Bangladesh textile industry is in deep trouble as the global cotton price has dipped sharply, leaving it stacked with the raw material bought at a much higher price.
The worst is the industry could have easily avoided this loss but for the archaic central bank regulations that bar them from participating in modern financial instruments hedging commodity importers from price fluctuations.
For a country like Bangladesh which is the second largest garment exporter and is projected to be the top exporter, such old-fashioned regulations now create a big hurdle, as a tussle between yarn producers and garment manufacturers is imminent.
Textile lobby will try to avoid loss due to price fluctuation by factoring in yarn price based on high cotton price. But garment manufacturers will argue that since global cotton price has dipped, yarn price should drop correspondingly.
Bangladesh has some 400 spinning mills affiliated with the Bangladesh Textile Mills Association (BTMA). Their 10 million spindles whir to produce about 1 lakh tonne of yarn a year to feed both the local and export markets.
For the knit apparels like T-shirts, they provide 90 percent of the yarn and for the woven apparels like shirts and trousers, at least 35 percent.
Bangladesh needs 40 lakh bales (each bale equals 480 pounds) of cotton a year for its domestic and export consumption. Only 25,000 bales are produced in the country, which is not regular, and the rest is imported from the USA, Africa, the Commonwealth of Independent States (CIS), India and Pakistan.
The total global cotton production was 117 million bales last year. China being the largest producer of fabric is also the top importer of cotton. Its total requirement last year was 59 million bales, of which it internally produced 33 million. The rest 26 million it procured from the global market.
But China right now is straddled with a huge carried-over stock of 69 million bales. To manage the carried-over stock, it discouraged further import by hiking duty on cotton.
This triggered off a global alarm that cotton demand will be less this year. Since June, cotton prices tumbled by 20 cents a pound from an average price of $1 a pound.
And this has left Bangladeshi spinners in a bad situation.
They had bought cotton at a higher price of $1 from the spot market. Since they could not take any hedging coverage, they were left in an open position meaning they were left uncovered for any fluctuations in the market.
The net result -- they either have to swallow the loss or the garment manufacturers will have to buy yarn from local producers at a higher price which does not reflect the global trend.
The situation is in stark contrast with other textile countries like India and Vietnam which allow hedging.
As much as it may sound simple, cotton procurement is a complicated method. Buyers from around the globe book their products at the Inter Continental Commodity Exchange, NY (ICE) where all agricultural commodities, metals like gold, copper, silver and even cattle are traded. ICE market is electronically active eighteen hours a day.
Every moment prices may fluctuate depending on a wide range of reasons starting from bad weather forecast to military conflicts to bad economic indicators of major countries.
The industry takes possession of its required raw material for future production from the commodity merchants, and then it needs to protect itself from the fluctuation.
A wide choice of hedging instruments is available. Buyers can opt for an instrument which will protect them against price slide once they purchase cotton or any other commodity. Under this arrangement, if a buyer buys cotton at $1 a pound and the price goes down to 80 cents, the buyer will pay the lower price.
Or the buyer can go for a fixed price contract under which he will pay his spot price (the price at which he bought) no matter what the prevailing price is.
This sophisticated system works well, and all major commodity importing countries allow their importers this facility. But Bangladesh, despite being the second largest garment manufacturer in the world, does not permit it.
When textile manufacturers faced such crisis in 2007, they demanded this facility from the Bangladesh Bank. The central bank set up a committee and said the committee might allow hedging on a case-to-case basis.
However, this proved useless as purchase decisions have to be made instantly as prices move fast and waiting for the committee's decision for days does not work.
Importers say cotton price was 75 cents a pound at the NY futures market on June 30 this year and it has slid to 64 cents now. If they had the hedging facility, they could have saved 11 cents straight.
The 2010-11 experience is another example of how our textile sector suffers because of open-ended deals.
From May 2010, the futures market started moving up on news that the Chinese production would be less.
The futures market in May 2010 was 70-80 cents a pound, and it went up to $2.05 by March 2011.
But new information on global carried-over stock and new production influenced the futures market and price started dropping by April 2011. By July 2011, the price came down to $1.
Bangladeshi spinners lost around $500 million due to this fluctuation. Many of them refused to buy cotton at such a huge loss.
Members of the international cotton body (Cotton Merchant Association) went to arbitration against the spinning mills and obtained award in favour of them of around $400 million. About 100 spinning mills were blacklisted and there were some lawsuits in Bangladeshi court.
Eventually, 70 spinning mills swallowed the loss and made some bilateral understanding with the merchants. But the rest 30 mills are still blacklisted.
This created a financial crisis in the industry. Lots of spinners are fighting back to recover. But they could have avoided the situation using hedging tools.
Bangladesh Bank, however, holds a different view on hedging.
It feels hedging is very costly and Bangladeshi businesses are not so wise to take advantage of it.
Some Chittagong-based businesses hedged commodities, especially edible oil, and incurred huge losses few years ago, bank officials say.
However, industry insiders say it is not really costly if risks are counted. A pound of cotton can be hedged for 3-4 cents only.