Ubiquity of Sugar
Unless you decide to boycott sugar altogether, it invariably slips into your diet. Either in your morning beverage, during celebrations, or simply by shameless indulgence. Given its addictive taste, its widespread use doesn’t come as a surprise. Interestingly, sugar production in India began not recently but way back in the fourth century under the Gupta dynasty rule.
Being one of the firsts to produce sugar, India has grown to become the second-largest sugar producer globally. Government reforms helped this in the 1900s. The import tariffs on sugar in 1930 encouraged domestic production. As part of the five-year plans starting in 1950, the government laid down sugar production and policy support targets. The impact of these measures is evident in the increase in production from 1.58 lakh tonnes (LT) in 1930-31 to 148 LT in 1994-95.
The Scale
Riding on the momentum, the industry now delivers north of 300 LT p.a. The Indian Sugar Mills Association (ISMA) in November 2020 estimated sugar production in sugar year (SY, aka. sugar season or marketing year) October 2020- September 2021 to be 310 LT. Nine months in, the industry has almost beaten the estimate already with 307 LT till 15th June this year. To put the size in perspective, this approximates 18% of the world sugar production estimate for SY 2020-21, which is pegged at 1,703 LT for 2020-21 by the Food and Agriculture Organization of the United Nations (FAO).
The Indian sugar’s significant share is made possible by the vast workforce – about five crore farmers and more than 5 Lakh workers are associated with sugar production, which accounts for 3.1% of our total population. Additionally, all allied industries depend on sugar for raw materials – the bakery, confectionery, biscuits, and indirect employment.
It’s challenging to trace sugar’s contribution to GDP as it is an intermediary product in many ways, while GDP is the final value of all ‘finished’ goods and services. But the industry’s annual turnover of INR 1 Lakh crore against India’s estimated GDP of INR 195 Lakh crore gives us an intuition of its scale.
The Process
With all this, we appreciate the importance of the Indian sugar industry. Being the largest sugar consumer globally, any severe disruption would prove costly to farmers, associated workers, and consumers. Moreover, the government might have to depend on other nations to meet the huge domestic demand. To avoid such adversities, a governance system to manage production, distribution, and incentives is paramount. Since this system is built on top of the manufacturing process itself, a quick brief on the process would help.
The sugarcane is harvested by farmers and sent to the mills. The cane is squeezed to extract the juice, which is filtered to remove fiber. The filtered juice is then boiled to remove moisture and impurities, leaving a concentrated paste, which is gradually cooled to form crystals. This paste is then put through a centrifuge, which, much like a washing machine, separates the crystals from a thick sugary substance, the molasses. The sugar crystals are dried and packed away for consumption.
The process isn’t necessarily complex, but ensuring effectiveness is. The smooth functioning of the process assumes the availability of resources. But this would be possible only when all participants have compensated appropriately. Misaligned incentives can snowball into undesirable outcomes. The sugar industry fell victim to this.
The Devil is in the detail.
For our discussion, the production process involves two participants- farmers and mills. The farmers are guaranteed a Fair and Remunerative Price (FRP) for their sugarcane produce fixed by the central government. The FRP is based on the recovery rate, simply the quantity of sugar recovered from cane as a percentage. For instance, 10kg of sugar processed from 100 kilograms of cane would mean a 10% recovery. But to protect the farmers, the FRP is not allowed to fall beyond a certain level. In some states, the farmers receive a higher State Advised Price (SAP) fixed by the state government. These mandates of FRP and SAPs gave farmers more than 80% return, much higher than other crops. Moreover, mills were mandated by the CG to purchase cane produced within a certain radius, formally called the cane reservation area (CRA). These protective provisions encouraged farmers to cultivate more cane.
The Mills, on the other hand, had to procure cane at fixed prices- FRP/SAP. Though the minimum selling price (MSP) for sugar was set to INR 31/kg by the government to assure the mills, it wasn’t enough to provide a decent margin. Considering the production cost of sugar at 3,580 per quintal (or 35.8 per kg) in 2017-18, MSP falls short. This high production cost is driven mainly by the high price of cane to the mills.
The farmers were incentivized to increase cane production, which mills had to absorb, resulting in higher sugar production. Sugar prices adjusted downwards to accommodate higher supply in the market. The reduced fees and increased costs squeezed the mills. With such high costs, they can barely make margins. Also, they couldn’t turn to exports much with the uncompetitive prices. In SY 2017-18, when sugarcane price per tonne was around USD 25 in other sugar-producing countries, it was USD 42 in India.
As mills’ earnings suffered, payment to farmers got delayed. These arrears in June 2018 rose to a whopping INR 22,000 crore, which is significant for an industry with an annual turnover of INR 1 Lakh crore. Though arrears were reduced to13,000 crores in September 2020, the problem persists.
The FRP began as an aid to farmers but is hurting them now in the form of arrears. But the farmers keep coming back because of the lucrative returns and the government assistance to clear the arrears.
Enter, Molasses
Fossil fuels are notorious for their emissions and contribution to climate change, and they take millions of years to replenish. The world had realized the need to shift to renewable resources. In its endeavor to go green, India looked to use ethanol-blended petrol to reduce petrol consumption. India produces a significant portion of the biofuel ethanol by fermenting molasses. The sugar by-product has assumed great importance in the recent past. Apart from the reduced environmental impact of its derivative ethanol, it does plenty good to the Indian economy too.
85% of India’s crude oil demand is met through Imports which cost INR 7.17 Lakh Crore in 2019-20. A blending rate of 20% (20% ethanol & 80% petrol) would help save forex of 30,000 crore. Lesser imports will also help reduce dependence on foreign states, which helps mitigate geopolitical risks and the impact of supply chain disruptions.
But most importantly, this program would help heal the sugar industry’s wounds. The excess sugar production can be diverted to manufacture ethanol. Ethanol sells quicker than sugar, and it puts more money in the hands of mills. Mills and distilleries generated 22,000 Crore in revenues from ethanol to OMCs in the last three sugar years. This will be furthered by the interest subvention scheme announced by the government in December 2020. The government would bear the interest for the first five years on loans to set up ethanol distilleries. The recent hikes in ethanol prices by the government also helps. Costs of ethanol produced from C-heavy molasses were increased by 4%, B-heavy by 6%, and 100% cane juice by 5%. C-heavy molasses contain least the least amount of sugar.
These measures will increase the earnings of the mills and help clear the piling arrears to farmers. As excess sugar produce gets diverted to manufacture ethanol, sugar supply in the market would reduce. This would create upward pressure on the sugar prices, which would also benefit mills.
Sugar Industry’s troubles began when the firm cane prices – FRPs and SAPs – weren’t aligned with dropping sugar prices. Reduced mill earnings led to rising arrears, making life difficult for farmers. Molasses went from being a residue to an agent of change, aiding the transition to a cleaner world, giving hope to revive the sugar industry.
Better days
Seeing the upsides, the government got serious with its schemes to encourage ethanol production. As a result, the blending percentage has improved from 1.53% in 2013-14 to 8.5% in 2020-21, indicating a rise in distillation capacities. To keep the momentum going, the government has released just this month a “Road Map for ethanol blending in India 2020-25,” where it has preponed the 20% blending target by 5years from 2030 to 2025. Modifications to engines to enable running on higher blends are also underway.
The industry is also enjoying good fortune with the rising international sugar prices, which presented an opportunity to the Indian sugar Industry. The price rise was due to a reduced global supply. European Union’s production was estimated to decline by 11.1% in SY 2020-21.21, as pests and weather attacked fields were dry and unfavorable. Brazil’s output is expected to decrease by 5% this SY due to drought last year and fire outbreaks in the fields. In Thailand, production is expected to fall by 8.6% due to drought.
Meanwhile, the government in December 2020 announced subsidies to the tune of 3,500 crores to help meet the export target of 60 LT for this sugar year. Until May this year, 57 LT exports have already been contracted, and 37 LT already shipped out till April.
And with the sugar production this SY till 15th June at 306 LT being 13% greater than that same time last year, the industry is having a good time.
But how long?
Two agents, in particular, were responsible for the excellent performance of the Indian sugar industry lately- Ethanol and Exports. Growth in ethanol sales is likely to continue due to the enormous scope for blending in India. But the surge in exports came from rising international prices due to a dip in supply from significant sugar exporting nations. These external supply shocks are outside the industry’s control; hence the resultant exports are not necessarily sustainable. Once the global sugar supply improves and prices normalize, Indian exports will start to look expensive again, and the industry will be staring at its previous problems once again- piling arrears due to misaligned pricing.
A way out
A solution was recommended in 2012 by a committee constituted to probe issues with the industry. The idea was to link the sugarcane price to sugar price using a Revenue Sharing Formula (RSF). The cane price would be pegged at either 70% of revenue from sugar and by-products or 75% from sugar alone. When sugar prices drop below FRP, the farmers would be compensated from a fund, which taxes on sugars would fund.
Therefore, when the going is good, we fund the fund, and when in trouble, we dip into it. As the cane cost to mills is not fixed, they would earn their margins. And cane price to farmers moves with sugar prices while guaranteeing a minimum price to farmers. A neat arrangement indeed.
But as of March 2020, only two states have passed laws to act on this recommendation. Mills will be watching closely for developments in this regard because they know that a band-aid doesn’t cure an illness.
This post was written in collaboration with Asif Yahiya Sukri LLP. Asif Yahiya Sukri LLP provides unparalleled personalized financial services to a broad range of clients across different geographical locations. With a presence in the USA, India and the MENA region, they ensure that all of your financial decisions are made carefully and with your best interests in mind. They are innovators who understand what goes into building companies.
You can also reach out to them on info@aysasia.com
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