De-regulating the sugar industry: do not drop the ball again

The sugar industry is in trouble, but it need not morph into a crisis. Last week, the industry association wrote a letter to the central bank, requesting extension in maturity of its short-term credit lines from September to calendar year end, in view of the unsold inventory held up under bank pledge due to slowdown in commercial demand.

The industry’s predicament is straight forward. Last October, the sugar industry was forced to accept a record rise in minimum support price of sugarcane without protest in the lead up to general elections 2024. To be fair, industry participants anticipated that PDM 2.0 would behave rationally post-elections, taking a long-term view that ensures sustainability for all stakeholders: growers and mills. Despite the rise in cost of production, it hoped that it would either be allowed to pass on the increase in raw material price onto consumers in the domestic market or would be given export access to offload surplus production and take advantage of the record rise in world sugar prices. This was circa Sep – Dec 2023.

Neither happened. At that time, this author warned that a politically embattled Sharif-led government would never dish out export quotas even post-elections, especially at a time when it was engulfed by inflationary fire – and given sugar’s outsized weightage in national CPI and inflation calculation. An imbalance in sugar supply and demand would have further fueled the inflationary fire. Moreover, the risk of being forced to import sugar later at higher prices due to a shortage was a prospect this government could ill-afford. Zardari maybe, but not Maryam and Dar led Punjab and Centre.

In retrospect, failing to protest the unreasonable rise in minimum support price last year was an ill-advised decision. But it was a commercial bet, and one premised on all actors behaving rationally and on status quo remaining unchanged. What everyone – including this author – failed to anticipate were two additional factors: that the currency would finally find stability, and that the smuggling across Afghanistan would be successfully stopped.

Recall that in Sep 2023, when exchange rate breached Rs300 in the interbank market, local retail sugar prices rose beyond Rs165 per kg, up 76 percent since the beginning of that year. Despite a thaw in domestic demand, local prices at the time rocketed upwards due to speculation in the currency market, a bull run in world sugar market, and the arbitrage for smuggling across Western border onto the Central Asian countries. The trends in sugar offtake indicated that even if export access did not come through, the aggregate demand – whether egged on by currency arbitrage, speculation, or smuggling, would persist – allowing the producers to keep their head above water even if domestic consumption tapers.

Significantly, not only did the leakages across Western border come to a halt abruptly, PDM 2.0 did not allow exports (or did, but very hesitantly). In fact, it went one step further: imposed a price ceiling on local prices of sugar, capping them at Rs140. Not only did the status quo underpinning market fundamentals shift overnight, the elections were also over. And while the government in Center and Punjab showed concern for short-run inflationary imperatives, their actions would now put the shaky equilibrium between growers and millers to test.

Now, in the run up to the upcoming crushing season the industry association is putting out appeals for a resolution to their predicament. Maybe it senses an opportunity after IMF’s sign off to get out of paying the steep MSP (from last year) to growers. Maybe it hopes to secure a bailout given the very real danger of industrywide shutdown and delays in loan settlement with commercial banks. What is missing, however, is leadership with a clear sense or vision for industry’s future – and a road map towards successful deregulation in the brave new world of no MSPs and no export quotas.

Perhaps individual firms and market participants cannot be blamed for making commercial decisions premised on rationally driven public policy. On the other hand, industry associations must take into account political economy, offer leadership to its members, and provide forward looking guidance to policymakers such that the efficient frontier is pushed ahead for all stakeholders. Not only the days of receiving subsidy against exports long gone, put an end to not only by fiscal constraints but also in the aftermath of anti-dumping investigation undertaken by WTO on Brazil’s request back in 2018-19. Demanding export quotas erratically will no longer heal the rot at the heart of this industry. It must adopt radical reform as its advocacy agenda if it is to protect itself from culpability for letting another crisis unfold while refusing to douse the flames. Below is one blueprint.

Short run:

1. The IMF has resolved one part of the problem by barring provincial governments from issuing MSPs. However, in the short run, the termination of MSP alone may not solve industry’s troubles. Even if buyers and sellers are free to trade sugarcane at a price of their choosing, the elephant in the room is unsold inventory from last year. As a first step, therefore, exports of sugar must be freed from all encumbrances, immediately. This means: no excise duty on export, and no minimum export price.

2. As in the case of all other commodities, autonomous traders must be allowed to enter the sugar export-import business, rather than restricting access to exports to sugar mills only.

3. Sugar export must not be limited by any condition such as receipt of 100 percent (or lower) advance payment; nor conditions such as export against LCs only etc. Sugar trade must face the same market conditions as export of all other commodities, whether it is export against DA/DP Contracts, open accounts etc.

4. Banks must suspend the annual clean up requirement and extend financing to firms for next season purely on commercial basis. Regulatory restrictions such as mandatory settlement of last year’s pledge financing before fresh financing is allowed must be removed, if commercially tenable. If a firm qualifies for a fresh line of credit (in spite of carryover inventory) upon assessment of its credit risk, banks should be free to extend credit.

5. Price of sugar in the local market are bound to rise in the short run once trade is liberalized. This is the line with other commodities, even kitchen essentials, where price of broken basmati rice rose by more than 50 percent last year due to export parity. Similarly, sugar price in local market must be allowed to find parity with international market prices.

Medium run:

1. Import of sugar must be encouraged and made free of any tariff and non-tariff encumbrances. Once private sector participation – other than that of mills or mills appointed agents, brokers and indentors – in both import and export of sugar increases, market participants will be able to anticipate shortfalls and surplus more readily and help maintain equilibrium. Public policy objective must be to minimize extreme and sudden price volatility, not ensure price stability for indefinite periods.

2. Private sector investment in cane sugar substitutes – whether beet root or high fructose corn syrup etc – be allowed and facilitated to reduce the outsized influence of cane millers on domestic sugar and sweeteners market.

3. An estimated two-thirds to eighty percent of refined sugar is consumed by B2B participants in confectionary, beverages, and hospitality industries. Any cap on ex-factory price of sugar offers an outsized benefit to B2B sugar consumers, and not retail end consumers of sugar. The policy objective of suppressing sugar prices through regulatory measures is flawed and must be changed.

4. State must put an end to using sugarcane prices as a vehicle for welfare transfer and stop encouraging local sugar consumption through caps on consumer prices.

5. If the market clearing price of sugar is deemed insufficient to account for the negative externalities in the value chain: damage to environment, water resources, health hazards etc., its local consumption should face excise duty to discourage demand, rather than discouraging exports.

Long run:

1. Allow raw sugar tolling to sugar industry to encourage refining as a full-time, 365 days industry and explore its re-export potential.

2. Make concerted efforts to ensure that domestically produced white refined sugar becomes the first locally produced commodity to be traded on a local futures commodity exchange.

3. Achieving price discovery through futures trading can help reduce uncertainty in pricing of sugarcane in absence of minimum support prices and will offer transparency to growers well in advance.

4. Sugarcane market is inherently structured as a monopsony. Encourage mills to offer put options to growers in lieu of MSP so growers can have visibility on minimum profits ahead of planting season.

5. Encourage B2B trading of sugar through the commodity exchange.

For any political government that claims to seek market reform and deregulation, the sugar industry presents the easiest test case. On the one hand, it is heavily politicized. On the other hand, it does not have an outsized footprint or forward linkages that would otherwise make it critical to wider economic growth. It is a capital-intensive industry which does not employ a lot of labor nor generates a ton of exports. The sugar industry relies mainly on self-generated power; truly operates for just 90-120 days a year. Compared to hundreds of rice mills or spinning factories, the country has fewer than 75 fully operating mills that are perhaps owned by fewer than 40 sponsor families. Many of these are financially sound and solvent to wither periods of financial trouble, especially if they are promised better days ahead. Cane is grown by the smallest number of farmers compared to other cash crops such as wheat or rice. Short run negative spillovers may be significant, but for a relatively lower number of market participants (growers).

It is unfortunate that thus far the industry has been led by business groups whose decision making has often been dictated by non-commercial, often political motives. These flawed policies over many years have brought things to a point where few mills may face closure in the days to come. The truth, however, is that macroeconomic disaster of the last few years has shutdown factories across many industries including SME and cottage industries. In comparison, sugar milling hasn’t exactly faced the worst of circumstances.

But if it is to thrive in a brave new world, it must take ownership for its circumstances and find leadership to demand reform, rather than waiting for Islamabad to come to its rescue. Successful reform of sugar industry can either become the litmus test for Pakistan’s elite run, rentier economy or a classic case of failure demonstrating our incapacity to adapt. The time is now.