114. “It is going to be ugly”

A few months ago I reflected here on how high prices can be a double-edged sword for smallholder farmers.  As we move into full harvest season here in Central America, prices are at record highs.  Farmers and traders may be excited about the opportunities the current market creates for them, but just about everyone else is concerned.  One importer, widely known for his sunny optimism and unwavering diplomacy, told me he expects this harvest to be “interesting.”  Another importer recently put it to me more bluntly: “It is going to be ugly.

How high prices cut both ways: short-term gain, long-term pain.

Over the short term, high prices mean that farmers have more cash in hand, are better positioned to meet their families’ needs, and may even be able to reinvest or save a little.  Unfortunately, the shortest path to quick cash rarely involves selling coffee through cooperative structures, since the deepest pockets at harvest are generally those of local intermediaries working on behalf of larger commodity traders.  When farmers sell to intermediaries, they are trading short-term gains for longer-term risk: without access to the coffee they planned to sell, smallholder cooperatives will run the risk defaulting on their commercial commitments, or folding altogether.  And while farmers may not miss cooperatives as long as prices remain sky-high, they will be exposed to the full fury of the market when prices inevitably decline.

Cooperatives are the most reliable strategy for smallholder farmers to insulate themselves from market volatility.  They pool risk, aggregate supply to achieve commercially viable volumes and economies of scale, and manage trading relationships in the wider marketplace on behalf of smallholder farmers.  In the absence of these services, farmers will suffer when market prices fall.

The 2010-2011 harvest: “It is going to be ugly.”

Smallholder farmers here in Guatemala are asking $3 a pound for coffee that is certified organic and Fair Trade and solid-but-not-spectacular in terms of quality.  And these are the prices quoted before harvest really gets into full swing.  The scrum in March or April or May when importers are trying desperately to fill depleted roaster inventories could drive prices much higher.

The less optimistic (or less diplomatic) importer quoted above expects carnage at both ends of the coffee chain — roasters will fail and cooperatives we thought were solid will struggle mightily to hold their organizations together.

What can be done? Filling the gap in the “missing middle.”

Although the competitive pressure on smallholder cooperatives is more acute when market prices are high, it is a perennial and structural problem whose essence is pretty effectively summarized in two words: “missing middle.”  Smallholder farmer organizations need more liquidity to compete effectively with local intermediaries at harvest time.  The microfinance institutions that have been successful in many cases in fostering household-level innovation and entrepreneurship can’t meet the demands of coffee cooperatives, whose capital needs are significantly greater.  And despite a track record that would suggest they represent profitable and low-risk clients, coffee cooperatives have not been able to access commercial loans at affordable rates.  They live in a “missing middle” that is underserved by capital markets.  As the New York Times recently reported,  Root Capital is working to fill this gap (along with others).  It has helped many smallholder farmer organizations compete more effectively for their members’ coffee.  We are working closely with Root Capital and local lenders here in Central America to support these efforts.  But the needs are massive and will not be met until commercial banking sectors in coffee-growing countries begin to colonize the spaces created by pioneers like Root Capital.

While expanded access to finance alone won’t guarantee the stability of smallholder farmer organizations, arguably no single measure would do more to position them for success than filling the missing middle.  We will continue to work to support cooperatives this harvest and hope for the best.  We will be disappointed, but not surprised, if things do get ugly.