting tea markets and in particular by use of modern time series methods. This is the first study on tea and tea markets by use of cointergration and novel econometric methods to the best knowledge of the author. Data was analyzed by use of several statistical and econometric software’s including, EVIEWS, SPSS and RATS.