‘Mills may not operate if support price set higher than Rs120*’

An interview with Iskander M. Khan, Director Premier Group of Companies

Iskander Khan is a three-time ex-chairman of Pakistan Sugar Mills Association (PSMA), presently holding the offices of Vice Chairman, and Chairman for local chapter, Khyber Pakhtunkhwa. He is also the Director of the Premier Group of Companies, which is the largest sugar mill group in KP and third largest in the country by capacity. Premier Sugar Mills was also the first mill set up in West Pakistan after independence.

While a representative of industry’s association, Khan is an independent entrepreneur known for speaking his mind. Not only an outspoken critic of government’s short-sighted policies ailing the sector, he also does not shy away from censuring people of his own cloth, specially those who profit at the expense of consumers.

As the sugarcane crushing season draws near, BR Research sat down with Khan to understand the challenges currently facing the sector and what the future holds for it. Below is his vision.

BRR: What is the industry situation like?

IMK: The millers are in shambles! We are still reeling from the actions of the last two governments. Last year, sugarcane was priced at Rs182 per 40kg. Remember that 90 percent of white sugar price is pre-determined: 80 percent of production cost constitutes of raw material, cane; whereas ten percent is taxation. So, in any given year, millers have a margin of ten percent to cover their fixed operating costs and financial charges. The policy solution is abundantly obvious: let the sugarcane price be dictated by market forces

Or, fix ex-factory price of sugar to guarantee minimum margins for millers. In 2015-16, we had a surplus of 2.8 million tons of sugar against domestic consumption of 5.5 million tons, at a time when sugar prices in international markets hovered around $550 per ton. We pleaded with the government to allow export of 2 million tons, which would have brought $1billion in exchange earnings. Increased profitability would have also allowed millers to make timely payments to farmers.

Our esteemed federal commerce minister at the time did not agree. The industry is accused of cartelization. How can there be a cartel? Commodity markets are driven by demand and supply. When the market has excess supply of 2.8 million tons against demand of 5.5 million tons, what is going to happen?

Millers have no choice but to restrict and delay sugarcane purchase. Delay in payments to farmers is also inevitable. Yet, when millers operate below capacity, we are threatened with legal action by the government.

BRR: Several millers privately admit that while the adverse impact of support price is real, they are able to procure sugarcane at lower rates. Should that not mitigate the losses?

IMK:  It is true that some farmers are forced to sell at lower than floor price, but usually to arthi or the middlemen. Due to financial distress, some mills take three to four months to pay farmers, leaving farmers little choice but to sell their crop on cash at a discount to the middlemen. Last season, some arthis were able to purchase cane for as low as Rs110*. But that’s not more than five to ten percent of the total output. For example, this practice does not take place at all in KP, because we make payments to farmers within three days of purchase through cash cheques. But millers that delay payments don’t have much choice either.

The root of the problem lies with support price, as it disincentivises investment in higher yield and productivity. Take for example Brazil, which is the largest producer of sugar in the world. Pakistan’s national sucrose recovery average stands at ten percent, compared to 15 percent in Brazil. That’s because sugarcane price in Brazil is linked with recovery rates; higher the recovery, higher the price.

BRR: If sugarcane price is linked with sucrose recovery, won’t you agree that farmers will be exposed to exploitation by millers? Millers could just as well claim low sucrose content and refuse to pay fair price.

IMK: The risk of exploitation is minimal. Specialized machines known as core samplers are used globally to measure sucrose content. These are installed at mill-gate and estimate sucrose ratio with very high accuracy. I lobbied FBR to this end, and a notification was also issued in 2005 but was never implemented. Farmers support it too. The equipment costs just Rs30 million, and it streamlines the payment process because cash payment receipts can be immediately issued against delivery of crop once sucrose content is measured and is as per mill’s requirement.

BRR: Sugar industry recorded highest ever production during last season. Sugarcane crop was also highest-ever. If both farmers and millers are suffering from poorly thought policy, why is production increasing?

IMK: Support price has led to a market failure. Over past 15 years, domestic sugar consumption has not increased by more than 1.5 million tons. Yet, during the same period, sugarcane production has almost doubled. While improved crop yield is one reason, area under cane cultivation is also increasing almost every year. When growth in supply outstrips demand growth, why are farmers growing more sugarcane?

The short answer is: support price. It distorts the market structure. Abnormal gains made by farmers due to artificially high held cane price more than offsets any distress caused by delay in payment. Why else does the farming community continue to prefer sugarcane over other crops? There is shortage of cotton and yet it is increasingly being substituted by plantation of sugarcane.

At an average recovery ratio of ten percent, and support price of Rs180*, raw material cost alone is Rs45 per kilo of processed sugar. Add two rupees for cane transportation and seven rupees in taxes. Even if ex-factory price of sugar is set at Rs64 per kg, millers have a margin of just Rs10 per kg to cover their overheads and operating costs. If mills are to remain profitable, retail price of sugar should be no less than Rs64 per kg, yet it is currently retailing at as low as Rs48-52 per kilo. Retail price is low because there is excess supply in both domestic and international markets. Remember, sugar price in the global commodity market right now is at $380 per ton, which is no more than Rs50 per kilo.

BRR: What do you propose then? Should support price be scraped altogether?

IMK: Farmers will not receive more than Rs120* for sugarcane if retail price of sugar does not increase as well. If the government increases support price at whim for the upcoming season, and does not take into account the surplus stock in the market, millers may refuse to operate altogether. What other options do we have?

We are cornered by all sides. Government already owes the industry about $3 billion in payments for export subsidy announced in yesteryears. The millers are reeling

If the government believes that millers are exploiting farmers, it should remove duty on import of white sugar. I predict that price of sugarcane will fall to Rs80*. Either deregulate cane price so that production cost declines and millers are able to compete in the export market. Otherwise, the only way to retain the support price structure is by fixing ex-factory price too. The current model is unsustainable, because there is no policy. The only reason honest millers are still able to post some semblance of profitability is through sale of ethanol.

BRR: Reducing supply will jack up retail price of sugar, which has been a highly sensitive and politically charged issue in recent past. Given Pakistanis’ sweet tooth, how will the industry respond to the fallout if supply becomes constricted as a result of deregulation of sugarcane price?

IMK: Remember that primary consumer of sugar is industry, not domestic buyers. Whom are we subsidising? Domestic consumption of sugar is no more than half a kilo of sugar per month (per household member). Even if price of sugar were to increase by Rs20 per kg, the impact on domestic consumer’s annual expenditure will be negligible.

It is the FMCG sector, which is impacted. It constitutes more than 70 percent of domestic demand. When price of sugar shot up to Rs80 per kilo in 2010-11, beverage and confectionary segments increased prices manifold. Retail price of sugar stabilised the very next year, and has averaged between Rs50-60 per kilo ever since. FMCG segments never reduced prices, and continue to make billions!

BRR: But surely government regulations alone are not responsible for the sector’s troubles. Is short-sighted expansion also not to blame for the gap between capacity and domestic demand?

IMK: Pakistan’s sugar sector became unprofitable when zoning laws were repealed back in 1990s. Globally, no two mills are allowed within 70-mile radius of each other. This helps maintain a balance between region-wise supply of sugarcane and demand. At the same time, it also incentivises the millers to help farmers invest in high yield seeds and fertiliser to improve productivity. Back in the day, government would purchase processed sugar from millers and sell it at ration shops and utility stores. This streamlined value chain as farmers received payment within stipulated period of 15 days.

When zoning ended, mills mushroomed across the country; Pakistan has 90 mills today against just 30 back in 90s. Installed capacity stands at 13 million tons yet domestic demand is no more than 5.5 million tons. Recovery rate has also suffered as a result, because individual miller sees no benefit in helping farmer maximize his productivity, because the farmer could end up selling his crop to a different mill.

The problem is that there is no system. During mid-2000s, the government issued licenses for 30 more mills. At that time, I conducted a press conference and pleaded that the existing 50 mills are more than sufficient to cater domestic demand for next five decades. Why are we interested in expanding an industry that does not contribute to our foreign exchange earnings, and instead has to rely on subsidy to be exported?

The answer is that producers with political clout want to shift their mills to fertile cotton growing areas in Southern Punjab abundant in water supply. Very few millers are profiting at the expense of cotton and textile sector, which is the lifeline of our exports. It is a tragedy.

BRR: You have held important positions in the industry for a long period, and your voice is heard in the important quarters. What is your solution and what has been government’s response to it?

IMK: The solution is to deregulate the market and incentivise synergies between farmer and millers so that miller becomes invested in maximizing farmer’s yield. Once the yield per hectare increases along with sucrose content ratio, farmers will no more be dependent on increasing crop volume alone to increase profitability. Right now, farmers are increasing area under sugarcane cultivation because their profitability is directly linked with increasing crop volume and weight.

When I was chairman of PSMA back in 2010, we presented recommendations for national sugar policy to the federal government. It has been eight years since but no action has been taken because there is lack of interest. We had received support from Kissan Board on our proposals because they understand that if prices are linked to sucrose content, productivity will increase and farming community will benefit in the long run. Moreover, the issue of farmer exploitation will end because cash payment receipts will be issued against farmer’s CNIC on mills letterhead. This will put an end to the role of middlemen. No mill will be able to purchase cane at a steep discount to market price; at the same time, farming income will be documented too.

On the other hand, so long as cane price is dependent on weight alone, farmers will prefer growing Indian cane that is higher in mass but low on sucrose content. Pakistan is the fifth largest producer of sugarcane, yet is ranked at 15th based on yield per hectare. Only when farmers with higher yield are duly compensated for their investment will Pakistan be able to compete globally.

BRR: If sugarcane support price dictates the profitability of the sector, should millers not enter upstream business and invest in farming so as to protect their margins against arbitrary government-set rates?

IMK: You are right. But appreciate that cane yield stands at 47 tons per hectare. Where will we get the money to purchase all the land needed? I had once suggested that government acquire cane producing land, and then lease it to millers for corporate farming. But other than that, and apart from JDW, no mill of note grows its own cane. It is just not cost effective. Out of the seventy thousand farmers that supply cane, no more than 15 to 20 percent own more than 100 acres. Average holding size of cane farmers is not more than 10 to 20 acres. It is just not feasible.

BRR: In the context of Pakistan’s growing water shortage, increasing noise is being raised that sugarcane is a water-thirsty crop and unsuitable for Pakistan’s climate. Do you agree?

IMK: Those who advocate reducing sugarcane cultivation as a solution to Pakistan’s water shortage miss the larger picture. The day Pakistan has to import 5.5 million tons of sugar instead of producing it locally, price of sugar in international market will jump to $900 per ton. Where will Pakistan get $5 billion to import and meet domestic demand?

As I said, once millers have an incentive to help farmers increase their yield and productivity, farmers will be encouraged to reduce inefficiencies in irrigation methods and invest in modern irrigation techniques such as drip irrigation that reduce water footprint. But for that to happen, the incentives for both supplier and buyer of sugarcane need to be aligned

.*support price rates as at 40kg of sugarcane