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April 16, 2020

The sugar supply chain


April 16, 2020

Amid the Covid-19 pandemic, the recent preliminary reports into the escalation of sugar and wheat prices are creating ripples through the political landscape in that they point the finger at some leading stalwarts of the ruling party.

The prime minister is drawing both accolades and fire: accolades, for having made the report public and promising across-the-board action against the people responsible; fire, for having allowed sugar export when doing so was unwarranted.

It’s important to bring to the book people who are behind the commodities’ shortage but it’s even more important to address the distortions present in their supply chains, particularly that of sugar. If left unaddressed, the distortions will set off another supply shock in a few years – or even earlier.

After all, the recent sugar, or for that matter wheat, crisis isn’t one of a kind. As it may be recalled, the year 2010 also saw a sugar crisis when all of a sudden it became a scarce commodity. As the sugar price went through the roof, the federal (PPP) and Punjab (PML-N) governments blamed each other for the crisis. In fact, subsidies granted to the millers for export of sugar has been a regular feature of the country’s political-economy, no matter which party wears the garb of government.

The three principal distortions in the sugar supply chain are: price support to sugarcane growers, the presence of a powerful sugar cartel, and export subsidies granted to the millers to cover the difference between domestic and international sugar prices.

Every year, the government fixes the support prices for sugarcane and wheat, which is higher than the price the growers would get under competitive market conditions. Whereas the wheat support price is fixed by the federal government, sugarcane prices are announced by provincial governments. In either case, the avowed purpose of the price support is to ensure that the farmers get a minimum return in the face of international price fluctuations, and protect them from a fall in the commodity’s prices below the minimum level at which its cultivation remains profitable.

Be that as it may, support prices suppress the market mechanism, inducing growers to jack up production, not by increasing the yield but by bringing more area under cultivation. The greater the sugarcane output, the more benefit the growers drive. Hence, regardless of its avowed objective, the subsidy is devised to benefit the big growers, who are politically remarkably influential.

According to the Agriculture Census 2010, households owning farms of less than 12.5 acres in size account for 89 percent of the total households, while the share of those owning farms of 12.5 acres or more is 11 percent of the total. However, these big farms account for as much as 45 percent of the total area under cultivation. This shows that only a small number of growers are the capital beneficiary of the price support. Small growers produce too little to avail themselves of the price support. Not only that, they face problems in selling their produce to the millers at the administered price. On the other hand, in several cases, the big growers of sugarcane also run sugar mills.

In either case, when sugarcane arrives at mills, it's more expensive than it would be in the absence of price support. High sugarcane production, undergirded by higher prices results in high sugar output. In Pakistan, the average annual sugar consumption is about 5.2 million tons (MT), while the average sugar output is generally above the consumption level. During the last three years, the average sugar output was 6.3 MT. As elsewhere, the excess of domestic output over consumption makes for export.

Due to the distortions in the sugar supply chain, the domestic price of sugar tends to be much higher than its international price. As a result, the government subsidizes the export of sugar. Export subsidy, in turn, induces the millers to produce more sugar. Not only that, the sugar industry is also protected by high tariffs (to the tune of 20 percent) on the import of sugar.

Here a question arises: If the subsidy can be an instrument of driving up output and export of sugar, or for that matter any other commodity, what’s wrong with it? The answer is that the subsidy has both winners and losers. The major beneficiaries of price support are big growers, while the beneficiaries of subsidized exports are sugar mill owners. The losers are the consumers, as export of sugar raises its domestic price. The government may even have to import sugar to stabilize its domestic price, which, again, will create rents for sugar suppliers. In this way, they derive a double – and possibly a triple if they also happen to be sugar growers – benefit.

On the other hand, since the subsidy is made from the public exchequer, it is the taxpayers or the consumers that bear the brunt of it. This amounts to a double whammy for the consumers (paying higher price for sugar as well as subsidizing its export).

Given a considerable gap between sugar demand and supply, Pakistan should not face sugar shortage. But from time to time, all of a sudden the market runs out of sugar and new stocks become available only after the commodity’s price has ratcheted up. This shortage is the handiwork of the sugar cartel, which draws its membership from all the major political parties. Next to the love for democracy, sugar provides arguably the strongest bond among politicians. That’s the reason governments come and go but the interests of the sugar industry as well as those of mega sugarcane growers are always protected.

The sugar scam on hand arose when in October 2018 the Economic Coordination Committee (ECC) of the cabinet allowed export of sugar amounting to one MT. The export quota was subsequently raised to 1.1 MT. Both the ECC decisions were ratified by the cabinet. The sugar export was allowed without subsidy. But as domestic prices were higher than the international prices, the surplus sugar could not be exported. It was then that in January 2019 the Punjab government announced Rs3 billion subsidy at the rate of Rs5.35 per kg – the gap between domestic and world prices – making it possible to export sugar. As always, the big beneficiaries of the subsidy were those who had large sugar stocks to sell. This is how subsidies work.

Although the ECC while allowing sugar export made no provision for the subsidy, because of the significant price differential the subsidy was inherent in the decision. That’s how the sugar barons strategize. They first ask the government to allow them to export sugar with or without the subsidy. Once they get the decision, the next logical step is to ask for the export subsidy, which is difficult to refuse.

If export of subsidized sugar is a matter of course, why did a similar decision by the PTI government brew up into a crisis? Well the answer consists in the economic slowdown since the present government took office. Between FY15 and FY18, the country saw an increase in sugarcane output from 62.8 MT to 83.3 MT. In FY19, however, sugarcane output came down to 67.2 MT. Since sugar is made mainly from the sugarcane, sugar output declined to 5.26 MT in 2018-19 from 6.56 MT in 2017-18 and 7.02 MT in 2016-17. Hence, in the face of declining sugar stocks, the decision to export the commodity drove up its price. From Rs55 per Kg in September 2018, sugar’s retail price scaled up to Rs71 per kg in June 2019 and further to Rs76 per kg in September 2019.

The long-term solution to avert another sugar crisis is to put an end to the distortions in the supply chain. In the first step, sugarcane support pricing should be abandoned. Let the growers cultivate sugarcane or any other crop in response to its market demand. Government intervention should be confined to building up strategic reserves for the commodity. In the absence of a sugarcane support price, the price of sugar will come down with the result that the sweetener’s export will not be dependent on the subsidy. At the same time, the 20 percent duty on sugar import should be slashed so that in case of domestic shortage, the imported commodity may be available at a much cheaper price. Finally, the sugar cartel, which is illegal under the Competition Act, needs to be broken.

The only problem in reforming the sugar supply chain is the inestimable political influence of sugar millers and mega sugarcane growers. That’s the reason that setting things right in the sugar industry is easier said than done.

The writer is an Islamabad-basedcolumnist.

Email: [email protected]

Twitter: @hussainhzaidi