Report No. 23405-EGT Arab Republic of Egypt Toward Agricultural Competitiveness in the 21st Century An Agricultural Export-Oriented Strategy December 21, 2001 Rural Development, Water and Environment Department Middle East and North Africa Region Document of the World Bank CURRENCY EQUIVALENTS (as of May 2000) US$1.00 = 3.44 Egyptian Pounds (LE) LE 1.00 = US$0.29 WEIGHTS AND MEASURES 1 centimeter (cm) = 0.394 inches I meter (m) = 39.370 inches 1 kilometer (k) = 0.620 miles 1 square kilometer (kn2) = 0.386 square miles 1 feddan (fed) = 0.420 hectares, 1.037 acres 1 hectare (ha) = 2.470 acres 1 cubic meter (m3) = 35.310 cubic feet I cubic meter per second (m'/s) = 35.310 cubic feet per second 1 liter (1) = 1.057 quarts 1 liter per second (1/s) = 0.03 5 cubic feet per second 1 kilogram (kg) = 2.205 pounds 1 metric ton (t) = 2,205 pounds 1 kilowatt (kw) = 1.360 horse power Ne or Na = English count ( = 1.7 millimeters) Vice President: Jean-Louis Sarbib Chief Economist: Mustapha K. Nabli Acting Sector Director: Salah Darghouth Country Director: Mahmood A. Ayub Sector Manager: Petros Aklilu Task Team Leaders: Jean-Fran,ois Barres and Alberto Valdes EGYPTIAN UNITS OF MEASURE-FIELD CROPS Winter Crops Unit Weight (kilograms) Barley Ardeb 120.00 Barseem seed Ardeb 157.00 Broadbeans, horse beans Ardeb 155.00 Chick peas Ardeb 150.00 Crushed beans Ardeb 144.00 Crushed lentils Ardeb 148.00 Fenugreek Ardeb 155.00 Flaxseed Ardeb 122.00 Lentils Ardeb 160.00 Linseed Ardeb 122.00 Lupines Ardeb 150.00 Onion Kentar 45.00 Safflower Ardeb 113.00 Wheat (grain) Ardeb 150.00 Summer crops SK cotton (unginned) Seed metric kentar 157.50 LK cotton (lint or ginned) Lint metric kentar 50.00 Cottonseed Ardeb 120.00 Cowpeas Ardeb 120.00 Groundnuts (in shell) Ardeb 75.00 Maize (grain) Ardeb 140.00 Rice (husked) Ardeb 200.00 Rice (rough or unmilled) Dariba 945.00 Rice (paddy) Ardeb 300.00 Sesame Ardeb 120.00 Sorghum (grain) Ardeb 140.00 Sugar cane Kentar 45.00 Crop residues Bran Ardeb 67.50 Broadbean straw Camel load (heml) 250.00 Cotton stalks Camel load (heml) 250.00 Flax straw Ton 1,000.00 Hay Camel load (heml) 250.00 Maize stalks Camel load (heml) 250.00 Rice straw Camel load (heml) 250.00 Wheat straw Camel load (heml) 250.00 GOVERNMENT OF TIE ARAB REPUBLIC OF EGYPT FISCAL YEAR July 1-June 30 ABBREVIATIONS AND ACRONYMS AgLink Agribusiness Linkages for Egypt Alcotexa Alexandria Cotton Exporters Association ALEB Agricultural-led Exports Business Project APRP Agricultural Policy Reform Program ARC Agricultural Research Center, Ministry of Agriculture and Land Reclamation ATUT Agricultural Technology Utilization and Transfer CAPMAS Central Agency for Public Mobilization and Statistics CATGO Cotton Arbitration and Testing General Authority CSPP Egyptian-German Cotton Sector Promotion Project DRC Domestic Resource Cost ExpoLink Egyptian Exporters Association ELS Extra Long Staple EPC Effective Protection Coefficient ESA Employee Shareholders' Association FIIHC Food Industries Holding Company FTE Full-time Employee HEIA Horticultural Exports Improvement Association HVI High Volume Instrument (for testing cotton lint) KADCO Kingdom Agricultural Development Company LS Long Staple MALR Ministry of Agriculture and Land Reclamation MEFT Ministry of Economy and Foreign Trade MLS Medium Long Staple MWRI Ministry of Water Resources and Irrigation NPC Nominal Protection Coefficient NPCP National Potato Cultivation Project PBDAC Principal Bank for Development and Agricultural Credit UID Universal Density (American-size bale of 480 pounds) UNDP United Nations Development Programme UJNEP United Nations Environment Programme UNSD United Nations Statistics Division CONTENTS PAGE NO. Foreword EXECUTIVE SUMMARY i Objectives of the Report Looking Ahead - An Analysis of Egypt's Export Potential ii Plan ofAction for Export Promotion of Egyptian Cotton and Horticultural Products iv Cotton v Horticulture v Horticulture Issues viii Technology Transfer, Skills Development, and Research viii Quality Management ix Transport and Infrastructure Services ix Implications of the Agricultural Export Strategy for Nonexport Crops x Strategy for Field Crops x Land and Water Management x The Evolving Public-Private Partnership xi PART I: Promoting Agricultural Export Development in Egypt 1 Chapter 1. Objectives and Audience of the Report 1 Chapter 2. Egypt's Agricultural Performance in the 1990s 3 Agricultural Labor Productivity 3 Non-labor Agricultural Inputs 3 Agricultural Trade Profile 4 Gauging the Competitiveness ofAgricultural and Agri-Processing Exports 6 Chapter 3. The Effect of Price and Trade Policies on farmers 'Returns 9 Nominal and Effective Rates of Protection 10 Adjustments for Water Charges, andfor Transport, Fuel and Oil Subsidies 12 PART II: SUBSECTOR ANALYSIS 17 Chapter 4. Toward a Better Marketing and Production Strategy for Cotton in Egypt 1 7 Shortcomings of the Current System 18 Lack of competition in marketing rings 18 Distortion of market signals by fixed prices for seed cotton 19 Lack of competition through fixed minimum export prices 19 Lack of accountability for management of carry-over stocks 20 Elements of a Sustainable Cotton Marketing Strategy 20 Adjusting farm prices to reflect market conditions and vary across varieties and grades 20 Holding weekly pilot auctions for price discovery 21 Controlling quality through high volume instrument testing and classing 22 Establishing an Internet-based marketing channel for cotton and yams 23 Privatization of downstream activities 24 Liberalizing farner price and instituting a market-based price insurance mechanism available to farmers 24 Removing taxes and restrictions on imported cotton 25 Liberalizing the market for cottonseed and cottonseed oil 26 Improving cotton exports' competitiveness through adjustments in pricing and the exchange rate 26 Eliminating the buyback option at the end of the season 27 Improving Cotton Production Technology 27 Cotton breeding and research to raise profitability and meet market requirements 27 Variety Policy 28 Seed Quality Improvement 28 Seed cotton quality 29 Technology transfer and research 29 Water and soil management 30 Chapter 5. Horticulture Exports 31 Technology 32 Marketing Mechanisms 32 Exports and employment generation 32 Export Potential 33 Market Information Dissemination 34 Coordination and Policy Advocacy among Producers, Exporters, and Freight Agents 35 Export Trading Arrangements 35 Lessons from Experience 35 Raise quality to meet international standards 35 Improve field management 35 Strengthen technical support services 36 Upgrade preparation and handling 36 Reduce post-harvest losses 36 Increase fresh exports and promote production efficiency 36 Looking Ahead-Development of Horticultural Exports 3 7 Addressing Logistical Constraints 38 Truck transport 39 Air transport 39 Sea transport 40 Social aspects 41 Chapter 6. Effect of the external economic environment on Egypt's exportpotentialfor cotton and horticultural products 42 The Egypt-European Union Agreement 42 Common Market for Eastern and Southern Africa 42 Other Trade Agreements 43 Agriculture and the World Trade Organization: Issues, interests, and Options for Egypt 43 Trade position indicators 43 Egypt-World Trade Organization agricultural policy 46 Reduction and removal of the prevailing anti-export bias 47 Annex. A note on the Rice sector 50 Marketing Issues 51 The Future of Rice Exporting SI REFERENCES 53 FOREWORD In Egypt, unlike in most developing countries, there is substantial rigorous technical analysis on various aspects of agriculture, covering both technical and policy aspects, carried out by the Ministry of Agriculture and Land Reclamation (MALR) with the support of the donor community. This report, coordinated by the World Bank with the participation of the Ministry, the Food and Agriculture Organization of the United Nations (FAO), and the United Nations Development Programme (UNDP), was made possible through the collaboration of the Ministry of Agriculture and Land Reclamation consultants and several Ministry projects. The World Bank team, with Jean Fran,ois Barres and Alberto Valdes as Co-Task Team Leaders, worked in close collaboration with the Ministry of Agriculture and Land Reclamation team under the leadership of Dr. Saad Nassar comprising Dr. Mahmood Badr, Dr. Mahmood El Adeemy, Dr. Mohamed Ragaa El Amir, Dr. El Rashad El Saadany, Dr. Mostapha Abdel Ghani Osman, and Mrs. Waffa Youssef, who organized the technical meetings. The analysis contained in this report relies heavily on the technical papers prepared by the national team and summarized in the draft Strategy of Agricultural Development until the Year 2017. The report benefited from the input of staff of key Ministry of Agriculture and Land Reclamation projects including the Policy Reform Program (APRP), the Agriculture Technology Utilization and Transfer Project (ATUT), and the Cotton Sector Support Project (CPSS). The analysis of price and trade policy effects on farmers retums is based on detailed data provided courtesy of the FAO office in Cairo and carefully prepared under the direction of Dr. Mahmood Ahmed, Senior policy Officer, FAO Regional Office in Cairo, with the collaboration of Ibrahim Adel Aziz (Consultant) and El Mohamed Abo El Wafa (GTZ). The World Bank team was fortunate to receive the assistance of the European Union Office, the Agricultural Led Exports Project (ALEB/Abt), the Agribusiness Linkages for Egypt Project (AgLink/ACDI-VOCA), and the Royal Netherlands Embassy Development Office. The peer reviewers, Malcolm Bale and Nwanze Okidegbe, provided very useful comments. Suggestions by Mustapha K. Nabli, Petros Aklilu, Trayambkeshwar P.N. Sinha, Sarosh Sattar and Nadir Mohammed are gratefully acknowledged. Remarks by Michel Debatisse, Philippe Chabot, and James Fry on cotton were helpful. Ms. Conchita Castillo, Program Assistant, edited and formatted the report. The report team included the following: Johan A. Mistiaen and Kelly Harrison (consultants). United Nations Development Program Consultants: Dr. Mahmood Badr, Dr. Mahmood El Adeemy, Dr. Mohamed Ragaa El Amir, Dr. El Rashad El Saadany, and Dr. Mostapha Abdel Ghani Osman Agricultural Policy Reform Project: Max Goldensohn, Development Alternatives, Inc. DAI; Edgar Ariza- Nino, DAI; Kenneth Swansberg, DAI; Ibrahim Siddi; Richard Magnani, DAI; John Holztman, Abt Associates, Inc. Cotton Sector Support Project: Helmut Scheon, German Society for Technical Cooperation (GTZ); El Mohamed Abo El Wafa, GTZ. Agriculture Technology Utilization and Transfer: Harvey Schartup, Antonio Lizana, Ronco Consulting Corporation. EXECUTIVE SUMMARY Under the Government of Egypt's agricultural strategy for the 1980s, the agricultural sector pioneered the economic and reform process that the government extended to the Egyptian economy at large in 1990, when it launched its comprehensive economic and social reform program. A decade later, the government's agricultural strategy for the 1990s aimed to complete the agenda of reforms initiated in the 1980s: price liberalization in input and output markets and the elimination of land-use controls for most crops. The main objectives of the strategy for the 1990s were to increase agricultural productivity of land and water through more efficient use of these limited resources, reduce unit costs of production, and thereby increase output and farm income. Sub-sector strategies were designed for: * Efficient and environmentally sustainable use of water and land; * Development of free markets and promotion of private sector-based resource allocation; * Crop and livestock strategies tailored to Egypt's competitive advantages; * Stimulation of export-based trade, marketing and agro-industrial developments; and * Development of support services (extension and research) and voluntary farming organizations. Most of the distortions that previously kept the sector from reaching its full potential were lifted during the 1990s. Prices and trading of many inputs and commodities were liberalized, and farmers were allowed to choose their cropping patterns. The agricultural sector is now a fully private sector, operating in a market and export-oriented economy. Objectives of the Report This report proposes key elements of an agricultural export-oriented strategy for Egypt that builds on the achievements of the agricultural strategy during the 1990s. The substantial improvements in Egypt's macro-economic environment following policy reforms during the past decade though necessary, have not been sufficient to improve Egypt's agricultural export performance. Overall, while Egyptian agricultural production increased during the 1990s, agricultural exports remained low and they were characterized by a highly volatile trend. The fact that both Egyptian production and world market trends are substantially less volatile is a first indicator of the potential to increase agricultural exports. In the context of overall agricultural and economic policy, the strategic focus on agricultural export sector is warranted because of the potentially large positive impact on Egypt's rural sector via higher farm incomes, sector-wide rural economic growth, and increased employment opportunities. In turn, this would result in better living standards in rural areas which, despite substantial migration rates to urban areas, are currently still inhabited by about 55% of Egypt's population. The proposed agricultural export strategy starts with an analysis of Egypt's agricultural export potential which includes: (a) a review of Egypt's overall agricultural export performance; (b) an analysis of the incentive framework in agriculture, including estimates of the current Nominal Protection Rates (NPRs) and Effective Protection Rates (EPRs) of key importables and exportables; and (c) the estimated effects of alternative agricultural and trade policy refornm scenario's on the returns to farmning in altemative crop (based on reduction of fuel and transport subsidies, exchange rate changes, and water charges). This analysis is presented in part one of the report. The analysis identifies two agricultural sub- sectors-cotton and horticultural crops-from which Egypt, contingent on policy reforms, could benefit from potentially substantial comparative advantages in trade. The underlying objective in Part Two of the report is to identify the main impediments of export growth in the cotton and horticultural sectors. The rationale for this focus is premised on the recognition - ii- that export promotion typically requires a mix of sector-wide and sub-sector specific reforms. The proposed export promotion strategy includes elements of potential sub-sectoral policy options that are based on the detailed analysis of the cotton and horticultural provided in Part Two of the report. The proposed strategy, in addition to identifying sector-wide and sub-sector specific policy options, offers suggestions with regard to implementation priorities. The suggested strategy implementation sequence aims at phasing in the reforms so that policies which increase returns to farming in exportables precede those that will decrease (absolute) returns in competing crops. Building on the foundations prepared by the previous initiatives of the Ministry of Agriculture and Land Reclamation, the proposed strategy is anticipated to be a significant step towards the identification and evaluation of policy options for improving the international competitiveness of the agricultural export sector and in particular the cotton and horticultural sub-sectors. Looking Ahead - An Analysis of Egypt's Export Potential The analysis presented in this report suggests that there is considerable scope for expanding Egyptian agricultural exports, particularly in two major areas: high quality cotton and horticultural products. This conclusion is based on two complementary analytical approaches. First, a market share approach to examine Egypt's export performance in world markets during 1994-98 accounting for the growth in trade of the various products-as opposed to a static market share analysis. Second, the source for optimism regarding Egypt's substantial capacity to expand agricultural exports is based primarily on a quantitative estimation of returns to farning under alternative price, trade and water charges policy scenanos. In what markets Egypt has performed better/worse than other countries? To what extent are Egypt's leading export products positioned in growing or declining world markets? Currently, the general destination of Egypt's agricultural exports is almost exclusively to Europe and the United States. An evaluation of the trends in intemational demand for Egypt's 17 leading agricultural and agro-processing export products in conjunction with Egypt's past export performance, suggests that Egypt performed particularly well in three export markets. These "champions" all fall into the category of processed cotton. Egypt's exports of these products have grown faster than world trade in general. Conversely, Egypt's share has declined in a growing cotton yam market. While intemational demand for several types of cotton yam has been growing at above average rates, Egyptian exports of yam cotton have not only fallen behind international standards, but they have in fact declined in absolute value. With respect to horticultural products, the European Union is the largest under-supplied market for fresh horticultural products in the world. Off-season imports (winter) enter the EU from a variety of countries including South Africa, Chile, Kenya, and Zimbabwe. However, the EU still lacks stable year- round supplies of fresh horticultural products at reasonable prices. Consumption of most fresh horticultural products drops drastically from November through April. By contrast, North American consumers now purchase a wide variety of fresh produce at reasonable prices during winter months via imports from Mexico, Chile, and Central America. There is great potential for expanding horticultural exports from Egypt because of its proximity to large markets in Westem Europe and the Gulf countries. Egypt's climate is suited for production of many fresh horticultural products and there is ample supply of labor. ATUT has estimated Egypt's export potential during those weeks when Egyptian products are available at prices above the exporters break-even cost level, concluding that Egypt could significantly expand exports of fresh products to Europe and the Gulf. Such products include table grapes, strawberries, cut flowers, cherry tomatoes, melons, watermelons, and others. This analysis is discussed in detail in the report. - ill- In addition to examining Egypt's agricultural export performance relative to overall world market conditions, this report also examined the current incentive framework at the farm-gate level for the production of key agricultural products. In order to determine the effect of trade and price policies on farm incomes and cropping patterns, two indicators are used: the Nominal Protection Rate (NPR) and the Effective Protection Rate (EPR). The NPR is the simplest and most widely used indicator, defined as the difference between the domestic and border prices at the prevailing exchange rate, in our case expressed as a 'tariff equivalent' (ad valorem) of tariff and non-tariff barriers. This indicator captures the impact of trade barriers on the price paid by consumers. The EPR measures the joint effect of trade barriers and price interventions on products and tradable inputs on the farm-level value added (returns to primary factors including land, labor and capital) associated with a particular activity. Tradable inputs include agro-chemicals, fuel, machinery and equipment. The results presented in Chapter 3 tell a revealing story indicating that the prevailing incentive framework in agriculture has a strong anti-export bias and is reflective of an extraordinarily selective and differential economic treatment for the various activities. The production of import-competing products is highly subsidized while the production of exportables is taxed. For example, the actual value-added per ton of wheat and maize in 1998-99 was 82.9% and 66.6% higher compared to the value added (farm returns) that would have prevailed at border price equivalents. By contrasts, the EPRs for exportables such as cotton in the same period indicate that valued added was 36.3% lower than what would have prevailed at border prices. The analysis of the cost structure indicated that the farm sector in Egypt benefits from subsidies on transport and fuel. In addition, current water costs are considered practically negligible relative to the opportunity cost of water in alternative uses. The analysis in Chapter 3 presents the estimated impact on farm returns of adjustments in fuel and transport, and in water costs. On the latter, computations are based on hypothetical water costs of 0.02 LE/m3 and 0.07 LE/m3 that are consistent with cost recovery scenarios rather than opportunity cost criteria. The results suggests that water charges would significantly reduce farm returns, while the removal of transport and fuel subsidies would only result in a relatively small decline in farm returns. As anticipated, the adjustment for water charges particularly erodes returns from water intensive crops. For instance, a water charge of 0.07 LE/m3 at prevailing market prices reduces the returns per feddan by 13.6% for rice, 6% for sugar cane, and 5.7% for cotton. Conversely, the effect on horticultural products is minimal because these are characterized by high returns and relatively low water use. In the context of policy reforms, the impact of trade and price reforms exceed those of the subsidy elimination and water charges by a significant order of magnitude. For example, cotton returns per feddan increase by 60% in a situation where border price equivalents prevail at the farm level (ERP equal to zero). Following trade reforms, cotton would yield substantially higher returns per feddan as compared to rice (i.e., 2,030 LE/feddan in cotton versus 1,441 LE/feddan in rice). Under a combined scenario of no price or trade interventions and water charges at 0.07 LE/feddan, the returns per feddan from cotton production would increase by 51% while returns in rice would fall by 11%. Hence, one would expect a considerable reallocation in cropping patterns from rice to cotton under these scenarios. The net result would be an increase in cotton exports, some reduction in rice exports, a net increase in the net value of exports, and a net increase in farm income. Trade and price reforms for importables would trigger significant declines in value added associated with these crops (e.g., wheat, maize, sugar cane and sorghum). These reforms would thus trigger major changes in relative incentives which, if applied across the board within the agricultural sector, would probably result in a major change in cropping patterns with expansion of the area for export production and a reduction of land used for import-competing activities. The overall net effect on farm income would be positive and very large. - iv- Alternatively, even under a partial reform scenario restricted to changing the trade and price policy for cotton only (cotton priced at border price equivalent), while the returns per feddan from cotton would increase from only 1,293 to 2,030 LE/feddan, the latter would be sufficiently large to surpass the current returns from rice and wheat. Thus, even a partial reform just covering cotton would still result in a significant additional incentive to expand cotton production. Finally, a simulation of the likely impact of exchange rate adjustment was conducted, based on the nominal exchange rate prevailing in May 2000. The analysis did not estimate the. degree of misalignment-this was beyond the scope of the report-but instead assumed alternative nominal exchange rate values that correspond to the findings reported in the recent World Bank Report Plan of Action for Export Promotion (Sept., 2000). If domestic farm prices were flexible to respond to an exchange rate increase, then domestic returns to cotton and other producers would increase significantly. Producers of tradable products in Egyptian agriculture (both import-competing and exportables) would benefit significantly from a policy that results in a relative higher real exchange rate. As result of the increase in the border prices resulting from the devaluation, agricultural producers and traders would be in a better position to compete both with imports and with foreign competition in export markets. For instance, a trade policy reform that removes the negative protection (ERP=0) on exportables simultaneously with a devaluation of 10% raises the retums to cotton producers by 36%. Under a 20% devaluation returns to cotton producers increase by 41 %. Plan of Action for Export Promotion of Egyptian Cotton and Horticultural Products The Ministry of Agriculture and Land Reclamation, supported by various projects, succeeded in establishing a forum that brought together the private sector and the government to discuss, define, design, and implement policy reforms affecting broad sectors of the agricultural economy. These reforms include the complete liberalization of the rice sub-sector; changes in customs tariffs on imported seeds and white rice; redefinition of the government and private sector roles in agricultural research and extension; and establishment of a permanent dialogue between the government and private associations representing commodity and trade groups. In addition, the Ministry of Agriculture and Land Reclamation has successfully implemented a major liberalization of land rental markets. The resulting higher land prices are anticipated to stimulate production allocation toward higher-value crops and stimulate productivity increases. From a longer-term perspective, these reforms create the necessary foundations for productive agricultural investments. These policy reforms appear to have induced significant improvements in the productivity of some major crops (mainly cereals). However, not only has the contribution of agriculture to the growth of the Egyptian economy continued to decline over the last 10 years, reflecting a natural structural adjustment in most economies, but also-and more revealing-the contribution of the sector to exports is also declining. In 1999, the agricultural sector accounted for 17.4 percent of gross domestic product, for only 10 percent of total exports, and for a mere 13 percent of non-petroleum exports. From an economy-wide perspective, two recent World Bank reports entitled "Plan of Action for Export Promotion" (Sept 2000) and a Policy Note entitled "Egypt's Export Promotion: A Review" (Feb. 2000) presents a comprehensive review of the major impediments for the development of the export sector in Egypt and develops a plan of action for the export sector. The above report examines the incentive structure and the following key institutional barriers were singled out: customs procedures and quality control procedures, transportation, trade financing, export support and promotion services. v - The analysis in this report on agriculture supplements these economy-wide policy suggestions by identifying specific elements for an export promotion plan tailored to the cotton and horticultural sectors. This framework for action is summarized in matrix form for each sub-sector and described below. Cotton The analysis indicates that Egypt has considerable potential to expand cotton exports, particularly of high quality ELS varieties. In order to achieve this, one of the most pressing challenges for Egyptian cotton sector reforms is the need to liberalize the seed cotton market. The lack of a transparent, competitive, and quality-conscience marketing mechanism has been detrimental to Egyptian cotton farmers. This report proposes a framework for action aiming to increase cotton production, quality and exports. This involves a step-wise liberalization of the seed cotton market coupled to floor price scheme by which the govemment, as a last resort, insures farmers in the event of exceptionally low cotton prices. The framework for action underlying the first phase of this proposal is summarized in the cotton sector matrix (Boxes (I. I)-(I.3)). In addition, (Box 1.4) suggests actions for moving towards improving the quality and hence, marketability of Egyptian cotton. Finally, it is crucial for farmers and traders alike to receive information explaining the proposed liberalization process ahead of time (Box 1.5). It is recommended to begin initially with liberalization of the ELS varieties only. This would ensures a progressive transition that will facilitate the adjustment of faimers and traders to a free market environment. Moreover, the advantages of a liberalized ELS market will be further accentuated by the contrast with the market for other varieties. Some acclimatization to the new market environment in this partial setting will facilitate the full liberalization of the seed cotton market proposed in a second phase. Horticulture One of the main challenges in the horticultural sector revolves around improving product quality to meet intemational standards by improved production, handling, and packaging practices and availability of adequate transportation infrastructure and facilities. A second issue is how to integrate the small farm into the horticultural export market. In addition to technical assistance, this will require establishing a legal framework for promoting contract farming between small farmers and larger commercial farmers and packaging enterprises. These proposals are summarized in the Horticultural framework for action matrix. The remainder to the executive summary addresses some of these issues in more detail. - vi- A Framework for Action: The Cotton Sector (I.1) Liberalize Seed Cotton Market Functioning at the Farm-Gate * Free entry of traders into the various "marketing rings." These measures ensure free entry of buyers (traders) and sellers * Farmers are free to choose the collection ring and trader they sell (farmers) into the seed cotton market, necessary conditions for the to. transition towards competitive farm-gate cotton prices. (1.2) Liberalize the Cotton Prices of the Extra Long Staple (ELS) Varieties * Traders compete freely for the ELS varieties and can offer prices The rationale for initially liberalizing only the ELS varieties is to that differ according to the quality grade. ensure a progressive transition that will facilitate the adjustment of * Alcotexa to refrain from setting export prices for ELS varieties. farmers and traders to a free seed cotton market environment. * Establish a cotton exchange that facilitates cotton marketing via Moreover, Egypt's cotton export potential is highest for the ELS auctions (a floor and/or pilot internet-based system) to which varieties. In addition, because the principal international competitor traders have free access. (the US Pima variety) also trades in US$, relative to trading in * The Government of Egypt (GoE) guarantees freedom of ELS markets dominated by non-US exporters, Egyptian exporter will be exports. less affected by the exchange rate of the LE. (1.3) The GOE Purchases Cotton only as a Last Resort at a Pre-Season Guaranteed Floor Price . A fixed floor price below the anticipated average international The floor price guarantee will eliminate the uncertainty to farmers of price is announced at the start of each the marketing season. exceptionally low prices. Since production costs do not differ among * This floor price is the same for all cotton varieties but variable cotton varieties, only one floor price should be set. However, post- according to the quality (i.e., grade) of the crop. harvest handling processes determine the quality of cotton thus, to provide incentives for higher quality, a different floor price for each grade should be set. (1.4) Moving Towards Meeting and Ensuring International Cotton Quality Standards * Enforcement of the MALR's regulation regarding seed cotton packaging in jute bags using cotton strings to minimize contamination and ensure a higher quality. * Introduce and enforce High Volume Instrument (HIV) testing of all cotton bales to be auctioned for export. (1.5) Expanding Farm Extension Services * Pre-Season dissemination of information to farmers and traders regarding the new provisions for seed cotton market functioning and product quality standards. * Promotion of integrated pest management, acid-delinting and seed dressing. (1.6) Liberalize the Seed Cotton Prices of all Cotton Varieties * Recommended procedure analogous to the actions outlined in 1.2 above. - vii- A Framework for Action: The Horticultural Sector (1.1) Expanding and Strengthening of Current Technical Support Services * Production Management to Improve Quality. * Improve Post-Harvest Handling and Packing Practices. * Expand training programs, particularly for women workers. (1.2) Obtaining Guaranteed Minimum Cargo Space on Air Cargo Operations * During the transition phase associated with the proposed deregulation of air cargo operations, this can significantly minimize product and quality loss at the Cairo International Airport. (1.3) Improving Current Export Inspection Procedures at Sea Ports__ * This can significantly minimize current product and quality losses at the sea ports. (1.4) Reduce Existing Import Tariffs on Refrigerated Trucks * To Provide Incentives for Investments in Transportation Equipment that Preserve Product Quality. |_ (1.5) Initiate Planning of Cooling Facility Developments at Sea- and Air- Ports * Promote private investment, development and operation of these facilities. j (1.6) Further Bi-Lateral Trade Negotiations for Horticultural Exports to Gulf Countries and the EU (1.7) Integrate the Small Farm Sector into the Horticultural Export Market * Expand technical support services (see 1. I above) and marketing information dissemination tailored to the small farm sector. * Facilitate voluntary small farmer marketing associations and cooperatives. * Provide a legal framework for promoting contract farming between small farmers and commercial farmers and packing enterprises. - viii- Horticulture Issues In the horticultural sector, domestic producers apparently suffer from excessively large margins and inadequate infrastructure for exporting. Under the controlled economy farmers focused exclusively on crop husbandry because decisions about cropping patterns and marketing of input and output were handled by the various intervention agencies. Consequently, today farmers have little experience in farm management. Even for crops with no government controls, such as horticulture, farmers most of the time simply sell their crops in the field, and the buyers take care of harvesting, sorting, packing, and marketing. This system does not make farmers aware of the quality requirements of export markets. The system of market integration between the farm and the retail market has changed little since the beginning of the reform program, and market information systems are still inadequate. For horticulture, the proposed strategy focuses on improving marketing mechanisms through: * Fostering contractual links between commercial farmers and small farmers; * Eliminating government control over cooperatives (for example, potato cooperatives); * Facilitating voluntary small farmers' cooperatives; and * Ensuring sustainable market information through professional private organizations. Technology Transfer, Skills Development, and Research During the reform, Egyptian rice farmers demonstrated that they can be responsive to market signals provided these market signals reach them. However, with some remarkable exceptions, extension and research services are still organized like the systems during the central planning period. Research programs have successfully addressed soil and water efficiency, especially for crops with no special quality requirements, for which breeders could concentrate on maximizing yields. Successful breeding programs have developed high-yielding varieties of wheat, maize, and rice. Rice production in the Delta region has been particularly profitable in recent years, partly because water supplies were abundant and prices high during the period, but also because new varieties fit into an intensive three-crop rotation system. In the cotton sector, breeding programs have been less successful in addressing the conflicting needs of the export and local cotton markets. Cotton has to compete not only in the world market but also with other crops such as rice that have benefited fully from the policy reforms. Faced with significant increases in land prices after the liberalization of land rent, cotton farmers must increase factor productivity to remain competitive. The proposed strategy for increasing productivity of cotton gives priority to: * Seed quality improvement through acid delinting and dressing; * Integrated pest management; and * Research and development of new crop rotations with shorter production cycles. Village cooperatives will continue to play an essential role in cotton area blocks, the grouping of several small fields to constitute the minimum blocks required for insecticide spraying. The horticulture export sector is leading the way in developing a more participatory approach to technology transfer based on direct interaction among farmers, extension workers, and researchers. This participatory approach bridges the gap between problem identification and problem solving. In addition, Ministry of Agriculture and Land Reclamation projects increasingly acknowledge the important role of - 1x- women in the horticulture sector, especially in tasks critical for ensuring product quality, such as harvesting and packing. Inadequate managerial skills at all levels is an important constraint to modernizing agriculture and further developing horticultural exports. The most successful projects directly address this issue by providing specialized high-level expertise. An example is the successful Agricultural Technology Utilization and Transfer (ATUT) project, under which exporting farmers receive direct transfer of technology from Chilean and Californian experts. Unlike manufactured goods, whose centralized production process can quickly adjust to meet continuous changes in demand, agricultural production is spread over millions of small farms that for decades had to deal only with the government and did not have to worry about global market signals. Under the new policy framework following the reforms, commercial farming plays and should continue to play a pioneering role in exploring new markets, developing new technologies, and enforcing quality standards. Professional organizations of export-oriented farmers and exporters are becoming a new intermediary between the markets and the farmers. At first, these organizations worked mainly with medium to large business-oriented farms. However, they are playing a growing role in technology transfer to small farms through contractual arrangements (for example, for green beans, sweet potatoes, and sweet peppers). The next critical step will be the restructuring of smallholder farm cooperatives. These were the only intermediary interlocutor for smallholder farmers in the controlled economy and should be adjusted or replaced by new bottom-up organizations able to understand and deal with market mechanisms. Quality Management Export markets require not only competitive prices but also, even more important, reliable (top) quality and sanitary standards. Those standards have no equivalents in domestic markets, and exporters who have neglected quality have incurred losses and withdrawn from the export business. Therefore, awareness of quality requirements and technical skills to achieve them consistently are crucial for Egyptian farmers and producers. While these standards are needed for all export products, they are particularly important for horticultural exports. Horticultural sanitary standards are increasingly restrictive, and importing countries often use them as a non-tariff barrier. For example, Egyptian potato exports to the European Union were cut in half after the detection of brown rot disease. Quality has also become an issue for lint cotton, as contamination of seed cotton by foreign matter reflects poorly on the quality and reputation of Egyptian cotton on the market. Quality management is a key component of the proposed strategy. The government should adopt product quality standards based on international standards and those enforced by the importing countries and accredited professional organizations. For cotton, the quality strategies include expansion of the quality program launched by the Ministry of Agriculture and Land Reclamation and high-volume instrument testing for every bale of exported lint. For horticulture, the strategy recognizes the important role played by women workers in quality assurance at harvesting and packing stages and supports training and promotion of women supervisors and managers. Transport and Infrastructure Services Ensuring the continuity of the cooling chain is another critical element of quality management. Shortage of adequate transportation and cooling facilities is an obstacle to the development of horticulture in general and to horticultural exports in particular. Air transport competition has improved, thanks to the efforts of the government and the Horticultural Exports Improvement Association (HEIA), but prices - x.- remain high compared to those of competing countries. For example, the cost of air shipment per kilogram is equivalent to the production cost of strawberries and twice the production cost of grapes. These costs illustrate the importance of developing sea shipment under controlled temperature to Europe and refrigerated truck transportation to the Gulf countries to transform Egypt's geographic comparative advantage into real competitive advantage. The proposed strategy calls for: * Full implementation of the tariff reduction on imported refrigerated trucks to reduce cost and losses of inland transportation; * Privately managed cooling facilities at the Cairo International Airport; * Simplification of customs clearance; and * Building upon the successful experience with sea shipments under controlled atmosphere to the EU. Implications of the Agricultural Export Strategy for Non-export Crops Export crops have to compete not only with foreign products but also for scare land and water resources claimed by other crops. Cotton in particular must find its place in crop rotation, in which farmers aim for high cropping intensity (around 200 percent). Protection indicators shows that wheat and maize are not competitive at shadow prices, and producers are subsidized by border protection against imports. These crops are unprofitable even at shadow prices because of the high consumptive water use of rice and sugar cane production. Furthermore, in the future, with expected rising input costs, especially as water and land rental values increasingly reflect their scarcity value, cultivation of these low-value crops would be difficult to justify. Strategy for Field Crops Analysis of the competitiveness of different crops and rotations shows that horticulture products remain highly competitive, followed by cotton. One of the key strategic objectives of agricultural research is to develop short-cycle varieties of cotton, as well as other crops that can be included in crop rotation and replace the traditional short berseem-cotton rotation with a more attractive rice-wheat-cotton rotation. The Ministry of Agriculture and Land Reclamation's Agricultural Research Center should also continue to experiment with intercropping cotton with other crops, including high value crops such as watermelons. Crop rotation competing with cotton (maize-rice, long berseem-rice and fava beans-rice) includes crops that are either highly protected (wheat and maize) or water intensive (rice) and therefore benefit from the low cost of water. The proposed strategy recognizes that lifting protection on cereals might not be feasible in the short term for political and social reasons. Therefore, the strategy recommends mitigating the adverse impact of protection on the competitiveness of profitable crops such as cotton by developing short-cycle, high-yielding cotton varieties and water-saving technologies for competing crops (for example, sugar cane), and improving irrigation at the meska (tertiary irrigation network) level as supported by the Irrigation Improvement Project. Land and Water Management The Ministries of Agriculture and Land Reclamation and Water Resources and Irrigation jointly address land and water issues. Because of the design of the irrigation system, water is still centrally managed in Egypt. The challenge for the irrigation and drainage system is to adapt to changing cropping patterns now under the control of the farmers. Rice cropping in areas where the drainage system was not designed for that crop creates stress for the water allocation system. A detailed analysis of water - x1- management is beyond the scope of this report, but farmers at the tail end do not receive their fair share of water, and cotton farmers suffer water logging generated by neighboring paddy fields. The introduction of continuous flow at the tertiary (meska) level under the irrigation improvement project supported by the World Bank and the German Development Bank should be extended to ensure efficient use of water. Land scarcity is reflected in the four-fold increase in land rent since the liberalization of land rent in 1996. To address this issue, the government launched a major program of land reclamation in the Westem Delta through the Nasser Canal, the Eastern Delta, and Sinai (Es Salam Canal), and more recently in the South of the New Valley (Toshka) and East Al Aweinet on the border with Sudan. The Ministries of Agriculture and Land Reclamation and Water Resources and Irrigation share the strategic objective of maximizing water and land efficiency. Public investments are under way and should continue supporting smallholder and graduate settlers in the New Lands to achieve the social-economic objectives of the land reclamation programs. The Evolving Public-Private Partnership The government should act as a facilitator and mediator of competing claims to Egypt's resources and as the architect of the enabling environment that would sustain high and sustainable growth. Experience in the cotton and rice sectors shows that market-based pricing mechanisms cannot function properly when public or semi-public operators are involved in the commodity chain. Public entities do not have the flexibility or accountability to operate in an open economy. Therefore, the proposed strategy focuses on completing the privatization process initiated during the 1990s in the cotton, textile, and rice sectors. Growing involvement of the private sector in the seed business is also a priority. During the 1 990s, the government supported by the international community, created an enabling environment for genuine voluntary professional organizations. The Horticultural Exports Development and Improvement Association (HEIA) represents its 120 private sector members and act on their behalf to promote exports, provide market information, quality control and is involved with horticultural sector policy making. The Agricultural Commodity Council created in July 1999, will deal with all crops except cotton, which is covered by many other institutions that should be consolidated. The Supreme Council for Cotton, which decides the choice of varieties in various regions (the cotton map), is the most important organization and could take the lead in establishing a professional organization. This strategy encourages the development of professional organizations not only for exporters and commercial farmers but also for smallholder farmers. The reform of the cooperative system is critical in this effort. In addition, the legal and regulatory framework for creation and operation of non- governmental organizations in Egypt need to be updated. The Ministry of Agriculture and Land Reclamation is drastically changing its extension and research approaches, developing research and extension programs with the active participation of farmers and professional organizations of producers and exporters. The proposed strategy calls for streamlining the new approach for other products. In the 1990s, Egypt had a massive public investment program for land reclamation. The challenge of the new decade is to create an enabling environment for private investment, which in the New Lands is expected to complement public investment at a level of 80 percent of total investment. More support for skills development and agricultural support services in technology transfer and research should also complement public investment in physical infrastructure described below. - xii- The government's program to improve water use efficiency includes the following national projects implemented by the Ministry of Water Resources and Irrigation (MWRI) and supported by the World Bank and other regional and bilateral agencies: * The ongoing Irrigation Improvement Project will provide continuous flow at the meska level and therefore increase the flexibility of irrigation at farm level; * The Second National Drainage Project approved by the World Bank and other donors in June 2000 will extend subsurface drainage on 0.8 million feddans over six years; and * The ongoing Third Pumping Stations Rehabilitation Project, supported by the World Bank, and the KfW will rehabilitate 77 main pumping stations over six years. This tranched program should continue. The Private Sector and Agricultural Development Project implemented by the Principal Bank for Development and Agricultural Credit will strengthen the financing private investment capacity in the new as well as in old lands. Facilitating the transition of smallholder farmers and their graduation to the market economy is an objective of the East Delta Agricultural Services Project co-financed by the International Fund for Agricultural Development and the International Development Association. Similar projects could be developed in Sinai and in West Delta (El Salam Canal). Support to the private sector on market-based technology transfer and research will be carried out by extending on-going projects such as ATUT, the Egyptian-German Cotton Sector Promotion Project (CSPP), the Agriculture-led Exports Business Project (ALEB), Agribusiness Linkages for Egypt (AgLink), and systematic use of matching grants to support private sector initiatives. The Skills Development Project under preparation will be a critical component of the investment program. The project will foster vocational training by rehabilitating existing vocational training centers through increased private sector participation in their management. - 1 - TOWARD AGRICULTURAL COMPETITIVENESS IN THE 21ST CENTURY EGYPT AGRICULTURAL EXPORT-ORIENTED STRATEGY PART I: PROMOTING AGRICULTURAL EXPORT DEVELOPMENT IN EGYPT CHAPTER 1. OBJECTIVES AND AUDIENCE OF THE REPORT 1.1 The main objective of this report is to contribute to a government policy road map for an Egyptian agricultural export-oriented strategy. The report is the first key component of a wider effort by MALR to develop a comprehensive strategy for agriculture development in Egypt up to year 2017. The emphasis on an export-oriented agricultural strategy is warranted because of the potential for effective rural poverty alleviation. In Egypt, increased agricultural exports can result in significant growth in rural incomes and employment, both farm and off-farm. In addition to these direct impacts on agricultural sector growth, the strategy should boost foreign exchange earnings. This report presents a selective agenda and incorporates recent work supported by the U.S. Agency for International Development, the Food and Agriculture Organization of the United Nations, the United Nations Development Programme, the World Bank, and bilateral programs. This report is not an agricultural sector strategy per se. It focuses on two major agroexport sectors, cotton and horticulture products, only briefly commenting on water management, privatization strategies for the cotton industry, and several other aspects that would belong in a sector strategy. 1.2 Agricultural development alone cannot solve rural poverty. No country has reduced rural poverty significantly without rural-urban migration, growth of the rural non-farm sector, and relatively rapid growth of the overall economy, which result in significant increases in employment and real wages. However, agro-export development can contribute significantly to employment creation and rural poverty reduction. 1.3 From a long-run perspective, Egypt is increasingly integrated in the world economy. This means that agricultural support for import-competing activities is likely to decline in the future, and that Egypt will face relatively lower trade barriers for its agricultural exports. A basic premise of this study is that Egypt has two critical assets in its favor for developing an agroexport strategy: favorable conditions for irrigated production of high value export products and a favorable proximity to major potential foreign markets, particularly the European markets but also the Gulf region. 1.4 For the economy as a whole, the goal of such a strategy is not necessarily to maximize the growth of production in any particular sector but to create the necessary and sufficient conditions for the agricultural sector to adjust to a more competitive environment. The production structure as well the agro- processing industry and inputs delivery system should be allowed to adjust rapidly to changes in foreign market conditions (output and input) and technologies, through changes in cropping patterns and farm structure. This adjustment capacity requires flexible rural factor markets (labor, land, water, and finance) as well as a competitive agribusiness sector, adequate infrastructure, technology development, and, most important, more human capital (education and training). Such a strategy would lead to faster agricultural growth, largely through adjustments in the output mix toward higher-value products, which should result in higher total factor productivity. 1.5 This report presents a road map for the government's strategy-and implications for domestic and foreign investors in the sector-to enhance the development of internationally competitive and dynamic cotton and horticultural subsectors oriented to the export market. - 2- 1.6 The report has two parts. The proposed agricultural export strategy starts with an analysis of Egypt's agricultural export potential which includes: (a) a review of Egypt's overall agricultural export performance; (b) an analysis of the incentive framework in agriculture, including estimates of the current Nominal Protection Rates (NPRs) and Effective Protection Rates (EPRs) of key importables and exportables; and (c) the estimated effects of alternative agricultural and trade policy reform scenario's on the returns to farming in alternative crop (based on reduction of fuel and transport subsidies, exchange rate changes, and water charges). This analysis is presented in part one of the report. The analysis identifies two agricultural sub-sectors--cotton and horticultural crops-from which Egypt, contingent on policy reforms, could benefit from potentially substantial comparative advantages in trade. The underlying objective in part two of the report is to identify the main impediments of export growth in the cotton and horticultural sectors. The rationale for this focus is premised on the recognition that export promotion typically requires a mix of sector-wide and sub-sector specific reforms. The proposed export promotion strategy includes elements of potential sub-sectoral policy options that are based on the detailed analysis of the cotton and horticultural provided in part two of the report. - 3- CHAPTER 2. EGYPT'S AGRICULTURAL PERFORMANCE IN THE 1990S 2.1 Although its share in nominal gross domestic product fell from 25.6 percent in 1985-86 to about 17.4 percent by 1998-99 (EIU 1999), the agriculture sector is crucial to the Egyptian economy in several respects. First, it employs about 30 percent of the labor force. Second, in the 1990s, agriculture accounted on average for about 12.8 percent of exports excluding oil products (Table 2.4). If downstream agroprocessing industries such as yarn, fabrics, textiles, and clothing are included, the agroprocessing sector accounts for 53 percent of exports. Because about 55 percent of Egypt's population is rural, the performance of the agricultural sector is critical for poverty reduction. 2.2 In this section, we describe the salient features of Egypt's agricultural performance during the past decade from two perspectives. First, using some basic economic indicators, we compare the performance of the Egyptian agricultural sector as a whole to that of other countries in the Middle East and North Africa Region. Second, we review the trade performance of Egypt's agricultural and agroprocessing sectors. Agricultural Labor Productivity 2.3 Egypt's agricultural labor productivity is one of the lowest in the region, with only Yemen lagging dramatically behind (Table 2.1). However, although still comparatively low in absolute terms, Egypt's labor productivity has almost doubled during the past 20 years, while Turkey's has experienced no improvement during the same period. Table 2.1: Agricultural Labor Productivity Trends Country 1981-83 1986-88 1991-93 1996-98 Arab Republic of 767.46 913.41 1,067.81 1,298.34 Egypt. Morocco 1,079.93 1679.11 1,623.58 2,062.08 Tunisia 1,749.44 2110.14 3,057.24 3,114.91 Jordan 1,505.38 1978.95 2,202.71 1,842.01 Turkey 1,835.51 1841.19 1,840.32 1,846.53 Republic of Yemen n.a. n.a. 292.47 376.57 Lebanon n.a. n.a. n.a. 19,991.59 Note: All measured as agriculture value added per worker in constant 1995 dollars; n.a.= not applicable. Source: Mistiaen (2000) based on World Bank Development Indicators (1999) data. Non-labor Agricultural Inputs 2.4 Unlike that of other countries in the region, Egyptian agriculture is entirely dependent on irrigated land. The govemment now provides irrigation water free except for cost recovery of on-farm investment projects. Consequently, an increase in farmners' contribution to the cost of providing irrigation and drainage main infrastructure would significantly affect their competitiveness. The aggregate figures for irrigated land as a percentage of cropland are somewhat misleading because irrigation water supplies have been irregular and often insufficient, and many irrigation drains need rehabilitation. In many areas drainage has not been able to counter the water logging and high soil salinity that were the unforeseen consequences of a rise in the water table following the construction of the Aswan High Dam. In addition, only about 2 percent of the cultivated land is irrigated by modem methods. Nevertheless, the agricultural - 4- yields generated by 3.5 million farmers cultivating holdings that average two feddans in size are among the highest in the world. 2.5 Egypt's fertilizer use is the highest in the region and among the highest in the world (Table 2.2). Fertilizer production in Egypt is dominated by six large private-sector companies that produce over 6.6 million metric tons a year and supply about 90--95 percent of the domestic demand. Since 1994, government reforms have virtually eliminated all fertilizer subsidies, terminated the government distribution monopoly, and allowed cooperatives and private dealers direct access to the fertilizer supplies. Table 2.2: Fertilizer use in the Middle East and North Africa Region Country 1981-83 1986-88 1991-93 1996-98 Arab Republic of 3,517.03 4,045.58 3,714.27 4,264.29 Egypt Morocco 311.58 402.56 360.39 338.41 Tunisia 251.96 347.63 341.75 302.81 Jordan 418.53 595.93 400.58 625.00 Israel 2,447.81 2,897.60 2,816.00 2,962.96 Turkey 604.79 660.62 801.38 734.95 Republic of Yemen 97.38 105.01 108.12 83.33 Lebanon | 1,840.78 1,051.51 1,867.33 2,688.17 Note: Fertilizer consumption is measured in 100 grams of nutrient per hectare of arable land. Source: Mistiaen (2000) based on World Bank Development Indicators (1999) data. Agricultural Trade Profile 2.6 In the early 1990s, Egypt's Agricultural Strategy for the 1990s (World Bank and MALR, 1990, p. 45) described the following trends in agricultural commodity trade for the decade: * Cotton, oranges, and tomatoes were the main agricultural exports, accounting for 90 percent of agricultural commodity exports; * Cotton exports declined; * Egypt ceased to be a cotton price setter in the world market; * Increased private sector participation and liberalization of cotton imports to meet local demand were considered important; * Export of oranges was targeted to the former Soviet Union (60 percent); * An aggressive search for new markets and improved quality were recommended; and * Rice, onions, dates, tomatoes, lemons, artichokes (10 percent), registered significant increases in volume term. 2.7 The European Union was the most important partner, with 30 percent of cotton, 50 percent of rice, 45 percent of vegetables, and 2.5 percent of fruits (trade restrictions made Egypt's beyond-quota outside-period exports unprofitable). 2.8 During the mid-1990s, the government also considered completing the liberalization of production, export, and marketing of cotton a priority. The Agricultural Strategy for the 1990s also recommended liberalizing cotton imports from pest-free countries (currently implemented), providing adequate and timely information on trade to the exporters, focusing extension and research on export products, and addressing quality issues. Further priorities were the completion of trade negotiations with - 5- the European Union and better storage, cooling, and marketing infrastructure (to avoid post-harvest losses, which reach 35 percent for horticulture). 2.9 Against this backdrop, the highly variable performance of overall agricultural exports in recent years suggests that many of these observations and policy recornmendations are still valid 10 years later. While overall agricultural and cotton exports expanded (on the average) during the 1990s, these trends exhibit a very high variability (Tables 2.3 and 2.4). During the past five years cotton has been Egypt's principal agricultural export (Table 2.5). The crop's importance is further underscored by substantial exports from the spinning and weaving sector. Exports of previously more important crops such as fresh fruits, vegetables, and citrus fruits have declined somewhat since the mid-1990s. On the whole, Egypt's export portfolio in terms of products is quite concentrated and centered around cotton. For example, 17 of Egypt's leading 30 export product groups are produced by the agroprocessing sector, and of these products, 13 are cotton related (Figure 2.1 and Annex table). Table 2.3: Trends in Shares of Agricultural Products in Total Export Revenues, 1990-99 Share 90-91 91-92 92-93 93-94 94-95 95-96 96-97a 97-98 98-99 As percentage 5.3 6.6 5.3 7.1 12.4 7.4 5.1 4.7 10.4 of total As percentage 12.0 13.0 12.0 15.0 20.0 14.0 10 7.0 13.0 of nonpetroleum exports __ I_ ==_ Cotton as 4.0 2.0 2.0 5.0 10.0 5.0 4.0 3.0 6.0 percentage of non-petroleum exports l a After including free zones export. Source: MEFT 1999. Table 2.4: Annual Growth Rate of Agricultural Export Revenues, 1990-99 Product Mean 91-92 92-93 93-94 94-95 95-96 96-97 97-98 98-99 Agriculture exports 22.9 13.7 -22.6 19.6 158.0 -44.8 -20.4 -10.0 90.1 Cotton 46.3 -57.8 5.7 127.0 264.3 -64.4 -1.8 -3.7 101.0 Source: MEFT 2000. - 6- Table 2.5 Trends in Agricultural and Agroprocessing Sector Exports, 1990-98 (US$ millions) Exports 90-91 91-92 92-93 93-94 94-95 95-96 96-97a 97-98* Total Exports 4,250 3,880 3,337 4,955 4,608 5,345 5,128 4,445 Cotton 83 35 37 84 306 109 107 103 Citrus 38 58 42 35 17 23 20 12 Potatoes 28 40 19 21 104 28 17 27 Rice 5 33 26 45 64 71 38 28 Fresh and frozen 23 42 27 25 33 21 20 1 1 vegetables Other agriculture 49 49 48 28 90 87 68 62 Total 226 257 199 238 614 339 270 243 agricultural Cotton yam 318 283 204 212 480 199 204 288 Cotton textiles 75 87 65 66 161 42 30 20 Readymade 115 170 152 163 285 161 195 258 clothes Other 21 35 30 55 152 172 176 193 Total spinning And weaving 529 575 451 496 1,078 574 605 759 Canned vegetables And fruits 11 14 7 2 27 6 5 7 Dried onions And garlic 8 8 10 9 10 6 3 3 Other 67 123 84 77 88 117 151 137 Total foodstuffs 1 86 l 145 101 88 125 129 159 147 Note: a Adjusted after including free zones export; n.a. = not available. Source: MEFT 1999. Gauging the Competitiveness of Agricultural and Agri-Processing Exports 2.10 We have reviewed Egypt's trade performance from a domestic vantage point, but developments in the World market will give a broader perspective on this performance and provide a benchmark against which to gauge export competitiveness in relative terms. For what export products has Egypt performed better/worse than other countries and increased/decreased its market share? To what extent are Egypt's leading export products positioned in growing or declining World markets? 2.11 Egypt performed particularly well in three export product groups (Figure 2.1). These champions, or winners in growing markets, all fall into the category of processed cotton. In these dynamic products, which have grown faster than World trade in general, Egypt proved its international competitiveness in the mid-1990s. The Egyptian product groups that lost out in a growing World market are the two principal cotton yarn types. While international demand has increased at above-average rates, Egyptian exports of cotton yarn have fallen behind. Egyptian exports of cotton yarn have not only grown more slowly than cotton in particular, but have actually declined. 2.12 The destination of Egyptian exports in general, and of cotton in particular, is almost exclusively the European Union and United States. Thus Egypt has most of its eggs in one basket in terns of both - 7- products and trading partners, even though they are the largest World importers. Chapter three addresses the reasons for these trends in the cotton sector. 2.13 Almost half of Egypt's leading agricultural and agro-processing product groups have been achievers in adversity. Egyptian products in this quadrant are thus gaining market share in a World market that has either been growing below average (oranges) or declining (potatoes). Thus while Egyptian exports of certain agricultural products, such as potatoes, have declined, they are declining more slowly than the average rate in a declining World market. The classification of Egypt's agricultural and agroprocessing export portfolio into the four groups in Figure 2.1 should be seen as a useful preliminary analytical step. An informative subsequent step would involve assessing Egypt's export performance in the context of the annual growth of imports by its principal trading partners (Mistiaen 2000). For concrete policy applications and product-specific trade promotion strategies, this analysis would need to be complemented with detailed information regarding the sectors and markets of these export product groups. - 8- Figure 2.1 Growth of national supply and intemational demand for Egypt's 17 leading agricultural and agroprocessing export products 20 Diagonal of constant Annual Growth of world market share World Imports Cotton yarn, /=85%.multi,combed, 71429tcdtexn/=232.56,not put up.,nes C hampion si Cotton yarn, >/=85%, single, combed, O / 714.29gdtex>/=232.56,not put up v e 5and t ~~~~Womenigirls truesand/ shorts, of cotlon, not knited/ Undeahivr j T-shirts, singlets and other Carpets of man-made textile (l rU ndgerothevmrks 10 vests, of cotton, knitted Q materials, woven made op. nes (losers~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~mtras wove madet up,et nes\v Bed linen, of cotton, nes ~ ~ ~ ~ ~ ~Q Mens/boys tousese and shorts. Bed linen. of cotton. nes /of cotton. not khotted Average nominal growth rate of total world imports Onions and Menst oyS / : ;. shallots, fresh shirts, of cottony :X_f or chilled not kn "ed / tRice, sem,-milled or whole milied. Cotton, w whether or notpolished of glazed £' Oranges, not carded _X. -s_ or cm beo or dried -30 -20 l,,Ft3 /( I Cotton yarn,., 20 30 40 50 60 / /=85%, single, comednot pu7t up 12 Toilet and kitchen Annual Growth in Plain weave cotton tabric,0f=85%, n P linen. of cotton, nes Egypt's Exports more than 200 g/m2, unbleashed Achievers in adversity ndeclining Market (winners in declining markets Bubble scale= Potatoes, fresh or chilled nes 0 US$ 50 million -10 Note: Export values are size of bubbles. The horizontal axis is Egypt's export growth. The vertical axis is growth in international demand for these product groups. The 1994-98 average notninal growth of 6 percent in World imports (horizontal line) is the benchmark against which to measure whether World demand for each product group is growing or contracting (see ITC 2000 and annex table). The 45-degree line of constant market share indicates that Egyptian exports of product groups to the right of this line increased faster than World imports and thereby increased their World market share. The opposite is true for the product groups to the left of the diagonal line. These two reference lines divide the chart into four quadrants. The figure also gives an overview of product group concentration in the export profile: the bubbles of similar size indicate that exports. while concentrated in cotton, are diversified among several different cotton-related groups. Source: Mistiaen 2000. - 9- CHAPTER 3. THE EFFECT OF PRICE AND TRADE POLICIES ON FARMERS' RETURNS 3.1 While the previous chapter assessed the agricultural and agri-processing export performance relative to overall world market developments, this chapter examines the current incentive framework at the farm-gate level for the production of key Egyptian agricultural products-including cotton and horticultural crops-to identify and gauge the potential for both trade and domestic policy reforms in the context of an agro-export strategy proposal. The methodological approach is based on two key quantitative indicators that reflect the structure of incentives and the underlying policy framework: the Nominal Protection Rate (NPR) and the Effective Protection Rate (EPR).' The NPR is the simplest and most widely used indicator, defined as the difference, in percentage, between the domestic and border prices at the prevailing exchange rate, in our case expressed as a 'tariff equivalent' (ad valorem) of tariff and non-tariff barriers. This indicator captures the impact of trade barriers on the price paid by consumers. 3.2 In order to determine the effect of trade and price policies on farmer income and cropping patterns, two indicators are used, namely the ERP and farm returns per feddan. The EPR measures the joint effects of trade barriers and price interventions on product and tradable inputs on value added (retums to primary factors, including land, labor, and capital) in a particular activity.2 Tradable inputs include agro- chemicals, fuel, machinery, and equipment. In the absence of any trade restriction or price interventions, NPRs and EPRs would be equal to zero. If, as result of domestic price and trade interventions, domestic returns to primary factors are less than those obtained on the international market, then the EPRs would be negative, and if domestic returns to primary factors are greater than those obtained on international markets, then EPRs would be positive. The measure of farm returns per feddan (value added/feddan) allows for flexibility to incorporate price adjustments in selected non-tradable inputs, such as altemative water costs and others. 3.3 Although these indicators are quite simple conceptually, the calculation of farm-gate border price and value added equivalents is often data intensive and require numerous adjustments.3 Such adjustments include current transport and marketing cost, and distinguishing tradable outputs from non-tradable by- products (e.g., wheat from straw).4 In addition to assessing the current divergence between current farm- gate and border equivalent prices (i.e., examining the effect of current trade policy reforms), this chapter also examines impact of three potential policy reforms: (a) introducing water charges-currently water is used by farmers at zero cost; (b) eliminating current subsidies on transport, fuel and oil; and (c) exchange rate misalignment. Considering that the data base on some variables is rather weak (such as the data on domestic and border prices for some products) and the adjustments required could introduce some margin of error, it is important to stress that the measures presented should be taken as a rough order of magnitude and not as precise estimates.5 ' For detailed treatments of these and other indicators of trade and production incentives one can consult Tsakok (1990), Schiff and Valdes (1 992), Vald6s (1 996) and Vald6s (2000). 2 In this context, value added refers to the difference between the gross value of farm output and the cost of tradable purchased inputs (i.e., returns to non-tradable primary factors). Thus, the EPR is defined as the difference between farm-gate value added and the border equivalent of value added, expressed in percentage terms. 3 The detailed data on which the analysis in this chapter is based was provided courtesy of the FAO office in Cairo and carefully prepared by Dr. Mahmood Ahmed and Ibrahim Adel-Aziz. 4 Notes of adjustments are noted for each table and computational details are available upon request from Vald6s and Mistiaen. 5Considering that some are summer crops (cotton) while others are winter crops, an extension of this analysis to produce estimates of the potential output and trade effects would have to consider explicitly the crop rotation in question. However, for the analysis of the signals on relative incentives presented here the indicators chosen are considered adequate. - 10- 3.4 Another caveat regarding estimates of agricultural support in Egypt is in order. Several reports have stated that agriculture was one of the sectors in which economic reforms were initiated at a relatively early stage (WTO 1999). This is in fact the case in a number of important features: the removal of crop allotments, the reduction of subsidies for inputs such as fertilizers and pesticides, privatization of parts of agricultural land held by public sector companies, increased private sector processing and marketing of agricultural products including opening up international trade to the private sector, and reduction of non- tariff barriers to imports and exports.6 These are very significant and positive policy changes. However, the current price, marketing, and trade environment is still one in which substantial support to import competing activities is provides (Table 3.1). These distortions continue because of import tariffs (at an average of approximately 20% for all agricultural imports), overly restrictive quality standards on certain imported products (e.g., meat) and guarantee prices for some crops. 3.5 On the export side , for the last fifty years, cotton has been considered a "strategic" crop and government intervention has taken place at every level, from production to marketing and exports, and prices paid to farmers and the price for exports were both set by the state. The net effect for farmers was that they received farm prices that were less than the border equivalent price. However, during the last few years the government has allowed for more flexibility on pricing and marketing of cotton but is still not yet fully liberalized. For horticultural products for exports, the main constraints are not in the form of export taxes or QRs, but mainly in the form of an implicit tax on exports as result of non-competitive transport and shipping services. This is discussed in detail in the sections on horticultural exports and on cotton. Nominal and Effective Rates of Protection 3.6 The results presented in Table 3.1 tell a very revealing story and indicate that the prevailing incentive framework in Egyptian agriculture has a strong anti-export bias. The production of import- competing products is highly subsidized while the production exportables is heavily taxed. The ERPs on import-competing activities are high and positive. For example, for wheat and maize, the actual value added per ton in 1998-99 was 82.9% and 66.6% per ton higher compared to the value added (farm returns per ton) that would have prevailed at border price equivalents. By contrast, ERPs for the production of exportables such as cotton in the same period was -36.3%. In other words, farmers' returns in cotton production were 36.3% lower than what would have prevailed at border price equivalents. The ratio of ERPs for import-competing to exportables, for instance wheat to cotton was +82.9%/-36.3%, reflective of the extraordinarily selective and differential economic treatment for the various productive activities. 6 World Trade Organization (1999), "Trade Policy Review: Egypt 1999," Geneva. - 11- Table 3.1: Nominal and Effective Rates of Protection per Ton of Output during 1998-99' Farm-Gate Price Value Added (LE) (LE/fed Actual Border NPR Actual Border EPR Equivalent Equivalent Importables Wheat2 679.1 434.5 56.3% 539.7 295.2 82.9% Maize2 579.6 396.3 46.2% 458.6 275.3 66.6% Sorghuni2 632.4 391.0 61.8% 526.9 285.5 84.6% Sugar Cane 100.0 80.6 24.1%2 81.4 62.0 31.4% Exportables Cotton2 348.9 494.9 -29.5% 256.06 402.0 -36.3% Rice2 723.8 528.6 36.9% 573.0 395.9 47.7% Tomatoes3 387.8 522.3 -25.8% 328.06 462.6 -29.1% Potatoes3 653.0 831.4 -21.5% 421.16 599.6 -29.8% Notes: (1) The indicators are evaluated at actual farm-gate domestic and border equivalent prices (adjusted for marketing and transport costs and, when appropriate, for non-tradable by-products) based on the May 2000 exchange rate of 3.4 (LE/USS); (2) These crops were adjusted for non-tradable by-products; and (3) the negative NPRs and ERPs for tomatoes and potatoes could be overstated, due to product quality differences between the domestic and export markets. The divergence's between the NPRs and ERPs are due to the high share of tradable inputs in the cost structure of many Egyptian crops, in addition to differences in trade barriers between intermediate inputs and the final product. FAO's analysis reported no trade barriers on tradable inputs (e.g. NPR equal to zero). Source: Basic data provided by FAO Office in Cairo (Mahmood Ahmed and Abdel Aziz Ibrahim), computations by the World Bank. 3.7 Policy reforn aimed at establishing a more neutral trade regime-for instance, bringing ERPs to near zero for exportables and to 10% for import-competing activities-would provide significant incentive to expand the production of exportables vis-a-vis that of importables. However, while reducing subsidies on the production of import-competing products (e.g., wheat, sugar cane, etc.) could be implemented in a relatively short period of time if the government decide to pursue such option, promoting production of exportables via the removal of the current implicit taxation would require additional institutional adjustments to reduce transactions costs (e.g., domestic and international transportation costs, improved port facilities, etc.) and this would obviously take longer to achieve. Identifying the adjustments required for export promotion are examined in detail in the next chapters for cotton and horticultural products. 3.8 The case of rice raises some special methodological and policy issues which warrant being highlighted. It is well known that rice is a crop that utilizes relatively large amounts of water per feddan and thus its competitiveness is sensitive to water pricing policies, a particularly complex issue in a large country with limited arable land. Increase of water costs could significantly reduce the competitiveness of rice production at the current levels of production. Moreover, World prices for rice are highly unstable (a particularly "thin" commodity market) and quality differences are important in determining the relevant border price. Rice cultivation in Egypt is characterized by very high yields per feddan and production has grown steadily since 1990 (except for 1998) with about 5 to 15% of the milled rice crop exported (primarily japonica rice to Mediterranean markets and lower grades of camolino to Black Sea markets) since the early 1990s (Holztman, APRP/MVE Unit, 2000). 3.9 The NPRs and ERPs for rice, based on the average farm price for the 1998 paddy rice harvest, show that domestic prices in 1998-99 were pushed up by a low crop and high local demand for Egyptian rice NPR of 36.9% and an ERP of 44.7%. However, the high average farm price hides wide fluctuations of the farm gate price during the season (from 420 to 900 LE). The rice exported was the rice bought at low - 12- prices at the beginning of the season. Subsidizing exports would be most undesirable, due to its fiscal cost and to a possible conflict with Egypt's commitments in the WTO; furthermore subsidizing exports would reduce the (relative) profitability of producing other exportables competing with rice production. On the import side, the GOE need to allow for more imports of rice by lowering and removing the tariff. This would allow cheaper, less preferred varieties of rice to enter the market and be sold to poor consumers, mainly in urban areas where demand for rice is expected to be highly price elastic. The highest grades of premium Egyptian rice could be reserved for export to traditional markets in the Mediterranean countries. Adjustments for Water Charges, and for Transport, Fuel and Oil Subsidies 3.10 The analysis of the cost structure indicated that the farm sector in Egypt benefits from subsidies on transport and fuel; similarly, water charges are considered practically negligible relative to the opportunity cost of water in alternative uses. The former were estimated based on detailed estimates compiled by FAO Office in Cairo. The evaluated adjustments for water costs are somewhat hypothetical (rather than the result of "hard" data on what these water prices would be these represent the best judgment of several specialists in the field) and are presented here for illustrative purposes. Computations are based two hypothetical water costs (0.02 LE/m3 and 0.07 LE/m3) and one for groundwater extraction costs. The price and cost used in these calculations was provided by the FAO Office in Cairo based on government sources, while the computations were done by the World Bank. Estimates for water costs represent a cost recovery criteria, which do not necessarily represent the hypothetical opportunity cost of water; the latter would correspond to market prices for water in a situation when water rights can be traded independently from the land. Currently, farmers in the Nile Valley are provided the water at the local distribution location at no cost, and only pay for the cost of pumping the water to their field and cost recovery of on-farm irrigation and public drainage investments. Farmers pay also the full cost of groundwater abstraction in the new lands. 3.11 Estimates of farm returns per feddan at market and border price equivalents after these adjustments are presented in Table 3.2. First, consider the transport, fuel and oil subsidies. Table 3.2 shows that without the subsidies, returns per feddan (value added) both at current market and at border equivalent prices would fall by no more than five percent (except for wheat at border equivalent prices). Moreover, if these subsidies are eliminated when border price equivalent prices were to prevail (i.e., at zero EPRs), then loses in returns would be smaller (larger) for exportables (importables) relative to those that would be incurred at the prevailing market prices. For example, upon elimination of these subsidies returns to cotton would fall by 2.7% at market prices versus 1.7% at border equivalent prices; a lesser loss, albeit only by a small amount. Finally, the ranking (from high to low) of return per feddan from the crops remains unchanged. The overall impression is that the elimination of current fuel, oil and transport subsidies would not significantly reduce the returns to these crops. - 13- Table 3.2: The Estimated Impacts of Eliminating Subsidies and Changes in Water Costs on Returns (per feddan) from Farming during 1998-99 Unadjusted Adjusted for Transport, Fuel and Oil Adjusted for Water Charges Adjusted for Groundwater Subsidies (0.07 LE/m3) Extraction Costs in New lands (0.2 LE/rn3) In LE Rank In LE %* Rank In LE %* Rank in LE %* Rank At Market Prices Importables L________ Wheat 1,441 6 1,404 -2.57% 6 1,404 -2.55% 6 1,336 -7.28% 5 Maize 1,481 5 1,436 -3.04% 5 1,421 -4.05% 5 1,310 -11.59% 6 Sorghum 1,259 8 1,219 -3.18% 8 1,193 -5.26% 8 1,070 -15.03% 7 Sugar Cane 4,028 3 3,919 -2.71% 3 3,784 -6.05% 3 3,332 -17.28% 3 Exprtables. Cotton 1,293 7 1,258 -2.71% 7 1,219 -5.74% 6 1,081 -16.40% 6 Rice 2,086 4 2,020 -2.51% 4 1,897 -13.58% 4 1,546 -38.79% 4 Tomatoes 5,367 1 5,298 -1.29% 1 5,304 -1.17% 1 5,187 -3.35% 1 Potatoes 4,220 2 4,167 -1.26% 2 4,170 -1.19% 2 4,076 -3.41% 2 At Border Prices ._.___. Eouiv_alent ___rtables Wheat 788 7 747 -5.20% 7 751 -4.66% 7 683 -13.32% 7 Maize 889 6 847 -4.72% 6 829 -6.75% 6 718 -19.30% 6 Sorghum 682 8 646 -5.28% 8 616 -9.71% 8 493 -27.74% 8 Sugar Cane 3,066 3 2,958 -3.52% 3 2,822 -7.95% 3 2,370 -22.70% 3 Exportables Cotton 2,030 4 1,995 -1.72% 4 1,956 -3.66% 4 1,818 -10.45% 4 Rice 1,441 5 1,396 -3.12% 5 1,252 -13.12% 5 901 -37.47% 5 Tomatoes 7,568 l 7,512 -0.74% 1 7,505 -0.83% 1 7,388 -2.38% 1 Potatoes 6,008 2 5,955 -0.88% 2 5,958 -0.84% 2 5,864 -2.40% 2 Source: Basic data provided by FAO Office in Cairo (Mahmood Ahmed and Abdel Aziz Ibrahim), computations by the World Bank. - 14- 3.12 A different picture emerges when examining the consequences of changes in water costs. As one would expect, these adjustments especially erode the returns gained from producing water intensive crops. For instance, a water cost of 0.07 LE/m3 at prevailing market prices reduces returns per feddan by 13.6% for rice, 6% for sugar cane, and 5.7% for cotton. Conversely, the effect on horticultural products characterized by high returns and relatively low water use are minimal. For instance, the returns to tomatoes and potatoes, even when subject to water cost of 2.0 LE/m3, do not fall by more than 3.5%. 3.13 With regard to water costs, at least two important results are revealed by Table 3.2. First, for both water costs scenarios, the losses in returns are greater (less) at the prevailing market prices for importables (for exportables) compared to what they would be if border equivalent prices prevailed. Second, while the ranking for all other crops remain unchanged, at current market prices with a water cost of 0.07 LE/m3 the returns to cotton would be marginally greater than those for rice. 3.14 In the context of policy reforms, the impact of trade reforms exceeds those of subsidy elimination and water costs by a significant order of magnitude. For instance, cotton returns increase by 60% from 1293 LE/feddan at the prevailing price to 2030 LE/feddan at border equivalent prices. Such substantial potential gains (losses) from trade reforms for exportables (importables) are not unexpected given the large NPRs and EPRs reported in Table 3.1. Rice is an exception for which returns only increase marginally following trade reforms. However, given the highly variable nature of international and domestic rice prices, these numbers for rice by itself are difficult to interpret. More meaningful and informative are comparative interpretations such as the observation that following trade reforms, cotton would yield substantially higher returns per feddan compared to rice (i.e., 2,030 for cotton versus 1,441 for rice). 3.15 In terms of returns per feddan, Table 3.2 also reveals that at current market prices cotton is ranked 8th compared to a 4th ranking following uniform trade reforms. Moreover, even if trade reforms were to be pursued for the cotton sector only, it would raise to the 4th place in the ranking. This can be seen from Table 3.2 by comparing the returns to cotton at the border price equivalent (i.e., 2,030) with the reported returns evaluated at current market prices of the other crops. 3.16 Hence, under a scenario of no price and trade interventions, and water cost at 0.07 LE/m, returns per feddan on cotton production would increase by 51% (1293 to 1956) while returns on rice would fall by 11% (from 1392 to 1252).Thus, under this scenario one would expect a significant reallocation in cropping patterns from rice towards cotton, which implies a reduction increasing cotton exports and a significant reduction in rice exports. The net effect should result in a positive and significant increase in the net value of Egyptian exports. To the extent that cotton competes for resources currently devoted to the production of the other importables, the net effect on the trade balance should be positive and significantly larger. For example, value added in both wheat and maize production would decline by approximately 48% and 44%, respectively (from 1441 to 751 LE/feddan for wheat and from 1481 to 829 in maize). These are major changes in relative incentives, which if applied across the board within agriculture would probably result in a major change in the crop mix, expanding the area in exportables and reducing that in producing import-substitutes. The net effect on-farm income would be positive and very large. Alternatively, if the reform was restricted to changing the trade and price regime for cotton only (cotton priced at border equivalent prices), other things equal, cotton returns per feddan would increase from 1293 to 2030 LE/feddan, surpassing the returns of rice (1392), wheat (1441). Thus, a partial reform just covering cotton production would still result in a significant additional incentive to expand cotton production. 3.17 Finally, the analysis presents a simulation of what could be impact of adjustments in the exchange rate on farmers incentives. The analysis did not estimating the degree of misalignment-this was beyond the scope of the report-but instead assumed alternative nominal exchange rate values that correspond to the findings reported in the recent World Bank Report Plan of Action for Export Promotion (Sept. 2000). In Table 3.3, the first columns report the NPR and EPR at the May 2000 exchange rate of - 15- 3.4 LE/dollar and correspond to the value reported in Table 3.1. The other columns present the potential impact of two devaluation scenarios, a 10% (3.74 LE/dollar) and a 20% (4.08 LE/dollar) devaluation. 3.18 The calculations indicate that a nominal devaluation of 10% would already significantly reduce (increase) the nominal and effective protection of importables (exportables). In other words, importables are now more competitive because the rate of protection to importables that makes them competitive to the import parity price would be significantly lower. For instance, after a 10% devaluation the NPRs associated with wheat and maize each fall by about 14 percentage points and the EPRs fall by similar amounts (e.g nominal protection "required" falls by 14 percentage points). The 20% devaluation scenario results in even more profound reductions. For example, following a 20% devaluation the NPR for maize is reduced to 21.9%, a less than half of the pre-devaluation level of 46.2%. For exportables, the exchange rate misalignment scenarios illustrate how a devaluation reinforces the effect of the implicit export tax. For example, for cotton, the negative NPR increases from -29.5% to -35.9% following a 10% devaluation and to -41.2% under a 20% devaluation scenario.7 Hence, if domestic prices are fully flexible to react to the devaluation (i.e., bringing NPRs and EPRs to zero), domestic returns received by farmers from exportables would increase significantly as a result of the devaluation.8 Relative to a situation in which the ERP is zero, the output response would reflect the impact of both the trade policy adjustment and the devaluation.9 3.19 Overall, Table 3.3. illustrates that the competitiveness of the tradable sector in agriculture appears to be quite sensitive to the exchange rate policy. Producers of tradable products in Egyptian agriculture (both import-competing and exportables) would benefit significantly from a policy that results in a relative higher real exchange rate. As result of the increase in the border prices resulting from the devaluation, agricultural producers and traders would be in a better position to compete both with imports and with foreign competition in export markets. After some time the devaluation is bound to result in some increase not only in domestic farm prices but also on the cost structure and general price level in Egypt, and so the price wedge observed (NPRs and ERPs) overstates the true impact in the longer term. Note that for the EPR computations the border price equivalent for both the final product and tradable inputs was adjusted for the exchange rate increase. This is what one expects, a very quick reaction in the price of the imported goods. This assumes price flexibility in these markets. However, with respect to the domestic farm gate prices (wheat, cotton, etc.), to the extent that there is some price rigidity as a consequence of government price interventions and/or rigidities in the marketing structure, it is unlikely that producer output prices will react significantly to the devaluation in the short-run. In the longer term, of course, one expects that domestic prices will increase by some proportion of the nominal devaluation. s The exchange rate effect is the same for all products. Here we have adjusted the NPRs and ERPs for the nominal exchange rate and not to changes in the real rate. For a discussion on the methodology to compute NPRs and ERPs adjusting for a real devaluation see Schiff and Valdes (1992). 9 The percentage change in output is equal to dlog X = E*ERP where X is the level of output of the activity, E* is the elasticity of supply of output with respect to ERP, and where E* = ev, where e is the elasticity of supply in the usual sense and v is the rate of value added to price (Valdes, 1973). - 16- Table 3.3: Simulation of the Short-Term Effects of a Devaluation on NPR & EPR for 1998-99 NPR EPR Devaluation 3.4 LE 3.74 LE 4.08 LE 3.4 LE 3.74 LE 4.08 LE scenarios May 2000 10% 20% May 2000 10% 20% Importables Wheat 56.3% 42.1% 30.2% 82.9% 66.2% 52.4% Maize 46.2% 32.9% 21.9% 66.6% 51.4% 38.8% Sorghum 61.8% 47.0% 34.8% 84.6% 67.8% 53.8% Sugar Cane 24.1% 12.8% 3.4% 31.4% 19.4% 9.5% Exportables Cotton -29.5% -35.9% -41.2% -36.3% -42.1% -46.9% Rice -2.6% -11.4% -18.8% -3.4% -12.2% -19.5% Tomatoes -25.8% -32.5% -38.1% -29.1% -35.5% -40.9% Potatoes -21.5% -28.6% -34.6% -29.8% -36.1% -41.5% Nota: The average exchange rate for the period January-September 2001 was 3.97 LE/US$1 - 17- PART II: SUBSECTOR ANALYSIS CHAPTER 4. TOWARD A BETTER MARKETING AND PRODUCTION STRATEGY FOR COTTON IN EGYPT 4.1 The 1999-2000 and previous two or three marketing seasons illustrate the impasse Egypt reached in the cotton and textile sectors by trying to promote cotton exports while protecting the textile industry. 4.2 The main features of this stalemate for cotton production are listed below: * Land use for cotton production in Egypt reached a record low in the past decade, with only 550,000 feddans planted in 2000 compared to about 900,000 in 1996-97. * While Egypt appears to have unique competitive advantages in the production of extra long staple varieties, this production nearly disappeared over the last decade, although it now shows signs of slow recovery. * Large inventories of extra long staple stocks were kept in storage at great cost to the government. However, half the inventories of extra long staple stocks were sold in 2000 because of rising world prices and prospects for low supply in the coming harvest. Nevertheless, the underlying cause of the problem-inflexible pricing-remains. 4.3 The main features of the cotton and textile export situation in Egypt are listed below: * Egypt suspended exports of cotton after only five weeks of the 1999-2000 season for fear that too much cotton might be exported. Spinning mills are not importing short staple cotton (priced well below those of Egyptian varieties) to satisfy the need for coarse yarns in the local market because they do not have cash and banks are not willing to provide them with credit. * High export prices for Giza 70 and Giza 77 cotton have made extra long staple non- competitive compared to American Pima, but the Alexandria Cotton Exporters Association (Alcotexa) is powerless to reduce prices to improve export sales. * Low prices for long staple cotton varieties in the domestic market made them competitive compared to American Pima, but Alcotexa minimum export prices restrict their competitivenes. * Spinning mills are non-competitive internationally in the production of yam, even fine yarn. Exports of yarns and fabrics have practically disappeared in recent years. In addition, the public spinning mills are highly indebted to the banks, with outstanding loans reaching LE 2.5 billion. * Neither Egyptian cotton producers nor spinners benefit from the boom in Egyptian exports of ready-made garments. Private sector manufacturers of ready-made garments are rapidly expanding investments and exports, but do not use Egyptian cotton. Instead, they mostly use imported yarns and fabrics from Asia, brought in duty free under "temporary admission." * Cotton, perhaps the product with the greatest export potential, prolongs the survival of the public sector spinning industry. - 18- * Egyptian consumers pay for fabrics and textiles nearly double the price of these products in the world market. High tariffs and non-tariff barriers on imported fabrics prevent real competition. * Pricing of cotton varieties is isolated from market signals and subject to state intervention. However, the govemment has made much progress over the last three years in reducing unsustainable levels of subsidies and bringing exports prices and floor prices for farmers in closer alignment with international prices. Shortcomings of the Current System 4.4 The current marketing system in Egypt is characterized by marketing rings, fixed prices for seed cotton, lack of competition through minimum export prices, and lack of accountability on carry-over stocks. Lack of Competition in Marketing Rings 4.5 Before the start of the marketing season, the government authorizes the Principal Bank for Development and Agricultural Credit to establish a network of about 900 collection rings to facilitate the reception and sale of raw seed cotton from farmers. Seventy percent of these rings are assigned to public trading companies and the remaining 30 percent to private traders. 4.6 Private trading companies compete for the right to be assigned these collection rings. Any rings remaining after this phase are assigned to the public trading companies. Farmers who bring cotton to a marketing ring can sell only to the trader designated to operate that ring. Farmers can also sell outside the ring to other traders, but then lose access to the weighing and classing services provided as part of the ring. The buyer designated to operate a ring is obliged to buy all cotton brought into the ring. 4.7 The government should cease the current policy of limiting the number of cotton marketing rings assigned to private sector buyers and allowing only one buyer per ring. Rules and requirements for competing for rings should be transparent and balanced, not biased in favor of public sector buyers. If only one buyer per ring is permitted, then rings should be allocated whenever possible to private sector buyers, or to all buyers on a competitive basis. 4.8 Multiple buyers should have access to all cotton rings. In the past, the Principal Bank for Development and Agricultural Credit has set up and managed the rings competently and handled payments to farmers. However, for accounting convenience, the Principal Bank allows only one buyer to purchase cotton in a ring, granting a virtual monopoly power to that buyer over farmers in the area served by the ring. Granting such exclusive rights to any one trader is unjustified. The Principal Bank's computerized accounting system already keeps track of each farmer's cotton deliveries and payments, provides detailed printouts of each farmer's individual account, and makes appropriate charges and deductions for services such as grading, weighing, guarding, storage, and overheads. 4.9 Buyers at marketing rings should be free to buy only what they want, not forced to buy all cotton brought into the ring. Again, the government should be only a buyer of last resort. Deficiency payments are distributed to farmers when market prices fall below the announced floor price, which should be the same for all varieties but varies according to the grade of seed cotton. - 19- Distortion of Market Signals by Fixed Prices for Seed Cotton 4.10 Tables of prices for every variety, grade, and out-turn ginning ratio are published at the start of the season. In principle, Alcotexa should adjust these price tables for raw cotton every week as it adjusts prices in response to changing market conditions. However, in practice, Alcotexa does not adjust prices, and therefore the seed cotton table becomes de facto fixed prices for the entire seed cotton sale season (September through November). If the government wants to keep issuing floor prices to pay farmers for seed cotton, it should announce only one floor price for all varieties grown in the Delta and another for those grown in upper Egypt. 4.11 Market demand, not government committees, should determine price differences between varieties. Separate official floor prices introduce arbitrary distortions and prevent farmers from learning the true market prices. Costs of production per feddan for all varieties of cotton grown in the Delta are virtually identical, and yields per feddan are similar. So, there is little justification for different floor prices for farmers producing different varieties. In normal years, market prices exceed the floor price, so that private and public traders can buy directly from cotton growers, The main reason for announcing separate floor prices for each variety is to give public trading companies a buying price. Public trading companies should learn to compete with the private sector by offering competitive market prices. Lack of Competition Through Fixed Minimum Export Prices 4.12 Alcotexa has legal responsibility for setting minimum export prices for every variety and grade of cotton exported, as well as setting the minimum exportable grade permitted. Alcotexa publishes a set of prices at the beginning of the marketing season in September. In principle, it has the power to adjust those prices weekly in accordance with changing market conditions. But in practice, Alcotexa cannot adjust prices, so the opening prices become fixed prices for each variety and grade throughout the marketing year. 4.13 The main purpose of the fixed price system is to prevent competition among traders, particularly between public traders and private traders. Public trading companies would not be able to compete with private cotton buyers without fixed prices. Public buyers offer farmers one price and have no discretion to negotiate, even when circumstances might demand negotiation. Without minimum export prices, public trading companies would not be able to compete with private exporters willing to negotiate prices with potential buyers. The system of fixed prices is therefore essential to keep public sector trading companies alive and active in the cotton market. 4.14 At the center of the many problems faced by the cotton and textile sectors is the export pricing mechanism: arbitrary and rigid export prices set by committee. These pnces are only weakly related to international markets, and once announced, they are inflexible. No other factor has been as detrimental to the Egyptian cotton sector as the lack of market prices. 4.15 Rigid non-competitive prices have led to several unintended outcomes: the demise of some of the best Egyptian varieties (Giza 75, 76, and 77); accumulation of huge and costly carry-over stocks; the near disappearance of extra long staple from Egyptian cotton exports; loss of market share of world extra long staple exports to competing countries; and bankruptcy of the public cotton spinning industry. 4.16 Repeated efforts to reform Alcotexa's pricing procedures have failed to make administrative export prices more responsive to market developments. While opening season export prices are more closely aligned with world market prices, they remain fixed throughout the rest of the season. In any cartel pricing system, adjustments can be made only when all members agree; any member can veto an agreement on needed price changes. - 20- 4.17 The government therefore should promote a competitive pricing mechanism for cotton by instructing Alcotexa not to announce export prices. Trading companies should learn to compete among themselves to market their cotton. Until now, Alcotexa has shielded public sector companies from learning to compete in both the domestic and international market. 4.18 The government should revoke or amend the decrees and regulations giving Alcotexa the power to set export prices. Alcotexa can and should continue its other valuable and legitimate functions, such as collecting and reporting export statistics, enforcing a code of conduct among its members, and arbitrating disputes between buyers and sellers when they arise. Lack of Accountability for Management of Carry-over Stocks 4.19 The government should cease the current practice of taking over responsibility for the financial and carrying costs of cotton remaining unsold at the end of the marketing season. Trading companies should be accountable for the disposition of cotton inventories. 4.20 At present, no one has clear responsibility for disposing of carry-over stock from previous years. At the end of each marketing season, all costs and responsibility for unsold inventories are transferred to "the government," removing incentives for state trading companies to sell old cotton. The government has no independent means to market old stocks, for which it depends on the state trading companies. But the trading companies have strong disincentives to sell old cotton stocks because such sales would compete with the sale of the current crop. 4.21 The present price setting system is designed for the current crop. Neither the government nor Alcotexa can determine market prices for stocks from previous years. Whenever price discounts on old inventories are proposed, any member of Alcotexa, private as well as public, can object to them. Only after the entire current crop is sold can Alcotexa consider price discounts for old stocks. 4.22 The result of this lack of accountability is that old stocks are forgotten. In the past, after a few years of deterioration, they were dumped in the local market by forcing state spinning mills to accept old cotton at salvage discount prices. In recent years, however, the disastrous yields of the 1998 crop and the severe decline in area planted resulted in record low production, opening the door for rapid disposal of accumulated inventories that reached at one point over 180,000 tons and about 40,000 tons in June 2000. 4.23 Public trading companies should be accountable for all the cotton they purchase, and should not have the option of transferring to the government cotton they have failed to sell at the end of the season. The government should be under no obligation to take the cotton back since the price deficiency payment has already compensated the trading companies for purchasing the cotton at floor prices. Elements of a Sustainable Cotton Marketing Strategy 4.24 The government retains its comrmitment to farmers to serve as the buyer of last resort if and when prices fall extraordinarily low. However, the government could set only one, common minimum floor price for all varieties and allows the market to determine price differences among varieties. The common minimum must be sufficiently low to allow the private sector to purchase cotton or the government will end up purchasing the entire crop, with known consequences. Adjusting Farm Prices to Reflect Market Conditions and Vary Across Varieties and Grades 4.25 Farm pricing that reflects market conditions and differs according to variety and grade of cotton is the most important step to allow market forces to determine price movements up and down according to changing local and world markets. Such pricing will also alleviate the government's impossible responsibility for setting fixed prices for cotton varieties. - 21- 4.26 In the proposed strategy, actual prices received by farmers would vary by variety and grade. Competition for spinning mills among traders, exporters, and buyers would ensure that the most desirable varieties and grades received better prices than ordinary and below-average cotton. 4.27 For cotton, as for other crops whose markets have been liberalized, a competitive marketing system alone would ensure that farmers' prices consider differences in grades, cleanliness, timing, and location. For marketing stability and continuity, Egypt should approach the move toward a single floor price for all Delta varieties in three stages. In the first year of the new strategy, the market would determine only the price of Giza 70, but farmers would still receive the floor price set for Giza 85. Of course, the market would determine export prices for Giza 70 in competitive interplay between buyers and sellers. Restrictions on minimum export grades would also be removed. 4.28 Domestic spinning mills could buy Giza at prices negotiated with farmers or traders according to the grade and conditions of the transaction. Public sector trading companies would have to compete with private buyers for the purchase of Giza 70 production. Public sector buyers might need training in how to compete when they are not given fixed prices to offer to cotton farmers. 4.29 In the second year, Giza 89 would be subject to the same marketing conditions as Giza 70- market-determined export prices, no restrictions on export grades, and the same guarantee floor prices as for Giza 85. Giza 86 and Giza 85 remain in the current fixed-price category. 4.30 In the third year, Giza 86, Giza 85, Giza 70, and Giza 89 would form a single block of market- priced varieties for the entire Delta region. The government would be responsible for deciding a single common floor price for all varieties, allowing market forces to sell all export prices and variety and grade differentials at prices received by farmers. 4.31 The government must be careful to choose a reasonable common minimum floor price. If that minimum is too high in relation to actual market conditions, the government may have to purchase large volumes of the cotton crop from farmers. In previous years, the accumulation of large stocks in government hands has been disruptive for the Egyptian cotton market. 4.32 This analysis does not consider the price of Giza 45 cotton, which is no longer grown in its small area. Huge unsold stocks of this variety are in storage. The high yields and modest export volumes of Giza 80 and Giza 83 planted in Upper Egypt warrant separate treatment from the Delta varieties. The government might extend the current policy to these varieties by assigning a single floor price for both and removing all restrictions on export prices and export grades during year two of the strategy. By then, the first-year experience with Giza 70 will have allayed decision makers' misgivings about the market. Holding Weekly Pilot Auctions for Price Discovery 4.33 Without fixed prices set by Alcotexa, farmers and traders will need a mechanism to determine the appropriate price for a given variety and grade. To facilitate price discovery in the first year of the new strategy, Alcotexa would establish a weekly auction of a small volume of Giza 70 taken from the large stock in government hands. The auction would determine transparently a reference market price for Giza 70. This market reference price could then be used by traders, exporters, farmers, ginners, and spinners to negotiate their own price levels appropriate to each transaction. The weekly auction reference price would serve as a barometer of demand for the variety auctioned. 4.34 The weekly volume sold at each auction should be known several months in advance. A small quantity would be sufficient to determine the auction reference price. The rest would be transacted directly between buyers and sellers using the weekly auction price as a reference. Four to six small containers (120- 160 tons) would be enough to attract the interest of foreign spinners and traders. - 22- 4.35 Alcotexa should manage the weekly auction, guaranteeing its transparency and enforcing its results. However, Alcotexa might prefer to subcontract the operation of the auction to a reputable international firm to widen the customer base and ensure credibility. Alcotexa would be bound to honor and enforce the results of the auction, even when these are not entirely satisfactory to the seller or the industry. 4.36 A system of pre-registration of bidders and down payments could prescreen potential bidders. Alcotexa could exploit the Intemet-based auction houses dedicated to business-to-business transactions to facilitate the auction and ensure transparency. Alcotexa already has a state-of-the-art information management center that publishes weekly reports of export transactions that can be downloaded through the Intemet all over the world. This computing center could easily be upgraded to manage the electronic auction. 4.37 The bales of Giza 70 offered for auction initially will come from existing government stocks, but as it gains experience and confidence, Alcotexa should offer for auction bales owned by either private sector traders or public sector trading companies. Given the public-good nature of the auction results- providing a market reference price as indicator-Alcotexa might charge a modest fee for the auction or even offer an incentive to traders who submit bales for auctioning. 4.38 Alcotexa should disclose all pertinent information about the bales auctioned. The year of production, classing grade, and high volume instrument test reports of fiber characteristics should accompany the auction announcement. All auctioned bales should include high volume instrument data because of their increasing prevalence in the world market and their widespread use by spinning mills to determine optimal blending of bales with different characteristics. Alcotexa should auction bales that are classed in the predominant grades obtained for a given variety. The auctions should focus on Giza 70 bales graded good+3/8th and good+l/4th, which make up most of the 1998-99 crop, rather than on the extreme upper and lower grades. Controlling Quality Through High Volume Instrument Testing and Classing 4.39 High volume instrument equipment rapidly tests for fiber length, strength, fineness, foreign matter, color, elongation, and uniformity. Use of high volume instrument fiber testing is irreversible in the spinning industry, especially among spinners of finer yarns with demanding specifications. More and more yarns are produced from blend combinations of cotton bales from multiple origins and varieties. Egyptian cotton adds strength to shorter staple cottons in blends, but because Egypt has lagged behind in high volume instrument data, foreign spinners lack evidence of the superior characteristics of Egyptian cotton. 4.40 The Cotton Arbitration and Testing General Organization (CATGO) is the official agency responsible for testing and grading cotton. CATGO tests every lot (20-30 gin bales) of cotton coming out of gins but cannot do bale-by-bale testing. Spinners need bale-by-bale information to judge the homogeneity within a lot for transactions. 4.41 Alcotexa issues price lists based on grades. These grades are determined subjectively by visual inspection. Unfortunately, grades bear little or no statistical relation to high volume instrument measurements. The system of grades used in Egypt for export lint probably has little significance in terms of spinnability. Since export prices are based on grades, prices of Egyptian cotton might only weakly reflect the spinning properties of Egyptian fibers. 4.42 Moreover, Egyptian cotton has traditionally been sold by type rather than grade. Types correspond roughly to a blend of grades within a given range of the same variety. Exporters have - 23- developed their own nomenclatures of types for each variety and customer. Different exports are not comparable. Customers receive samples of each type and decide on purchases accordingly. 4.43 Egyptian cotton is sold almost entirely to large intemational merchant houses, and these merchants then resell to foreign spinners. One of the services provided to the spinners by the cotton merchants is high volume instrument information on Egyptian cotton. By providing such data bale by bale, Egyptian exporters might be able to deal directly with foreign spinners and bypass the arbitrage activities of merchant houses. 4.44 Unless data on fiber properties is made known to the trade immediately after it becomes available, it is nearly useless. CATGO only publishes averages for each variety at the end of the season. The periodic reports on its cotton that CATGO provides to Alcotexa members is not publicly available. Grading and testing are legitimate government functions used in many countries. Testing by CATGO, a neutral organization between buyers and sellers, facilitates trade and is more trustworthy than self-testing by individual exporters. The government should empower and enable CATGO to sample and test each cotton bale from private and public gins and to disseminate fiber test information through a Web site or other public media. CATGO should first test all export bales (universal density bales or standard Egyptian bales after farfara-mixing different bales to homogenize cotton quality, carried out in Alexandria-and repressing). 4.45 To make the weekly auction reference prices more useful, export transactions should rely on high volume instrument testing of fiber specifications. In the first year, all Giza 70 export transactions should provide high volume instrument test results and classing reports. For this purpose, CATGO's capacity to perform high volume instrument tests on samples of every bale of Giza 70 should be strengthened, as CATGO has the equipment to conduct all appropriate high volume instrument tests but does not perform these tests routinely on all cotton bales. Establishing an Internet-based Marketing Channel for Cotton and Yarns 4.46 The Intemet and e-commerce are revolutionizing trade in many commodities. Any Internet user in the world can purchase and sell at the New York Board of Trade cotton futures contracts and options to buy (calls) and sell (puts). The United States Department of Agriculture has started an Intemet-based tendering system to sell cotton stocks accumulated when farmers forfeit upland cotton to the U.S. government in lieu of payment of govemment-guaranteed bank loans. hi January 2000, the Kansas City office of the Commodity Credit Corporation opened Intemet-based tenders for the sale of extra long staple cotton (American Pima). Several tenders have covered nearly 50,000 bales, or 12,000 tons. Each potential buyer submits one blind bid through the Internet. There is no auction-like upward pressure on offered prices in subsequent bids. 4.47 The Egyptian govemment should establish and support an Internet-based cotton trading facility to enable cotton and yarn producers, manufacturers, traders, and exporters to submit for export at competitive prices through open and transparent intemational bidding. 4.48 The ministry in charge of foreign trade or another suitable agency such as CATGO or Alcotexa could set up and maintain this international online auctioning facility, with the intent of transferring it to a private organization after two or three years of operation. With donor support, Egypt could model the facility on the TELCOT system, which was based on the New York Stock Exchange system and managed by the Plain Cotton Cooperative Association in Texas for more than 30 years. Initially, this Internet auction facility could facilitate exports of cotton lint and yarns supplied mainly by several public sector enterprises. Eventually, however, the e-commerce facility could be opened and expanded to a large variety of export products from Egypt. - 24- 4.49 The principal benefit of the proposed online trading facility would be a transparent marketing mechanism to determine market prices for Egyptian cotton and yarns to replace the current system of fixed administrative prices for exports. The govemment should accept the prices generated by such a competitive and transparent system and abandon its failed attempts to control international prices through price fixing. Privatization of Downstream Activities 4.50 Privatization in the Egyptian cotton and textile industry, although limited, has contributed significantly to quality and competitiveness. Despite the 1994-94 crisis, the share of the private sector in procuring seed cotton rose from 22 percent for the 1998-90 season to 44 percent for the 1999-2000 season, with 18 private firms out of a total of 31 firms delivering cotton to the gins (Krenz and Mostafa 2000). Experience with leasing has been mixed. Leasing has not been successful in the cotton ginning industry and has not allowed modernization of equipment, although it has been successful for spinning and weaving companies. Two public textile companies have been leased, ESCO spinning by the Korean company Dong Il and Cairo Silk (dye house) by Glass Company. These have been quite successful. The Glass dye house is running at full capacity, having added a garment sewing section and planning to add a weaving section. 4.51 Although limited to two public ginning companies, private ownership has improved performance and quality significantly. The ginning technology used by the public gins, although very old (from 1840) is considered the best available for Egyptian ELS cotton. Therefore, all improvements aim at improving quality of lint though cleaning and exportability through pressing international standard bales. Cleaning tables have been installed at nine gins, and pneumatic suction systems and automatic feeding systems have been installed at four gins. Export costs have been reduced by the installation of universal density presses at six gins. These presses produce standard high density bales (500 kilograms per cubic meter) ready for export, avoiding repressing in Alexandria. 4.52 Private ginning companies are establishing quality control systems and training facilities and now compete with the Alexandria Pressing Company for re-pressing services. Completing the privatization of the ginning companies is a priority to improve competition and reduce costs. The scarcity of industrial land in the Delta and the Nile Valley is exacerbated by the law preventing building on agricultural land. In privatizing the ginning companies, the government is concerned that the land on which the gins are built could be used for other purposes. A special clause in the privatization contracts could guarantee the land's exclusive use for the textile industry. 4.53 Despite the success of the ventures described above, there have been no further sales or privatization. Overvaluation has priced the companies outside their market value, and leasing and management contracts have not been forthcoming. The cotton trading companies have not begun privatization. Although these companies have no physical facilities and simply rent office space, they have built up excessive debt of 4 billion pounds, or $1.16 billion. Two years ago, the government forgave the debt, but the opportunity for privatization through management buyouts with anchor investors was lost. Now the trading companies have incurred more debt, although their receivables (from the government spinning companies) equal their debt levels and make their balance sheets positive. The reason for considering management buyouts is that the companies' only value is their directors' unique blends for each company and their exclusive clientele. This intangible asset (goodwill) will be difficult to value. Privatization of the trading companies is an important step toward full liberalization of the sector. Liberalizing Farmer Price and Instituting a Market-based Price Insurance Mechanism Available to Farmers 4.54 After establishing the market-based cotton trading system, the government could develop a program to manage price risks. Such a system would be useful because if hedging on forward or future - 25- contracts can reduce the uncertainty of the selling price for cotton (that is, if the market risk can be reduced), then incentives to grow cotton may increase. Managing price risks would have a favorable impact on both poverty alleviation and policymaker concerns about the cotton sector, because cotton is much more labor intensive than most other major crops (A 1997 GTZ farm-level survey estimated labor demand for cotton at 127 labor days per feddan, compared to 48 labor days per feddan for rice). Hence, increased cotton production will provide more demand for labor in the agricultural sector and increase on- farm employment. 4.55 Egypt has no independent provider of price insurance, as the state provides this service free of charge. However, the country continues to take steps to liberalize its agricultural sector and to eliminate its unsustainable state price policy for cotton (as it has already done for all other crops). Once the state price policy is eliminated, it is unrealistic to assume that a private sector entity will immediately step in to provide price risk management to producers. Moreover, elimination of a price policy may create substantial disruption as producers and traders adjust to the new environment, as experience has shown this type of policy reform to do. Viewed in this context, the government could offer producers a program such as that of the Intemational Task Force on Commodity Risk Management in Developing Countries. In this way, the International Task Force program can foster and facilitate liberalization in the sector. 4.56 The cotton industry sees the development of a standard price insurance policy for cotton and its intermediation with price insurance providers as a promising possibility, albeit one with high implementation costs. This policy would require high technical expertise at both local market and international levels. In addition, such an initiative would need guarantees that the government would not interfere and create such disincentives as highly subsidized floor prices for seed cotton, which would undermine the demand for such insurance. 4.57 Because of its superior spinning and weaving characteristics, Egyptian extra long staple cotton faces a market quite different from that of standard upland cotton varieties. Prices correlate poorly with those of most other types of cotton, so that it is impossible to hedge Egyptian Extra long staple cotton on the New York cotton exchange (a 1993 World Bank study by Varangis and others established conclusively that there was little possibility of using the New York Cotton Exchange to hedge Egyptian cotton exports). However, Egyptian cotton is comparable to the Pima extra long staple cotton grown in the western United States. While American Pima cotton is traded actively, it has no futures contract. A price quotation for American Pima cotton is published by both Cotlook, an industry organization that provides market information, and the U.S. Department of Agriculture's Agricultural Marketing Service. Therefore, the preferred approach for a pilot case for Egyptian cotton is likely to be evaluating an agent's willingness to supply price insurance based on one of these two reference prices. In the long term, an Internet-based cotton trading facility for these types of high quality cotton would improve the ability of price insurance providers to hedge adequately. Removing Taxes and Restrictions on Imported Cotton 4.58 The government of Egypt should remove all unnecessary administrative and regulatory restrictions on and impediments to importation of cotton by spinning mills. Any private or public company should be allowed to import cotton from the world market under reduced import duties and sales taxes, so that the combined burden does not exceed 5 percent of the cost-insurance-freight price. 4.59 Egypt expects a series of low cotton production seasons over the next few years. The decline in cotton production is the result of farmers adjusting to low prices and rising costs in recent years and the rising competitiveness of other crops and crop rotations. Preliminary projections for the 2000-2001 crop are truly dismal: area surveys indicate that farmers have planted only about 550,000 feddans, the smallest area in a century. - 26- 4.60 In the past, the government's natural reaction when faced with low production was to impose a ban on exports, as it did in October 1999 when exports of long staple cotton were unexpectedly successful. The effect of export bans on the future of Egyptian exports would be devastating, as the 1995 cotton export ban demonstrates. Egypt should avoid repeating the vicious cycle of flushing excessive carry-over stocks followed by banning exports. To prevent a ban on exports of Egyptian cotton in 2000- 2001 and in subsequent years, the government must allow spinning mills to import short staple cotton for the domestic market. This would release Egyptian cotton for export at higher prices and improve the competitiveness of spinning mills by accessing raw materials at only half the cost. 4.61 The Ministry of Agriculture and Land Reclamation has greatly liberalized the phytosanitary restrictions that in previous years practically blocked imports of cotton from the outside world. However, spinning mills have not been able to take advantage of the simplified phytosanitary regulations because imported cotton still encounters bureaucratic hostility and unexpected problems in clearing customs. For example, the dispute about the legality of imposing a sales tax on imported cotton while exempting domestic cotton remains unresolved. 4.62 Most yarn production from Egyptian spinning mills goes to the domestic market. This market can be satisfied with imported lower-value cotton instead of Egyptian cotton, freeing high-value Egyptian cotton for export. Egyptian consumers would benefit from more affordable cotton fabrics. 4.63 International promotion of an Egyptian cotton logo need not suffer from the importation of short staple cotton for the local market. Those manufacturers granted permission to use the logo should abide by truth in labeling requirements, and adequate inspections could enforce the proper use of the logo. Liberalizing the Market for Cottonseed and Cottonseed Oil 4.64 The Ministry of Agriculture and Land Reclamation should revoke the current decree that requires all cottonseed to be surrendered to the government after ginning. The Ministry will still require mandatory sterilization of cottonseed not used for planting. Private sector trade in cottonseed is practically banned. After ginning cottonseed is sold to the government at fixed prices and then resold to vegetable oil manufacturers, also at fixed prices, farmers are not allowed to reclaim their own cottonseed for use as livestock feed. 4.65 Huge stocks of cottonseed have accumulated in past years as a result of this dual-fixed-prices policy. When oil extractors find it cheaper to import soybeans or other types of vegetable oil than to buy cottonseed from the government at the fixed price, the cottonseed stocks become a source of pests and disease. 4.66 Cotton authorities' concern that farmers might use commercial cottonseed to plant unauthorized varieties in their districts can be addressed by retaining mandatory heat sterilization to prevent use of the seeds for planting. The government has no strong rationale for trading cottonseed after it is sterilized. The private sector should be able to market cottonseed, cottonseed oil, and cottonseed cake at competitive market prices. Improving Cotton Exports' Competitiveness Through Adjustments in Pricing and the Exchange Rate 4.67 Egypt's cotton exports in the past two decades were affected by two major factors: the closure of the Eastern European and Russian markets, where barter trade agreements paid little attention to quality, and the shift in fashion from formal wear to casual wear. In spite of these market shifts, until recently, Egypt continued to overprice its cotton products, denying the declining productivity and competitiveness of Egyptian cotton and the declining performance of the textile industry. - 27- 4.68 Overpricing of Egyptian cotton exports made possible the rapid growth in the past 15 years of competing long staple cottons, notably American Pima grown in the southwestern United States. Only in the past few years has Egyptian cotton regained part of the world market share. It is, now roughly on a par with Pima. 4.69 Furthermore, the competitiveness of Egyptian cotton exports in its principal markets in Europe has been severely damaged by the appreciation of the Egyptian pound compared to European currencies and most recently the Euro. The Egyptian pound is pegged to the U.S. dollar, and prices of Egyptian cotton are quoted in U.S. dollars. The drop in exchange of the Euro to 90 cents means an increase of 29 percent in the price of Egyptian cotton from the perspective of European spinners since January 1, 1999, when the Euro was introduced. Eliminating the Buyback Option at the End of the Season 4.70 The final element essential for the new cotton marketing strategy is the elimination of the government buy-back of all cotton on stock remaining unsold at the end of the season in July or August. In past years, trading companies had little or no incentive to sell off their cotton because they knew the government would buy back all the unsold stock at the end of the season at the original price paid to farmers. The government should make clear in the first year of the new strategy that it is not responsible for unsold stocks of Giza 70 at the end of the marketing season. Of course, the government may continue the buy-back commitment in the first year for varieties still subject to fixed prices, but it should discontinue the buy-back as those varieties change to market prices. 4.71 The weekly auction reference price also provides a way to implement a price deficiency mechanism supporting the floor price. If the price of Giza 70, for example, falls below the guaranteed common floor price set for Giza 70 and Giza 85, a deficiency payment can be paid. The payment should be equal to the difference between the auction price equivalent and common minimum floor price. Payments would be made directly to exporters or to traders selling to local spinning mills Improving Cotton Production Technology 4.72 Egyptian cotton yields have not improved significantly during the past decade, and many observers believe they have declined. By contrast, yields of American Pima consistently increase and have reached, in California, nearly the levels of upland cotton. Reasons include the decline in world market prices in recent years for cotton and the increasing relative competitiveness of rice and maize, the major alternatives to cotton. 4.73 Subsidies aside, the key to regaining the attractiveness of cotton for farmers is increasing the productivity per land unit. According to field trials of the Egyptian Cotton Research Institute, the yield potential of some Egyptian varieties is above 12 kentar per feddan, while the average harvested is about 7 kentar per feddan. Egypt's most competitive variety, Giza-70, is over 20 years old, but its yield remains strong and higher than that of most long staple varieties. Other extra long staple and long staple varieties introduced in recent years were phased out for agronomic or commercial reasons. The transition of new varieties from experimental station to commercial production has been difficult. Breeders need to test new varieties under farmers' growing conditions before deciding the merits of new varieties. Cotton Breeding and Research to Raise Profitability and Meet Market Requirements 4.74 Administratively determined prices and marketing controls on cotton trade have distorted the perceptions of farmers, agronomists, and policymakers perceptions about real market signals. Low exports of the legendary Giza 75 (an extra long staple variety with exceptional characteristics, highly valued by foreign spinners), which led to its discontinuation, resulted more from noncompetitive pricing decisions than from quality deterioration of this variety. Lack of market prices for Egyptian varieties - 28- makes it difficult for agricultural scientists and decision makers to compare the profitability of different cotton varieties. 4.75 Introduction of genetically engineered cotton varieties with built-in resistance to disease and insects has enhanced the competitiveness of growers in the United States and other countries. Egyptian cotton varieties are far from such advances in genetic engineering. Variety Policy 4.76 Breeding and research in Egypt is burdened by the conflicting goals of producing the finest cotton in the world for the export market or producing ordinary and cheap cotton for the domestic Egyptian market. Dual-purpose varieties have not been successful. Egypt would be better served by pursuing separate breeding and research programs for these two markets. 4.77 The choice of cotton varieties remains a central government decision with little or no input from farmers. Traders and cooperatives should have a greater voice in decisions about which cotton variety to plant in their districts. Ideally, such decisions should be left entirely to farmers' associations or negotiated by these associations with traders and gin mill operators. Farmers' interest in and potential for producing the most profitable varieties have been sacrificed in the past to ensure the supply of raw material for the domestic spinning industry. Egyptian farmers' competitive advantage in producing high- value extra long staple cotton for the upper end of the intemational market is thus compromised in the interest of maintaining a stagnant and noncompetitive industry. 4.78 Egypt needs a clearly defined long-term (over several years) market-oriented variety policy to provide markets with the right product and farmers with the highest-quality seed in sufficient quantities. For exports, Egypt's competitive advantage lies in the extra long staple varieties, in particular Giza 70. Therefore, the export strategy should be extra long staple oriented. The local spinning industry needs high-yielding long staple and medium long staple (MLS) varieties. According to Cotton Research Institute studies (CFDT 1999), the highest yield potential for the producer comes from the Giza 70 (7.5 kentars per feddan), Giza 89 (10.3 kentars per feddan) and Giza 83 (11 kentars per feddan). The number of varieties should be reduced and new varieties should be introduced slowly and carefully into the market. 4.79 Introduction of short staple upland cotton production in some of the New Lands under reclamation could provide cheaper raw material for the local industry and thus release land in the Delta and Nile Valley to increase extra long staple production for export. However, the country must weigh the potential benefits of upland production under highly mechanized conditions in the New Lands against the option of importing the same cotton from the international market. 4.80 Technological advances in the spinning industry worldwide have raised challenges for the Egyptian cotton sector. For example, core-spinning yarns combining the strength of man-made filament core with a wrapping of high-grade cotton compete effectively against yarns made solely with extra long staple cotton. Similarly, high-strength, low-twist, ring-spun yarns developed by the Swiss expanded the use of short staple cottons at the expense of long staples. But the main factor behind the declining demand for extra long staple cotton in the last two decades has been the shift in consumer preferences toward casual wear. However, this trend seems to be reversing, and there are signs of increasing consumption of fine cottons in America and possibly Europe. Seed Quality Improvement 4.81 Expanded use of acid-delinted seed in combination with seed dressing with systemic insecticide, such as Gaucho®, could increase yields substantially. For the new season, the seed dressing could be introduced for varieties that are already acid delinted. More important, these innovations allow - 29- production of high-quality seed on specialized farms instead of the current reliance on commercial production of breeding material for the next season. Moreover, the proposed seed quality improvement removes the rationale for mandatory assignment of only one variety to each district to prevent potential mixing of seed from different varieties. 4.82 Long-term components of a strategy to increase productivity include research programs and improved problem-oriented extension services to provide farmers with productive varieties and improved crop management practices. Decades of state patronage have left farmers with weak crop management skills in spite of the long tradition of cotton production in Egypt. In the short run, the seed sector urgently needs technical innovations. Field trails show that the combination of acid-delinted seed with a seed dressing containing fungicides and systemic insecticides increases the yield between 10 and 40 percent (20 percent on average). Higher germination rates of better-selected seed during processing could reduce the seed rate per land unit significantly. 4.83 Under given price conditions and the currently applied seed rate, the price for cotton seed for one feddan would increase from LE 55 to LE 130 (without subsidies). Assuming the potential reduction of the seed rate to 15 kilograms per feddan (still high compared to that of other countries), the reduced quantities would nearly compensate for the additional cost for the new type of seed. On the output side, the return would also increase by about LE 450 per feddan (0.2 x 6.9 kentars per feddan x 330 LE per kentar). At sector level this increase would reduce area for seed production from 200,000 feddan to 50,000-70,000 feddan. 4.84 The acid delinting plant established under the Egyptian-German Technical Cooperation Program is a first step in this direction, but the country needs another two or three such plants to cover total seed production. Ideally, private seed companies would invest in such plants. Unfortunately, the legal framework for private sector cotton seed production is missing in the cotton sector. 4.85 The second, equally important, technical innovation is seed dressing, which would add significant value to seed quality. Seed dressing reduces farmers' risks from early season pests. The stronger development of the root system of the cotton plant during the early growing phase reduces the impacts of water stress during the summer season. Investments in such technical innovations would have a long-term sustainable effect on the cotton-growing sector. Seed Cotton Quality 4.86 Along with market orientation of varieties, reducing foreign matter would improve the quality of Egyptian cotton. Handling with polypropylene bags has been a major cause of cotton contamination. In 1998-99 the Ministry of Agriculture and Land Reclamation imposed the use of jute bags tied with cotton string instead of polypropylene bags and plastic ties to reduce contamination. The Ministry should enforce the measure strictly and inform foreign clients about the quality program. In addition, private sector investments, particularly in the ginning sector, have led to significant improvements because of better management, improved technologies, and direct exports from the gins by universal density bales. 4.87 The price differential in seed cotton grades does not encourage two-stage harvesting. Most farmers favor harvesting during the school summer recess, when cheap labor is available at LE 3 a day from students looking for seasonal income. A second harvest, after schools are in session, costs at least twice as much. The government should remove fixed price differentials at producer level between different grades and allow the market to set these. Technology Transfer and Research 4.88 Recommendations by the extension services, particularly on the seeding rate, should be reviewed. Improved extension services should help farmers optimize their crop management skills, - 30- including pest management. The Egyptian-German Cotton Sector Promotion Project's extension approach leads to reduced production costs and increased yields. In the long run, research programs should be problem-solving and market oriented, focusing on on-farm research (for example, improved irrigation methods and intercropping). Extension users and research should be more closely linked to guarantee that innovations reach farmers and problems of farmers and users reach researchers. Water and Soil Management 4.89 Despite its importance in the Egyptian agricultural sector and the overall economy, the cotton crop has fought an uncertain losing battle for survival in the past decade. Preliminary reports indicate that the cotton area in 2000 might reach only 550,000 feddans, the smallest area in a century. Only one-tenth of that area is planted to Giza 70, the only remaining extra long staple variety. At average yields of 7 kentars per feddan, the total crop might reach only 3.5 million kentars, barely enough to cover annual needs of the domestic spinning industry. 4.90 Other crops, notably rice, maize, and wheat, are displacing cotton on farmland as sources of both cash income for farmers and exports. Rice has become one of the most profitable crops in the Delta, and rice market liberalization has raised both prices and production. The introduction of short-season varieties and progressively higher yields per feddan have made rice a competitive source of farm income as well as an export crop. Official prohibitions against growing rice have been ineffective, and farmers currently plant over 2 million feddans, almost three times more than the official target of 700,000 feddans. 4.91 With no water pricing or quantitative water allocation mechanism, farmers are not concerned about the large volume of water required to grow rice. Above average rainfall in the past few years in the Nile Basin have resulted in record high levels in Lake Nasser. Abundant water contributed to the increase in rice areas of the last three years. In contrast, cotton's competitiveness has suffered from stagnant cotton yields, lower intemational and domestic prices, and state interference in all aspects of cotton marketing. For farmers, cotton's longer growing time is balanced by its significantly lower water requirements. 4.92 The relative profitability of maize and wheat has also been enhanced by government policies protecting poultry and livestock production, as well as procurement prices for wheat above world market prices in the interest of promoting food self-sufficiency. 4.93 In a few years, when the two massive irrigation projects in Toshka (where the Kingdom Agricultural Development Company, or KADCO, is considering cotton production on its farm) and El Salam Canal are operational, Egypt will no longer have a surplus of irrigation water. Conditions of water scarcity might once again demonstrate the relative profitability of cotton. - 31- CHAPTER 5. HORTICULTURE EXPORTS 5.1 Egypt produces over 40 different fruits and vegetables over two million feddans. Total value of horticulture output in 1996 was LE 13.7 billion, accounting for 27.4 percent of the total value of the output of the agricultural sector (Krenz 1998). In 1996, vegetable crops (including potatoes) were cultivated on over 1.4 million feddans (604,000 hectares), which represented 11 percent of the total 13.7 million feddan cropped area. 5.2 Since 1987, the horticulture sector has shown significant growth. Production has rapidly increased in response to rising consumer demand. Growers have supplied products to private sector companies that have begun rebuilding exports of potatoes, citrus, and other traditional products and have successfully experimented with strawberries, green beans, grapes, and other nontraditional products. The horticulture subsector is large and diverse. Fruit trees occupied 866,00 feddans (364,000 hectares) and accounted for some 6 percent of the total cropped area in 1996. Tomatoes, cultivated on 416,000 feddans in 1996, are by far the most important vegetable crop. Potatoes follow at about 210,000 feddans. Vegetables are grown mainly by small farmers in the Delta and in the Valley, who account for 80 percent of production. But while smallholder farmers produce most horticulture products, relatively large commercial farmers, mostly in the New Lands, export nontraditional horticulture products. 5.3 In 1998, total fresh and processed fruit and vegetable exports reached about 535,100 tons (ALEB 1999), with a value of $138.2 million (CAPMAS 1999). This production compares well with the value of cotton exports for the same year of $158.2 million. Valued at $90 million, fresh product exports are twice as large as exports of processed products. Accounting for 54 percent of exports in 1990, the European Union is the main destination for Egyptian fresh and horticulture products. The second-largest importers are the Gulf Cooperation Council countries, accounting for 21 percent of total exports. Saudi Arabia is the largest importer of fresh and processed horticulture products, with 100,000 tons valued at $17.7 million (ALEB 2000). 5.4 Exports of dried and processed vegetables reached $22.6 million in 1999. Valued at $14.5 million and accounting for 46 percent of processed food exports, dried onions lead this category of exports. Export of frozen vegetables reached $13.3 million in 1999, accounting for about 28 percent of processed exports. Artichokes, potatoes, okra, and vegetable mixes lead this group, accounting for $10 million of exports. During the past decade, the European Union has been the main destination for Egyptian potatoes, accounting for about 81 percent of exports. The Gulf countries are the second-largest destination for potatoes, accounting for 14.5 percent of exports (NPCP 1999). Potato exporters have been the main beneficiaries of bilateral trade agreements concluded by Egypt in the past decade. Potatoes are cultivated mainly in the Delta (78 percent of area in the 1990s), although cultivation is expanding in the Valley and in the old New Lands (for example, Nuberia and Ismailia). Farmers are organized in the Potato Growers Association and assisted by the National Potato Cultivation Project in Egypt supported by the Netherlands. 5.5 In general, the main constraint to agriculture is management inadequacy at all levels of production and post-harvest processing, including the owner level. Many important farm owners are businesspeople in other industries and see agriculture as a secondary or tertiary activity. Given the limited pool of private sector-oriented management expertise and the prevailing management styles of micromanagement and absentee management, the lack of skilled business management in agriculture is a serious limitation for more rapid expansion of horticultural exports. - 32- Technology 5.6 Most of the technological systems for horticulture export production are broadly applied in Egyptian agriculture. However, inadequate management and the lack of systems and procedures lead to inefficient use of the technologies. 5.7 The main technological constraint is unreliability of the planting material available to the farmer. Nurseries play an important role in propagating adequate plant materials. Fruit trees and table grape nursery production are not registered in Egypt in terms of volume produced, type of cultivar propagated, sanitary control, age of plants, and source of plant material. As a result, table grape growers face considerable uncertainty about the productivity of new plantings and the quality of fruit they will produce. Furthermore, the country desperately needs new strawberry cultivars (for example, camarosa) to compete in the intemational marketplace (Picha 1997). Strawberry cultivars used in Egypt were developed in California some years ago and have been replaced by new early-maturing cultivars such as camarosa in Califomia and several Mediterranean countries competing with Egypt. As a result, Egyptian growers are several years behind their competitors. The situation is similar in vegetable production. The fact that the main varieties in demand for fresh produce production now may be patented further adds to Egypt's disadvantage. 5.8 The Strawberry Improvement Center at Ain-Shams University could be the licensee for in- country distribution of patented strawberry cultivars. The Ministry of Agriculture and Land Reclamation's Strawberry High Commission would monitor the free access of new germ plasm to all interested growers (Picha 1997). 5.9 Needed on-farm infrastructure is generally lacking, or poor management hampers its efficiency. For example, a farmer may have an up-to-date irrigation system but maintain it poorly, impairing the system's efficiency in water distribution as well as fertilization. Small strawberry farmers lack proper infrastructure in the field or post-harvest facilities such as cooling or refrigerated trucks needed for exports. The Ministry of Agriculture and Land Reclamation is promoting producer cooperatives in which small farmers can share cooling facilities and refrigerated trucks. The deterioration of the quality of Nile water is a matter of growing concerm and was reviewed in a recent World Bank study (IWACO 1999). Farmers in the new lands often use groundwater and have more control over water quality. Marketing Mechanisms 5.10 Most farmers, including small export-oriented farmers, practice the traditional "kelala" system, selling the crop in the field at a price per feddan. The buyer takes possession of the produce in the field and handles harvest, selection, grading, and transportation. This system is well adapted to the domestic market, in which prices are more important than quality and almost all grades of produce manage to find their niches. In the export market, however, quality comes first and must be established and maintained throughout production, harvesting, sorting, packing, and transportation. Exporters buying from small farmers are introducing changes in the kelala system by selective buying and contractual arrangements including quality criteria. Exports and Employment Generation 5.11 Potatoes and citrus have led traditional horticulture exports. Potato exports have accounted for 65 percent of vegetable exports over the past five years, reaching a maximum of 419,000 tons in 1995 and 410,000 tons in 1996, when they benefited from poor climatic conditions in Europe and competitive prices. Since the beginning of the 1990s the European Union has been the main destination for Egyptian potatoes, accounting for 82 percent of the market. Egyptian potato exports were badly affected by European Union phytosanitary regulations in 1997. After samples of Egyptian potatoes were found to be contaminated with brown rot disease, the European Union banned Egyptian potatoes and the country cut - 33- exports by 43 percent, to 233, 000 tons. Exports to the European Union now originate exclusively in areas declared pest-free by a joint Egypt-European Union committee (45 percent of total area in 1998). The Ministry of Agriculture and Land Reclamation's efforts to promote horticulture exports through ATUT must be credited with the rise in nontraditional exports of strawberries, grapes, melons, and so on. Progress was slow during the first years of these exports and is just gathering momentum as more exporters reach the quality levels required by the European Union and Gulf country markets (Table 5.1). Table 5.1 Actual export volume and value (free on board) of horticulture exports, 1995-97 1995 1996 1997 1998 1999 Exports Value Exports Value Exports Value Exports Value Exports Value Product (metric (millions (metric (millions (metric (millions (metric (millions metric (millions tons) of tons) of tons) of tons) of tons of dollars) dollars) dollars) dollars) dollars) Citrus 43,400 13.4 54,800 17.5 44,700 14.3 217,700 60.8 67,200 17.7 Grapes* 2,467 1.6 3,483 2.1 1,823 1.1 2,597 1.9 2,866 6.2 Mangoes 2,280 1.8 1,368 1.3 1,440 1.4 988 1.0 995 1.0 Dates 2,500 1.0 2,200 0.8 1,900 1.3 700 0.5 5,350 3.0 Peaches 1,140 0.4 1,130 0.2 610 0.2 740 0.1 263 0.06 Potatoes 419,000 102.0 411,000 80.0 233,000 41.0 228,000 43.0 255,600 46.2 Strawberries 1,155 3.6 1,704 6.3 2,027 8.1 2,138 8.8 3,738 19.2 Greenbeans 13,485 10.5 18,780 15.2 17,322 13.8 22,589 18.0 22,716 17.7 Melon 1,753 2.2 1,246 1.6 977 1.3 1,078 1.7 1,992 3.0 Watermelons 980 0.3 980 0.3 1,300 0.3 800 0.2 380 0.8 Sweet potatoes 4,800 0.9 5,200 0.9 4,100 0.8 3,600 0.8 4,200 0.7 Garlic 2,900 1.2 7,200 2.8 4,900 1.9 3,200 1.1 2,900 0.8 Salad tomatoes 9,700 1.9 10,700 1.6 12,400 1.3 19,500 2.3 5,400 1.0 Artichokes 5,200 1.9 5,200 1.9 2,900 1.3 3,500 0.8 1,820 0.4 Fresh onions 115,600 17.2 104,000 10.9 104,000 12.8 150,600 18.8 105,800 9.5 Total 159.9 143.4 100.9 159.8 127.3 * Exports of grapes reached 7,000 tons in 2000 Source: FAO 2000; ATUT 2000 (beans, melons, strawberries, and mangoes). 5.12 Employment generated by current exports (including post-harvest labor) is estimated at about 29,000 full-time employees. Although horticulture is highly labor intensive compared to field crops, the area planted in horticulture products for export is modest. 5.13 Thanks to the efforts of ATUT, exports of selected candidate crops rose in the past two years. ATUT selects candidate crops on the basis of their competitiveness in export markets and their impact on employment generation. The list of candidate crops is updated regularly. Current crops include grapes, strawberries, green beans, melons, mangoes, artichokes, sweet potatoes and cut flowers. According to data collected by ATUT (statistics are based on surveys of exporters, and cost-insurance-freight values have been adjusted for transport costs for estimates of the free-on-board value), exports of strawberries have increased by 75 percent in volume and 113 percent in value between 1998-99 and 1999-2000. This rise reflects improvements in post-harvest handling that have led to quality improvement of exports, as well as the market response to higher quality. Export Potential 5.14 The principal export destination for strawberries is the Gulf countries (63 percent of total exports) followed by England (17 percent). Egypt exports from November to June. Its strongest competitor on the European market is Morocco because of that country's lower transportation costs ($0.3-0.38 by refrigerated truck and $0.17 per kilogram to England and $0.16 kilogram to mainland Europe by 40-foot sea container, compared with $0.5 per kilogram from Egypt to European ports). - 34- 5.15 Better production techniques (Spanish Parron trailing system) and proper handling and packing have led to the success of export of seedless grapes to Europe, with a three-fold increase in value between 1998-99 and 1999-2000. Successful experimentation with sea shipment shows that transportation costs can be cut by about 50 percent to increase the profit margin. 5.16 Egypt has dominated the bobby bean market in Europe, with about 17,000 tons of exports per year. The country is also in a good position to enter the fine and extra-fine green bean market currently dominated by Kenya with 16,000 tons per year. Although its production costs are similar to Kenya's, Egypt is closer to the European market, which reduces air freight costs and can reduce transportation costs even more by sea shipment under controlled temperature. Market Information Dissemination 5.17 Export support projects and professional organizations have established market information systems using the Intemet. The Horticultural Exports Improvement Association manages several databases (available on the ATUT Web site: www.atut.gov.eg/) on the following: * Daily fresh produce wholesale prices in international wholesale markets by origin, packing, weight, variety, and so on; * Historical market prices for all products over the past four years; * All intemational fresh produce importers and local growers and exporters; - Intra- and extra-trade statistics of all fresh produce commodities; and • Quality standards, rules, and regulations. 5.18 Maintenance of these databases after the Horticultural Exports Improvement Association (HEIA) project ends will be an issue. Considering the high cost of developing the system and the public good nature of the service, the government should continue supporting ATUTs MTI unit via matching grants. 5.19 The ALEB Project funded by USAID has published a CD/ROM for Egypt's processed food export industry. The Market Pulse CD/ROM includes a wealth of detailed European Union food sector information; macroeconomic and related information; and supply, demand, and trade information. 5.20 The macro-economic database includes detailed information on population, exchange rates, inflation rates, gross domestic products in national currencies, gross domestic products in U.S. dollars, and real gross domestic product per capita for each country. The supply database includes detailed information on area, production, and yields of fresh fruits and vegetables and production of processed food for 32 countries since 1989-90, with projections to 2001. The market demand database contains information on the supply, stocks, total consumption, and per capita consumption of fresh and processed food for 13 countries. The trade database includes information on imports, exports, tariffs, prices at different levels, suppliers, and importers. 5.21 The information in these databases can be accessed by product and by country. Available in hard copy as well as on CD/ROM, the databases will accessible on the Intemet in the near future. To maintain the usefulness of the databases, their management should be transferred to professional organizations - 35- Coordination and Policy Advocacy Among Producers, Exporters, and Freight Agents 5.22 The individualism of Egyptian farmers and entrepreneurs was considered in the early 1990s a major constraint to developing a competitive agricultural export sector. The establishment of some dynamic and efficient professional organizations in the past five years shows that mentalities can change quickly with proper leadership and guidance. 5.23 The Horticulture Exports Development and Improvement Association, for example, created in 1996, joined a core group of 25 growers and exporters to establish an industry promotion system to expand horticulture exports by enhancing consumer confidence and the image of Egyptian products. The association has become a major partner for the Ministry of Agriculture and Land Reclamation and Ministry of Economy and Foreign Trade (MEFT), as well as for other administrations. Export Trading Arrangements 5.24 The greatest barrier to horticultural exports is the failure to produce and deliver the quality of products required by the export markets (ATUT 1999). Most products are exported by air freight, and the lack of airport cold storage facilities jeopardizes their quality. 5.25 For instance, strawberries are currently exported via air transport and can lose half their shelf life because of sitting for hours in the open air before loading. With appropriate agreements among countries, refrigerated trucks could export to the Gulf countries. Air freight rates range from $0.95-$1 per kilogram to Europe to about $0.40 per kilogram to the Gulf countries. This season, modified atmosphere sea shipment of strawberries will be tested. Lessons from Experience 5.26 Egypt can improve several aspects of its production of export agricultural goods with the measures listed below. Raise Quality to Meet International standards 5.27 Poor agricultural practices have been costly. An example of the effect of such practices on production is the estimate that 1994 pre-harvest losses in table grape production (that is, the amount of fruit that was not produced or the missing yields due to inappropriate agricultural practices) of Thompson Seedless grapes reached $11.3 million. Improve field management 5.28 Appropriate field management needs to be improved for: * Fertilization, irrigation, weeding, soil types, and cultivars; * Pruning and cultivar training systems; * Integrated pest management and sustainable production; * Harvest and post-harvest (time-methods-handling); and * General and specialized laborers, supervisors, and managers. - 36- Strengthen Technical Support Services 5.29 Deficiencies in the technical aspects of handling, storage, and transport adversely affect the export capability of Egyptian fresh produce. Improvements in the following areas will contribute to efforts to export Egyptian fresh produce: * Selection, conditioning, and packing procedures; * Pre-cooling and cold storage facilities; * Local refrigerated transportation; * Airport receiving, transit, and dispatching facilities; * Phytosanitary procedures (quarantine and residues); * Quality control assurance and certification; * Fast and simple administrative support to exporters; and * Support infrastructure (roads and ports). Upgrade Preparation and Handling 5.30 Better preparation and handling techniques would ensure consistent quality of exports. Producers and exporters should become more familiar with the following information and proper techniques for preparing and handling their products: * Use of growth regulators and pesticides; v Pesticide residue and tolerances; * Harvesting procedures (maturity index); * Post-harvest handling; * Quality standards and control; * Boxes and packing materials; 3 Transport alternatives; and D Controlling and modifying atmospheres. Reduce Post-harvest Losses 5.31 Post-harvest losses for table grapes are estimated in the same way as pre-harvest losses. The post-harvest losses or deterioration of table grapes from harvest to consumer occur at all stages of product handling. Post-harvest losses may be total, partial, or a decrease in quality. Evaluation of post-harvest losses in each step of table grape handling in Egypt indicates that mechanical damage, disease, and physiological disorders are the main causes of post-harvest losses. Rumi Red presented a 35.3 percent loss and Thompson Seedless, a 20.2 percent loss. The greatest losses in Thompson Seedless were at the wholesale and retail levels, while losses in Rumi Red were more equally distributed throughout the marketing channel. In 1992, 108,780 tons of Thompson Seedless failed to reach consumers because of pre-harvest and post-harvest losses. The estimated value of those losses is $32.2 million (ATUTT 2000). The government should extend the scope and duration of the ATUT project, which is helping Egyptian farmers improve pre-harvest and post-harvest handling. Increase Fresh Exports and Promote Production Efficiency 5.32 The proposed strategy recommends the following steps to increase fresh exports and production efficiency: - D7- * Existing and potential exporters must have adequate and timely information on markets; * The government should support and invest in roads, airports, and port facilities, as surface transportation systems constrain exports of fresh products; * Exporters should be encouraged to establish export quality control systems; * Applied research and extension activities (with direct private sector involvement and orientation) should target production, post-harvest, and marketing problems; and * Egyptian exporters should begin to monitor developments in potential new markets. Looking Ahead-Development of Horticultural Exports 5.33 The European Union is the world's largest undersupplied market for fresh horticulture products. Since the accession of Spain, Portugal, and Greece, European Union consumers have had access to low-cost fresh products in the spring and winter for the first time. Off-season imports of a wide range of horticultural products from Spain to other European Union countries have soared. At the same time, Israel, South Africa, Chile, Kenya, Zimbabwe, Colombia, the United States, and other countries have supplied products that could not be produced in southern European Union countries in the winter. However, the European Union still does not have stable year-round supplies of fresh horticultural products at reasonable prices. Consumption levels of most products drop drastically from November to April. Experience in the United States indicates that consumers will consume large quantities of most horticultural products during the winter months if these are offered at.reasonable prices. For example, North American consumers now purchase a wide range of products at reasonable prices from nearby Mexico, Central America, and Chile during seasons when domestic growers can grow these products only under high-cost greenhouse regimes. European consumers already have demonstrated their willingness and desire to buy the same type of products. 5.34 This prospect offers great potential for Egypt because of its proximity to large markets in Western Europe and the Gulf countries. Egypt's climate is suited to competitively growing many fresh horticulture products, and the country has adequate labor for competitive production. The supply and use of sea transport facilities are improving. ATUT has improved the expertise of a small number of producers and exporters and the quality of Egyptian produce, so that Egypt's reputation in Europe for certain crops has improved significantly. 5.35 ATUT has estimated Egypt's horticulture export potential using the concept of Unmet Profitable Demand (the volume of a product that a specific importing country is likely to purchase above recent import levels during weeks of the year when Egyptian products are available at prices above the exporter's break-even cost level). Opportunities are growing for Egyptian exports of fresh produce to Western and Eastern Europe. With effective marketing strategies and careful planning, Egypt could also export more fresh produce to Saudi Arabia and other Gulf countries, and Africa could become a new market. On the other hand, the larger local market for high-quality produce among the Egyptian middle class and the lower risk and management burden of local marketing make exporting a less attractive alternative for some important producers. By estimating a sale price at which an Egyptian supplier would break even, the Profitable Demand methodology uses historical volume and price data to estimate how much additional product each importing country market would absorb during the months when Egypt could potentially supply at a price above or equal to the break-even price. 5.36 The Profitable Demand methodology estimates total potential profitable demand for selected nontraditional horticultural products during Egypt's demonstrated export season for each product, considering only the four major country markets in the European Union-Germany, the United Kingdom, the Netherlands, and France (Table 5.2). The same methodology could be applied to estimate profitable demand for all European Union countries for these products. The value of exports has been estimated using the break-even price as a minimum. - 38- Table 5.2 Potential profitable horticulture exports and jobs created, 1999 Potential Break-even FOB Worker Potential Product exports FOB price potential days full-time jobs (tons) (dollars per value per ton kilogram) Strawberries 115,000 1.23 141,450 56 24,902 Grapes 207,000 0.87 180,090 26 20,700 Melons 150,000 0.96 144,000 23 13,327 Watermelons 167,000 0.81 135,270 15 9,635 Green beans 42,100 0.60 25,260 38 6,153 Mangoes 44,400 2.17 96,348 34 5,772 Salad tomatoes 36,500 0.33 12,045 20 2,808 Cut flowers 11,700 0.93 10,881 60 2,700 Sweet peppers 13,600 0.89 12,104 25 1,308 'eaches 14,550 0.38 5,529 15 839 Spring onions 8,500 1.10 9,350 20 654 Artichokes 10,100 0.41 4,141 14 544 Sugar peas 5,600 0.72 4,032 39 840 Dates 5,160 0.56 2,890 7 139 Total horticulture jobs 831,210 783,390 90,320 Source: ATUT MTI Unit 2000 (from Kelly Harrison) 5.37 Estimates of potential employment generation for each product in this table are based on actual labor usage data collected by ATUT personnel from export growers, exporters, shipping companies, and other product and service suppliers in 1999. According to an ATlUT study in May 2000, cut flowers, strawberries, and cherry tomatoes are the most labor-intensive crops. Cut flowers require 11.3 full-time employees per feddan, while strawberries require 5 full-time employees, and cherry tomatoes, 3.8 full- time employees. In comparison, potatoes require 0.77 full-time employees; tomatoes, 0.55 full-time employees; cotton, 0.28 full-time employees; and wheat, only 0.08 full-time employees. These figures include post-harvest labor (sorting and packaging). Women's labor represents about 50 percent of total labor (70 percent for cut flowers exports). Addressing Logistical Constraints 5.38 Egypt's success in meeting its objective of increasing exports, particularly of horticulture products, will depend chiefly on improving the transportation system. The country's productive base is clearly able to produce high-quality fruits and vegetables; improved production practices and farm-level post-harvest handling have been positive. However, the state of land, air, and sea transportation continues to nullify potential gains in productive improvements, and outmoded and inefficient transportation degrades the quality of output. - 39- Truck transport 5.39 Egypt's domestic trucking fleet of refrigerated and flatbed trucks is old because high purchase and maintenance costs preclude new purchases. The high cost of newer trucks, of course, translates into higher transport costs and higher prices for exports. Operating costs for new trucks are 30-50 percent higher in Egypt than in competitor countries such as Lebanon and Jordan. Truck operators try to cover the high costs per running kilometer by overloading. The lack of adequate policing of overloaded trucks makes it difficult for firms operating legally loaded trucks to compete with those that overload. Overloading seriously damages roads and reduces the availability of flatbed trucks to haul refrigerated containers to seaports because the trucking revenues for such purposes are lower than those of overloaded hauls. 5.40 Other important transportation problems include: * Poor road conditions, particularly on roads to seaports, which increase truck breakdowns and maintenance costs; * Inadequate truck servicing facilities along important roads; * Poorly trained and poorly educated truckers; * High cost of imported tires as a result of an import tariff of 40 percent, and high cost and low quality of recapped tires; * Duties on imported refrigerated trucking equipment as high as 45 percent, despite a Cabinet decree lowering the tariff to 5 percent that has not been fully implemented; * Restrictions on importation of trucks over five years old, which limit the supply of good quality used trucks; * High truck rates resulting from the lack of truck brokers arranging use of the majority of available trucks; * Weak competition for truck rates because of inadequate information on rates; and * Restricted trucking by non-Egyptian companies in Egypt and on certain back-hauls from Egypt (because non-Egyptian truck rates are lower, these trucks are in high demand), resulting in numerous illegal truck broker offices. 5.41 The following actions would improve the capacity of the local refrigerated trucking industry: * Reduce the tariff on imported refrigerated trucking equipment and tires (the Agricultural Policy Reform Program is seeking implementation of the 1998 Cabinet decree to reduce tariffs on refrigerated trucking equipment to 5 percent); * Educate truckers through formal training and licensing programs; * Establish an information system, preferably through an association, to provide information on truck availability and rates; and * Permit non-Egyptian trucks to operate only from specified depots in or near port areas. Air Transport 5.42 Air cargo space for perishable products is not regularly available during peak exporting periods, and is costlier for products shipped by Egypt's competitors. Only two airlines have regularly scheduled cargo service at Cairo International Airport. The lack of adequate inbound cargo discourages regular cargo scheduling and forces higher outbound rates. - 40- 5.43 Excessive cargo handling costs at Cairo Airport are another major deterrent to export expansion. Commercial rates for loading and unloading a cargo aircraft are about $170 per ton. Though similar rates are charged at European airports, low local labor rates should permit dramatically reduced local rates. Only Egypt Air and Egyptian Aviation Services (EAS) are authorized to provide cargo handling services at Cairo International Airport. Egyptian Aviation Services is a parastatal organization created to provide these services, and Egypt Air is a major shareholder in Egypt Aviation Services, along with Lufthansa and other international carriers. Lack of competition in cargo handling results in excessive fees. Airlines have limited equipment to service their own flights because of the low number of flights, and they are not allowed to share equipment or facilities. 5.44 As many larger exporters have improved their operations by adding refrigerated packing and transportation capacity, the absence of adequate cold storage facilities at Cairo International Airport has become a more serious constraint to improving exports. The lack of a complete cold chain from the packing house to the aircraft hold contributes to product losses and quality degradation. Horticulture products are handled and stored in areas lacking climate control, particularly during the summer months. The negative impact on export potential is even greater from condensation when produce that is pre- cooled and transported in refrigerated trucks is exposed to warm temperatures. 5.45 The public sector cold stores (the Global Village) in the customs area at Cairo Intemational Airport are old, poorly operated, and too small to accommodate offloading of refrigerated trucks. Horticultural exporters have a few options to circumvent this problem. One option is to arrange to ship cargo by passenger aircraft that typically depart early in the morning when temperatures are lower. This practice works well for some products and exporters. However, passenger cargo capacities are limited, so smaller passenger aircraft cannot accommodate large volumes aggregated by freight forwarders. 5.46 The following steps would improve air transport of Egyptian export products: * Permit a privately operated cold storage facility in the customs area at Cairo International Airport (the ministers of transportation and economy and foreign trade have recently agreed to support this venture); * Improve airport ground handling services at reduced cost by allowing international airlines to compete with Egypt Air and Egyptian Air Services. Restricted competition yields costs similar to those in European airports. The Agricultural Policy Reform Program wants to modify regulations by Cairo Airport Authority; and * Obtain guaranteed minimum space for horticulture exports on Egypt Air cargo freighters. Sea Transport 5.47 Lengthy inspection procedures delay port clearance of imported refrigerated containers. Exporters cannot find enough empty containers to export products, port facilities are congested, and shipping lines lose revenues because of slow container tumaround. 5.48 If refrigerated containers are not available during the peak export season for horticulture products, opportunities to export highly perishable products are lost. A major problem in the supply of refrigerated containers is the delay in clearing imported foodstuffs from the seaports. Delays are less significant for air and truck imports than for sea imports. All food consignments must be inspected by four agencies: the Atomic Energy Organization (for radiation), the General Organization for Export and Import Control (for food quality), the Ministry of Health (for safety and quality), and the Ministry of Agriculture and Land Reclamation (for safety and quality of both fresh produce and meat, fish, and dairy products). With few exceptions (frozen products) inspections, and in all cases laboratory analyses, are done independently; that is, sequentially rather than simultaneously. - 41- 5.49 The multiple, and sometimes unpredictable, nature of inspections results in substantial container "dwell" time in the port (the length of time between vessel offloading and container clearance from the port). Exporters, freight forwarders, shipping lines, shipping agencies, and container handling companies report typical dwell times of 20-30 days. Long dwell times can result in high demurrage costs to importers (shipping lines offer 5-21 days of free time before charging demurrage). Shipping lines are penalized because their stocks of containers do not generate revenue during the dwell period. Horticulture exports suffer if exporters cannot obtain refrigerated containers when their products are ready to ship. Export inspection procedures are not excessive and do not contribute to port congestion and dwell times. One technical solution to long dwell times is to "strip" (offload) products into cold storage during inspection. Empty container seaports are inadequate for this purpose. 5.50 To improve sea transport of Egyptian exports, coordinated import inspection services (radiation, veterinary, agriculture, and health) are urgently needed to reduce duplication of testing and time delays on clearing imported foodstuffs and refrigerated containers. All inspection services should operate in the same office, sharing a single, well-equipped laboratory, and conduct simultaneous inspections. 5.51 Combining a market-led approach with a public-private sector partnership is the best way to address current constraints to the development of the horticulture sector in Egypt. Cooperation between the private sector and public services will continue to be organized around commodity-specific action plans. Social Aspects 5.52 Women and children provide about 60 percent of the labor for Egyptian horticulture. Because they are the cheapest labor available, they are recruited by labor contractors in the Delta and hauled to work each day, with high tumover during the cropping season. 5.53 The role of women is increasingly acknowledged in technology transfer activities, and the Ministry of Agriculture and Land Reclamation has created a Women-in-Development Policy and Coordination Unit to promote awareness and disseminate information on women's issues. Extension activities targeting rural women include the Fayoum Horticulture Development Project and the training program launched by HEIA and ATUT. 5.54 In addition to its traditional technology transfer activities for cultivation of tomatoes (the main horticultural crop in Fayoum), the Fayoum Horticulture Development Project has introduced Farmers' Field Schools to provide fanning extension to illiterate women. The project based this initiative on the recognition that structural adjustment reforms and land fragmentation have forced more and more men to seek off-farm employment, leaving women to tend to agriculture. Women head about 40 percent of households in Fayoum, while absentee husbands work outside the farms. The project involves some of the female agricultural engineers of the Fayoum Agricultural Department, who do field work in addition to their tasks in home economics. The participatory teaching method involving women facilitators working with women farmers has been a success. ATUT uses similar participatory extension methods, and the Ministry of Agriculture and Land Reclamation is progressively mainstreaming participatory extension to replace the traditional training and visit extension system. 5.55 HEIA and ATUT train women and girls mainly in harvesting and packing. The training is provided on the farm and focuses on hygiene, food safety, and self-esteem. Trainers are trained on each exporting farm to cover all workers. The program is well-received and men workers have asked to be included. HEIA is considering issuing a training certificate that will qualify trainees for higher wages. Exporters are under pressure from Egyptian child labor regulations and international concern over child labor. Reducing child labor by switching to women and men laborers will increase the cost of agricultural labor in the future. - 42- CHAPTER 6. EFFECT OF THE EXTERNAL ECONOMIC ENVIRONMENT ON EGYPT'S EXPORT POTENTIAL FOR COTTON AND HORTICULTURAL PRODUCTS 6.1 The Comtrade database of the United Nations Statistics Division (1995-96) suggests that Egypt has a relatively concentrated export profile. With the exception of Saudi Arabia, Egypt's 10 leading export markets are the United States and countries in the European Union (particularly Italy, Germany, France, and the United Kingdom). For example, 13 of the country's leading 30 exports are various forms (raw or processed) of cotton; the United States is the principal export market for eight of these exports, and the European Union (especially Italy) is the principal export market for the other five. Thus Egypt's export profile is concentrated not only in the export countries but also to some extent in the goods exported. Cotton's importance is further highlighted by the fact that 13 of the leading 17 agricultural exports are cotton sector related (see ITC 2000). 6.2 This chapter explores the impact of the regional and global economic environment on Egypt's export potential. We outline below the terms of the country's current trade agreements, discuss issues emerging from the World Trade Organization's agricultural trade liberalization and the possible effects of industrial country reforms on Egypt's domestic policies, and recommend removing the country's anti- export bias to create a supportive environment for agroindustrial exports. The Egypt-European Union Agreement 6.3 The European Union receives half of all Egypt's exports and generates 40 percent of Egypt's imports. Therefore the conclusion of the Egypt-European Union Partnership agreement is of paramount importance for the development of Egyptian trade. Most of Egypt's competitors (Morocco, Tunisia, and Israel) have already reached agreement. However, Egyptian exports to Europe, with the exception of potatoes, are far from the current quotas. 6.4 Egyptian-European Union Partnership Talks began in 1995, to reformulate a new cooperative framework to replace the 1977 Cooperation Agreement. State agencies and the business community are working together to establish Egypt's negotiating position from the perspective of all national interests. In negotiating with the European Union, Egypt builds on its comparative and competitive advantages and seeks to maximize existing privileges. For example, Egypt seeks tariff exemption for its processed food products in return for tariff reduction on European products in the Egyptian market. 6.5 European Union Directive 503 requires that Egyptian potatoes imported into the European Union be free of brown rot disease. Positive test on five samples will result in suspending imports from Egypt. Since such a suspension in 1997, Egyptian potato exports to the European Union have decreased by 45 percent. A joint Ministry of Agriculture and Land Reclamation-European Union committee works on the delimitation of brown rot-free areas from which exports to Europe are allowed. Common Market for Eastern and Southern Africa 6.6 Egypt joined the Common Market for Eastem and Southem Africa (COMESA) in June 1998. the Common Market for Eastern and Southem Africa was established in 1994 to replace the Preferential Trade Area (PTA) Common Market for Eastern and Southem Africa. To support the development of member countries, the Common Market for Eastem and Southern Africa adopted five priorities: * Improving industrial productivity; * Increasing agricultural production; * Developing transportation and communication networks; * Promoting and expanding trade; and - 43- 0 Setting up databases covering all economic sectors. 6.7 In close geographic proximity, the Common Market for Eastern and Southern Africa market of 20 countries offers another opportunity for the Egyptian export market. In the short term, the opportunities may lie not only in direct exports to these countries, but also in strategic alliances and joint ventures that could pave the way for Egyptian processed food exports. In the first half of 1999 Egypt exports to the Common Market for Eastern and Southern Africa market reached LE 87 million, a 140 percent increase over the same period in 1998. Egypt's main trade partners are Ethiopia, Kenya, Madagascar, Sudan, and Uganda. Egypt's participation in the Common Market for Eastern and Southern Africa should strengthen cooperation with the 10 Nile Basin riparian countries, all of which are members of the Common Market for Eastern and Southern Africa. Other Trade Agreements 6.8 Egypt has bilateral agreements with Morocco, Tunisia, Lebanon, and Jordan and is negotiating an agreement with Saudi Arabia. Under the agreement with Lebanon, Egypt imports apples duty free from Lebanon and exports potatoes duty free. Agriculture and the World Trade Organization: Issues, interests, and Options for Egypt 6.9 This section draws on the work and methodology of Valdes and McCalla (1999) to identify issues, interests, and options of developing countries in World Trade Organization agricultural trade liberalization. Valdes and McCalla based their research on the notion that no developing country is typical and focused instead on the heterogeneity of developing countries. By desegregating from a number of perspectives, they identified groups of countries that appear to share overlapping interests large enough to warrant considering a collective negotiating position. This section first presents key trade position indicators to help identify Egypt's core trade policy issues, and then compares and contrasts these indicators to those of other developing countries both to add perspective on Egypt's relative position and tO identify countries with potentially overlapping interests. Trade Position Indicators 6.10 Egypt has been and continues to be both a net agricultural importer (NAIM) and a net food importer (NFIM). On average between 1995 and 1997, about 83 of 148 developing countries shared these characteristics. Further disaggregating regionally, Valdes and McCalla (1999) find that 13 of the 14 developing countries in the Middle East and North Africa Region are net importers of both food and agricultural products (Syria is a net importer of food but net exporter of agricultural products). This common characteristic sets this region, together with South Asia, apart from all others (for example in Sub-Saharan Africa, only 27 of 47 countries meet these criteria). Al other regions have mixed interests in terms of being net importers or exporters and of food or agricultural products in general. However, while the Middle East and North Africa Region is the most import dependent region, only five countries besides Egypt are also World Trade Organization members, and six are currently only observers. 6.11 A country's income category is a criterion for preferential treatment in the World Trade Organization negotiations. Income is categorized as low income, lower-middle income, upper-middle income, and high income. Egypt belongs to the 52 countries in the lower-middle income group, along with Algeria, Morocco, Jordan, and Tunisia in the Middle East. However, while classified as a food- deficit country, Egypt is not in the low-income food-deficit group that is likely to capture most of the special and preferential treatment in the World Trade Organization negotiations. 6.12 Food-import capacity and agricultural tradability are important trade indicators for Egypt. Foreign exchange availability is critical for a country to stabilize food consumption through imports. How far do food imports burden the balance of trade? Given fixed supplies of foreign exchange, how much can - 44- the food import bill increase in years of unfavorable production and/or world prices? A crude indicator of these relationships is the food import capacity index (FIC), the ratio of the actual value of imports to total export revenues (merchandise only) averaged for the period 1995-97. The food import capacity index primarily indicates the demand on foreign exchange needed to finance food imports. 6.13 Egypt's relatively high food import capacity ratio (Table 6.1) is uncommon among countries large in both population and surface area. However, Egypt's the food import capacity is overstated because it is based only on non-oil exports and excludes foreign exchange inflows such as workers remittances. Generally, countries with relatively large ratios (above 0.25) are smaller economies, especially small island developing countries. If we use the narrow concept of food import capacity, then Egypt's high ratio makes it vulnerable, particularly in years of domestic harvest shortfalls or higher world prices when this ratio can increase substantially. Table 6.1: Foreign exchange constraint for food imports in selected Middle Eastern and North African countries Country Foreign exchange constrainta Saudi Arabia 0.08 Syria 0.15 Egypt 0.20 Lebanon 1.08 "The ratio of the total value of food imports relative to total export revenues. Source: Valdes and McCalla 1999. 6.14 The ratio of trade to gross domestic product is a standard indicator used to rank countries according to the openness-and vulnerability to trade-of their economies. But the same criteria can also be applied at a sector level. The agricultural tradability (AT) indicator is the ratio of the sum of agricultural exports plus imports relative to agricultural gross domestic product. This indicator reflects how developments in world markets for agricultural products directly affect a country's agricultural. From a global developing country perspective, Egypt is moderately open and has a very low agricultural tradability ratio compared to other countries in the region (Table 6.2). In general, lower ratios are correlated with larger economies. 6.15 The agricultural tradability indicator triggers two important related issues: the extent of concentration in trading partners and the degree of concentration in the commodities exported. In other words, we must also consider how broad the trade base is. Countries with very concentrated trade profiles are more vulnerable to unilateral trade measures and possibly more restricted in their negotiating powers. In general, developing countries with concentrated trade profiles have a particular interest in the unilateral trade measures and domestic reforms adopted by their main trading partners. In this sense, developing countries with otherwise different characteristics could share collective interests in the trade and domestic policies of large single agricultural importing countries such as the United States or groups of countries such as the European Union. - 45- Table 6.2: Agricultural tradability for selected Middle Eastern and North African countries, 1995-97 Country Agricultural tradability Iran 0.17 Egypt 0.37 Jordan 4.16 Bahrain 7.25 Note: Includes the highest and lowest observed values in the region. Source: Valdes and McCalla 1999. 6.16 At the center of potential trade reform effects is the potential effect of trade liberalization on world prices for agricultural commodities. For example, the high level of agricultural support in industrial countries (implemented through border protection, export subsidies, and domestic support policies) results in world prices that are lower than they would be under lower levels of protection. Moreover, the past system of protection has helped exacerbate the instability of world prices. The effect of protection on world prices is perhaps the most visible apparent divergence between the interests of developing countries that are net agricultural exporters-and would benefit from higher world prices after trade liberalization-and those of developing countries that are net agricultural importers-and would lose from higher world prices after liberalization. 6.17 We must approach these questions from an inter-temporal perspective, looking, for example, at long-run trends as opposed to shorter-term effects. Long-run trends in the real world prices of basic grains (for example, the most common food importables, such as wheat, corn, and rice) have been declining conclusively since at least the 1920s. Hence, the potential increase in world prices resulting from trade liberalization would represent a temporary upward shift, and otherwise declining long-run trend, in world prices. Several modeling studies have estimated that the impact of trade liberalization of world prices on grain prices would be small (less than 10 percent), but the impact on sugar, dairy products, and some meats would be larger. 6.18 In the long run, we might expect Egypt, as a net agricultural and food importer, to favor these falling world prices because their import bill would fall. However, all trade liberalization causes winners and losers, not only among countries but also within countries. Understanding the diversity within a country allows a clearer debate of the consequences of specific kinds of liberalization and possible mitigating measures. Two sets of trade figures indicate the potential winners and losers of liberalization inside Egypt. First, the share of fresh foods in Egyptian (total) non-oil exports is 12 percent; that of processed foods, 7 percent; and that of textiles, 14 percent. However, fresh foods represents 14 percent of Egyptian imports; processed foods, 9 percent; and textiles, 3 percent. Hence, while imports of fresh and processed foods outweigh their exports, exports of processed foods are substantial, probably reflecting potentially sharp diverging interests among Egyptian producers and/or consumers. In this respect, we must factor in the greater importance (compared to previous trade negotiating rounds) of domestic politics and lobbying. 6.19 This discussion raises two questions whose answers would help us appreciate better the issues, interests, and options of Egypt's agricultural sector in the World Trade Organization negotiations. First, what is the expected magnitude of adjustments-both actual changes and variability-in world prices for agricultural products? Second, what is the aggregate country welfare effect associated with the predicted world price changes, and how can we disaggregate this net welfare effect among various categories of domestic producers (poor and small semisubsistence versus large and modernized) and consumers? - 46- Egypt-World Trade Organization Agricultural Policy 6.20 We have constructed a policy matrix to illustrate issues arising out of the interface between domestic and world prices on the one hand, and non-price trade-related issues (for example, sanitary and phytosanitary requirements and contingency measures) on the other (Table 7.3). We approach these themes from two angles: Egypt's possible perception of the importance of these issues in terms of reforms in industrial countries, and effects on Egypt's own domestic policies. Table 6.3: Egyptian World Trade Organization Agricultural Trade Policy Matrix Industrial country reforms Egypt's domestic Policy (particularly in the European trade policy effect Union and United States) 1. Market access Fairly significant Adverse impact Very significant 2. Export subsidies Fairly significant Adverse impact -- 3. Domestic support Fairly significant Adverse impact Not very significant 4. Sanitary and Very significant Very significant phytosanitary measures _ 5. Contingency measures (safeguards, antidumping, Very significant Very significant and countervailing measures) 6. Dispute settlement Very significant --Fairly significant 7. Preferential access Very significant Source: Adapted from Valdes and McCalta 1999. 6.21 Improved market access, reduced export subsidies, and diminished domestic support on the part of industrial countries should rank high in priority and positively affect the net exporting developing countries. From the net importers' perspective, these net impacts are likely to be negative, since (at least in the short run) trade liberalization is expected to trigger a rise in world prices. However, if changes in world prices are transmitted to domestic producers, the welfare of farmers, small and large, should improve. 6.22 As for effects on Egypt's domestic trade policy, most developing countries protect some sectors through tariffs (or state trading), either to collect tariff revenues or protect noncompetitive sectors. Egypt does not require import licenses. In most cases the tariffs are below the bound tariffs specified in the World Trade Organization schedules. Thus further reductions in the bound tariffs would not represent a major threat to domestic producers in these countries. The most difficult situation would arise for countries that maintain high (actual) levels of protection-those net food and agricultural importers such as Egypt that might press for more flexibility in their tariff reduction schedules. 6.23 The elimination of export subsidies in industrial countries is clearly a high priority of net agricultural exporters (for example, the Cairns Group) because export subsidies are considered the most disruptive trade interventions. Only 12 developing countries registered export subsidies during the Aggregate Measure of Support notification period and consequently cannot apply them now. Similarly, for most developing countries the AMS cannot exceed the 10 percent allowed on individual products under the de minimus in the World Trade Organization code. 6.24 The Sanitary and Phytosanitary (SPS) Contingency Measures and Preferential Access arrangements are important non-price-related issues from Egypt's perspective. Sanitary and phystosanitary measures include antidumping, safeguards, and countervailing duties. Technical measures - 47- such as food safety standards, labeling requirements, and sanitary and phytosanitary requirements can impede agricultural exports from developing countries, as was the case for potato exports to the European Union. For food exports in particular, compliance with technical requirements is a prerequisite of successful export trade (to understand better the SPS-related problems associated with developing countries' exports, Henson and associates made in 1999 a series of in-depth case studies of 10 developing countries, including Egypt, over the period October 1998 to March 1999). 6.25 Various studies have addressed sanitary and phytosanitary requirements and developing country exports. A few have quantified the related costs of compliance with these requirements. For example, the cost for Argentina to achieve disease- and pest-free status to export meat, fruit, and vegetables was $82.7 million in 1991-96. Similarly, the cost of upgrading hygiene standards in slaughterhouses in Hungary over the period 1985-91 is estimated as $41.2 million (Finger and Schuler 1999). Furthermore, particularly in the case of processed export goods, improvements and investments in hygiene standards might be required throughout the sector, i.e., not only in processing plants but also in farms themselves and in transportation. The preliminary data available on rejections of agricultural exports at the border following border inspection in developed countries suggests there were significant rejections for example in the USA due to microbiological contamination and decomposition. 6.26 Based on the experience of many developing country exporters of farm products to the European Union, the most significant factors have been "insufficient access to scientific/technical expertise and incompatibility of sanitary and phytosanitary requirements with domestic/marketing methods" (Henson and others 1999). Looking ahead, Egypt's agroexport strategy must consider that the necessary resources to develop a system to monitor and enforce/comply sanitary and phytosanitary requirements will be substantial, both financially and technically, and will have to be allocated on a continuous bases, i.e., this will not involve a one-shot effort. Reduction and Removal of the Prevailing Anti-export Bias 6.27 A central goal of the strategy in this report is to identify policy options to create a supportive policy environment for agroindustrial exports. A simple, often forgotten, and yet important economic principle is that trade-related protection of importables represents an implicit tax on exportables. 6.28 In Egypt, as in most developing countries, agriculture is a very tradable sector. The prices of tradables are determined by world market prices, the exchange rate, and trade policies. The prices of nontradables, that is, home goods, are determined domestically by changes in domestic supply and demand. Thus trade policy and the exchange rate play central roles in the profitability of-and thus signal for investments in-tradables, both import-competing (such as wheat) and exportable (such as cotton and fruits). 6.29 Industrial and agricultural protection of import-competing activities helps these sectors at the expense of the production of exportables. A policy that protects industry and subsectors of agriculture raises the cost of importable inputs such as fertilizers, machinery, and other materials used by farmers and the agroprocessing industry. Thus protection reduces the competitiveness of the export sector. Indirectly, as domestic import prices increase in response to import restrictions, import demand declines and the "surplus" generated in the trade account requires a lower (real) exchange rate. Thus the exchange rate that maintains a balance in the extemal account at the prevailing, "higher" rate of protection to industry and sectors of agriculture is below the exchange rate at lower levels of protection. Why? 6.30 Import restrictions are taxes. Whether direct, such as tariffs, or indirect, such as quotas, these taxes have the same effect: they increase the price of imported protected goods compared to the price of exportables, home goods, and other importables. Who pays these taxes? - 48- 6.31 Initially the import tax is paid by the direct consumers-farmers and households alike. But eventually wages and the price of home goods are also driven up. The sector that is especially hard hit is exportables. Since exportables must be priced to compete in world markets, exporters cannot raise prices to recoup the high costs of industrial and agricultural protection. The losers are usually the exporters of agricultural products. Government policy controls nominal protection through commercial and price policy. But the impact of trade policy on incentives for exportables and import-competing activities will depend on what economists call "true" protection, not on nominal protection. True protection measures changes in the prices of the protected activity relative to the prices of home goods and other tradables. The discouragement of agricultural exportables cannot be removed by nominal devaluation. As long as industry and import-competing agriculture is highly protected, the production of export products will suffer the consequence of a lower real exchange rate. 6.32 Export promotion policies such as tax rebates, drawbacks, export credit subsidies, and direct subsidies on inputs reduce the "true" tax on exportables and thus help reduce the anti-export bias of previous policy. However, such measures are fiscally costly, their sustainability is uncertain, and they are unlikely to offset completely the anti-export bias of relatively high industrial and agricultural protection of import-competing products. 6.33 While Egypt has decreased tariffs and bans on the importation on many products, it has increased other nontariff barriers have increased. Widespread use of nontariff barriers applied to imports into Egypt, including unclear quality standards (such as the nearly unattainable 7 percent maximum fat level on beef imports) and sanitary and phytosanitary requirements perceived as excessive by exporters to Egypt, could result in a de facto retaliation against Egyptian exports in foreign markets. Egyptian exports of fruits and vegetables would be particularly sensitive to such import restrictions abroad. Hence, the argument on protection through tariffs and quantitative restrictions as an implicit tax on exports applies also to some nontariff barriers. - 49- Annex Table: Tends in domestic supply and international demand for selected leading Egyptian agricultural export products, 1994-98 Value Egypt export World Category Product (millions of trend import trend 1998 (percentage) (percentage) dollars) T-shirts, singlets and other 102 13 9 Winners in vests, of cotton, knitted 1_02 139_ growing markets Men's/boys' trousers and 47 33 8 shorts, cotton, not knitted Carpets of man-made textile 36 43 10 materials, woven made up Cotton yam, >/=85%, single, Losers in combed, 714.29>dtex> 78 -17 13 e /=232.56, not put up growing markets Cotton yam, >/=85%, multi, combed,714.29>dtex>/=232. 56 -5 16 56, not put up Rice, semi-milled or whole 134 15 4 Winners in milled, polished or glazed declining markets Oranges, fresh or dried 61 50 1 _ Potatoes, fresh or chilled 43 1 -8 -- Men's/boys' shirts, of cotton, 42 2 1 not knitted Toilet and kitchen linen, of 40 11 -2 -- cotton Cotton, not carded or combed 158 -10 -1 Losers in !_______________________ _ =declining markets Plain weave cotton fabric, >/=85%,more than 200 g/m2, 39 -11 -2 -- unbleached ,All goods (benchmark) 3,186 0 6 Source Mistiaen 2000, based on ITC 2000. - 50- Annex A Note on the Rice Sector 1 Rice cultivation has benefited from price liberalization and low water costs, becoming cotton's main domestic competitor. Area under rice cultivation has reached about 1.7 million feddans, while cotton area has shrunk to 500,000 feddans. In addition, rice has become a major export crop. 2. Rice is a water-intensive crop requiring 10 billion cubic meters, or 18 percent of Egypt's water resources. To limit rice cultivation in the lower zones of the Delta, the government enforces a tax on rice cultivation in other areas. Egyptian rice is appreciated in many markets for its special characteristics. Egypt produces mainly japonica rice, short-grain rice used in Mediterranean and Near Eastern mahshi cuisine. Egyptian consumers prefer the short, sticky grains of Egyptian japonica varieties and do not consider long-grain rice varieties an acceptable substitute. International Rice Research Institute varieties, despite high yields, have been rejected by most Egyptian consumers, and their milling yields are low with the equipment used in Egyptian rice mills. 3. Except in 1998, when Egypt's cultivated area in rice dropped by 18 percent and paddy production fell 20 percent from that of the previous season (MALR 1999), paddy area and output have risen steadily since 1990. A record area sown to paddy was expected in the summer of 2000, possibly exceeding 1.7 million feddans. This could result in anotheT record crop (greater than the record 5.8 million metric tons of paddy estimated for 1999). Most of Egypt's paddy crop, which exceeded 5.0 million tons in 1997 and 1999, is consumed domestically. At an average milling yield of approximately 65 percent, the 1999 paddy crop of 5.824 tons converts to 3.786 tons of milled rice, of which an estimated 75.1 percent will be consumed in Egypt. Exports reached 409,200 metric tons in 1997-98, a record year; exports did not exceed 400,000 metric tons in any other market years (15 September to 15 September) during the 1990s. Exports have ranged from 5.1 to 15.5 percent of the milled rice crop since 1990-91. 4. Despite high domestic consumption (more than 40 kilograms per person per year), Egypt is an important exporter of japonica rice to Mediterranean markets, principally Turkey, Syria, Jordan, Lebanon, and West Bank and Gaza and Israel. Egypt's chief competitors are the United States and Australia. Since 1994-95, Egypt has shipped lower grades of camolino rice (rice with five liters of paraffin oil per ton, giving it a sheen and enhancing its whiteness) and natural rice (milled from Egyptian paddy varieties that are less-preferred in Mediterranean markets) to Black Sea markets, mainly Eastem European countries and Russia. Camolino rice makes up 75 percent of exports. Export shipments to these Black Sea markets averaged 91,965 metric tons a year from 1995-96 through 1998-99, while exports to Turkey averaged 61,206 tons and exports to Arab Mediterranean markets averaged 101,883 tons over the same period. Egyptian exporters now face stiff price competition from Chinese exporters of medium-grain rice, an acceptable substitute in the Black Sea markets and the lower end of the Turkish market. U.S. Department of Agriculture situation and outlook reports state that China is in the export market to stay; its competitive threat is not a single-season phenomenon. 5. The fact that a desert country with limited arable (and almost entirely irrigated) land, exports rice, a high water-consuming crop, is an apparent paradox. However, rice production in California, a competing producer of medium-grain rice, is also irrigated production on what would otherwise be semiarid land. Most observers, mainly farmers, report that paddy production yields higher financial returns than cotton cultivation, which is largely the result of the implicit taxation on cotton production and the availability of a highly subsidized irrigation system..What farmers pays covers only for pumping the water from the canals onto their fields (El-Zanaty and others 1998). Pricing of water is a politically sensitive issue in Egypt In the foreseeable future the government is likely to continue its current water policy. Hence, rice production should remain financially attractive to growers. - 51- Marketing Issues 6. During the fall of 1999 farmers received higher paddy prices (24-43 percent higher on the three key traded varieties) than during the fall of 1998, mainly because of the strong market presence in 1999 of the public sector rice mills and former public sector mills, which are now run by Employee Shareholders' Associations (ESAs). The fact that many growers received high prices for their paddy after the harvest in 1999, and considering the low profitability of cotton cultivation, definitely encouraged farmers to plant paddy in 2000. Imports or rice are restricted by a 20 percent tariff and a 5 percent sales tax. 7. The government plans to reduce paddy area to 1.0 million feddans, largely on the grounds that the New Lands in North Sinai and Toshka need water savings. The threat to penalize farmers who grow paddy illegally in restricted governorates and areas in rice-producing governorates has not changed farmers' behavior, and was difficult to enforce during the past three years when water was abundant in the Nile system. Destroying nurseries in these zones was more effective in 1998. 8. The govemment's strategy is to persuade growers to plant less area to paddy, realizing higher yields, water savings, and high enough output from this reduced area to meet domestic requirements and allow export of a modest surplus. The Agricultural Research Center has developed short-season, high- yielding varieties that mature in 120-130 days, a month or more less than the longer-season varieties preferred by millers and exporters. However, exporters and large commercial millers have a somewhat different vision from that of the government. They argue that exports should not be restricted (to some residual of production over domestic consumption), but should instead be encouraged by long-term contracts of preferred varieties with consumption characteristics desired in Mediterranean markets. The preferred varieties in foreign markets are the long-season varieties Giza 171, 172 and 173, which have been canceled by the Ministry of Agriculture and Land Reclamation, and Giza 177, the one short-season variety with comparable milling and consumption characteristics. 9. Another key policy variable is the high import tariff for rice (about 30% considering the sales tax), which de facto practically eliminates rice imports for the mass market, except in 1998-99. Small quantities of high-quality specialty rice (less than 1,000 metric tons a year) are imported into Egypt at high prices; bought by well-off consumers. In 1998-99, an anomalous marketing year, the domestic rice prices spiked in April and May to exceptionally high levels precipitated the largest volume of commercial rice imports ever, when proximately 35,000 metric tons of Chinese medium-grain rice were imported. Removing these trade barriers would allow traders to import cheaper medium-grain rice for lower-income consumers, while Egyptian millers and exporters could continue to buy and ship the premium Egyptian short-grain rice to nearby foreign markets. This policy would benefit poor consumers while maintaining market share in key export destinations. Reducing or eliminating the import tariffs would also help decrease the artificially high private profitability of paddy cultivation, which would lower area planted through economic incentives rather than policing of growers. The Future of Rice Exporting 10. The Monitoring, Verification, and Evaluation Unit of the Agricultural Policy Reforn Program forecasts that Egypt will remain an important exporter of short-grain japonica rice during the first decade of the 21 st century. This prediction assumes the following production and policy scenario: * Area cultivated to paddy will reach 1.5 million feddans or more each summer growing season (far above the govemment's declared objective of one million feddans). The government should have an opportunistic policy regarding rice areas. During the years of abundant floods in the Nile Basin, it would be difficult to prevent farrners from using water for rice cultivation that would otherwise flow to the sea. However, during low flood years - 52- (and when Toshka and Salam Canal projects are operational) the policy limiting rice areas should be enforced; * Yields will increase; marginally, and area planted to short-season varieties will expand from about 70 percent of total cultivated area in 1999 to nearly 100 percent by the end of the decade; * The exchange rate will depreciate steadily in response to trade imbalances, foreign exchange outflows, and other market forces; and * The government will lower tariff barriers and sales taxes on imported rice to 5 percent or less. I1. Reducing trade barriers is essential to maintain export levels, because domestic consumption will increase and cheaper, lower-quality imports will be needed to replace more expensive high-quality Egyptian (exportable) rice now used by some lower-income domestic consumers. On the long term, the volume of rice exports may be affected by rising domestic demand which may absorb the large paddy crops. Empirical evidence from a national household sample survey conducted by the Food Security Research Unit of the Agricultural Policy Reform Program seems to support this view, albeit over a 10- year time horizon or longer. Domestic population growth is at least 2.0 percent per year, and national income growth is about 4-5 percent a year. Expenditure elasticity of demand is estimated at 0.22 to 0.27, which means that rising household incomes together with population growth will lead to greater rice consumption, particularly among poorer households. 12. A second set of policy issues centers on the role of the public sector rice mills. Six of eight mills are being privatized through employee stakeholder buyouts over periods of ten years or more. The public sector, particularly the Food Industries Holding Company, effectively controls these mills. Since 1996-97, the public mills have been in and out of the domestic paddy market in alternate years, receiving either cheap credit or plentiful credit at market rates through the former Rice and Flour Mills Holding Company's intervention with the banks. The Rice and Flour Mills Holding Company merged into the Food Industries Holding Company in December 1999. This new holding company's management of the public and Employee Shareholders' Association mills is not yet clear. 13. In years when the public and Employee Shareholders' Association mills bought large quantities of paddy in the domestic market, this trend has pushed up domestic price levels and squeezed the competitiveness of exports. An important policy question is whether the Employee Shareholders' Association mills will continue to depend on the holding company for access to finance. 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Washington, D.C. WBI6053 P:\!IUNITS\MNSRE\BARRES\AgrExportOrientedStrategy FINAL December 21,2001 .doc December 28, 2001 2:31 PM