Why Reduce Sugar Subsidy?
Seems like the government has some bitter plans for “Sugar” industry.
News flash: Government reduced subsidy on sugar exports and stock prices of sugar companies tumbled down by 2.8%.
What crosses your mind when you read this?
Pretty obvious, haa?
Well, the workings of the sugar industry aren’t that simple and there’s more than meets the eye. The Rs. 80,000 crores industry that spreads sweetness in the world is often itself left with a bitter aftertaste. Right from harvesting of sugarcane to sales of sugar, the industry has to be regulated and supported by the government.
Imagine that a wealthy person buys an exotic fruit from a farmer at a very low price. He then makes juice out of that exotic fruit and earns a very handsome profit. The wealthy person becomes very wealthy without putting in much effort. The poor farmer on the other hand, is pushed further into poverty, in spite of putting in sweat, blood and tears in his produce (excuse the gross simplification - you get the idea).
Perhaps, next time, the farmers won’t think of producing this exotic fruit. This would put the wealthy person in trouble. He would have to spend a fortune to procure whatever little supply of the fruit that is there, but his previous year’s profits would get drained in the process.
Now seeing the high rates of the exotic fruit, the farmer is again tempted to produce in bulk. And, this cycle goes on and on and no one prospers.
That’s exactly what was happening with the sugar industry - with the 5 crore sugarcane farmers.
Now, the government obviously wanted to break this cycle. But, how?
Sugarcanes account for 3/4th of the cost of sugar. And so to be fair, and to encourage consistent production, it was decided that the price to be given to the sugarcane farmers should depend on the final sales price of sugar (approx 70% of the sales price). This amount was called the Fair and Remunerative Price (FRP). And this amount was to be paid up-front to the farmers, within 14 days of receipt of sugarcane.
But, mind you. FRP is not fixed by the sugar mills. It is fixed by the government. Here’s what the website of Department of Food and Public Distribution reads:
Under the FRP system, the farmers are not required to wait till the end of the season or for any announcement of the profits by sugar mills or the Government. The new system also assures margins on account of profit and risk to farmers, irrespective of the fact whether sugar mills generate profit or not and is not dependent on the performance of any individual sugar mill.
While cane price is fixed by the state government, sugar realisations are totally market driven and are dependent on demand-supply dynamics. So, are the sugar mills supposed to pocket huge losses if prices were to unexpectedly crash? And if they go in losses, who will pay the farmers?
To safeguard this risk, the government has fixed a Minimum Support Price for Sugar as well. Too many regulations? Haah. There’s more.
With FRP and MSP working in tandem, the price of sugar in India is higher than other countries. Result? In order to protect our desi market from videsi cheeni, the government has imposed a 100% import duty on sugar! It’s been there since the last 3 years.
After all the efforts and regulations, there has been consistent surplus production of sugar since 2010-11. You might feel that is good news. But, remember high supply-low demand leads to lower price. So something had to be done with the extra sugar. Export was an option. But hey, remember the prices of videsi cheeni are lower than our desi ones? Thus, to make Indian sugar prices competitive in the world market, the government gave the Indian mills support in the form of subsidies.
Now coming to the news flash. Why were the subsidies reduced? The entire sugar industry seems to be extensively dependent on the policies of the government. One move and things could unravel. Right?
Well, the global supplies of sugar have been hit by covid, and the price of sugar in the international forum has gone up. The Indian mills are very much capable of supplying the sugar at competitive prices without requiring such high subsidies from the government. In this process, the government will be able to save a cool Rs. 60 crores.
So, technically the sugar mills won’t be impacted that much by this move. To add cherry to the cake, the sugarcane prices have not been revised by the government of India’s largest sugar producing state (UP) since the last 4 years. Low cost and high revenue. There has never been a better time to be in the sugar industry in India.
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That's a good article ...
I just want to add few pointers.
1. I bet the precise reasoning for the reduction and rather a intendedphased reduction in export subsidies is due to the fact that government has been pushing for ethanol blending programme since last 3-4 years heavily but owing to constant heavy production and capacity constraints for production of enough ethanol (particularly from B-Heavy molasses and direct sugarjuice), the govt has not been able to move in their goal much till last year. But since last year, owing to subsidised loans for capacity building for ethanol plants) they have incentivised the sugar manufacturers to become integrated plants rather than operate as a standalone sugar mills as this results in higher realisation per sugarcane crushed (1st RM for all the output - sugar, ethanol, molasses).
2. Further, the prices of sugar have been controlled in domestic market since ages and thus despite surplus production mills never could raise price much beyond the regulated price due to constant demand glut, (I think that's currently Rs. 3100/qtl since 2018). Further, the demand india has predominant demand for white sugar whereas the global demand is predominant for raw brown sugar and further since brown sugar gives better yield in terms of sugar realisation, mills have been able to divert more of late for brown sugar for exports)
3. Further, due to revision in ethanol blending targets and capacity buildup with mills, they have now been trying to shift to sourcing revenue from ethanol sales rather than sugar sales (sugar segment has margin of around 4-5% - considering both domestic and export; whereas spirits segment has margin of 25-30%) plus the reduction in power rates by state discoms have cumulatively making mills to focus more now on alcohol production as it is more lucrative - all major producers be it Dhampur, balaram, EID Parry, Avadh, Magadh, etc have doubled their capacities of ethanol production because the margins of sugar companies will be now more from ethanol and not from sugar.
4. The sugar output may be in mills hands but the qty they can sell in domestic market is controlled by govt through monthly sugar sales quota (infact it's released on monthly basis and even the calculation is based on past output and realisations- hence they margin constraint of mills is not the price but the qty they can statutorily sell in domestic market whereas there is no such restriction wet ethanol and exports - ethanol contracts are done on annual basis and it's industry trend that annually around 15% of the contracted qty is left over or unfulfilled so there is headroom for qty increase leading to better profits predominantly through ethanol in future)
Summarising -
1. Ethanol blending picking up pace since last year due to capacity buildup
2. Export prices ( though I doubt this will be much exploited by mills considering the associated export costs compared to more lucrative ethanol margins)
3. Chances of rise in FRP in UP in coming year.
4. Sales qty quota restrictions wet sugar but no such restriction in ethanol.
So, even though mills were dependent on subsidies for their margins and working capital on soft loans from government, but with ethanol blending they are shifting focus more to spirits mfg and sale.
So, I personally think even though stock prices may see short term shocks due to effects of lack of subsidy, but over next year, the ethanol dependence will be clearly evident, and hence may not be much affected by subsidy issues.
Very insightful
Thanks team ReadOn