Cane We Do It : Untangling The Mess in Sugar



First, some historical perspective. Over time, sugar became the favorite crop of the ‘kulak’, the landlord in absentia. This was because it was a hardy crop, which needed one planting for 2 crops (the second is called a rattoon), it is after all a weed. It can’t be stolen in material quantities, because it is expensive to transport and it can’t be sold except to a sugar/ khandsari mill.

Declaimer: This article written was originally in February 2016, and some of the data points may be outdated.
The Sugar Industries

After Independence, the principal landlord in absentia is the politician-sardar, or the corrupt IAS/ IPS officer, in other words, sarkar as we know it. So benami rural landholdings are the store of value for the politician, and he needs to extract ‘agricultural income’ from his ill-gotten gains. This gives him a very important motive to keep milking the sugar industry with high State ‘Advised’ Prices (SAP). Needless to say, it created a hugely powerful lobby that kept high cane prices, even as sugar prices fell over 2007-2015.

You wonder why sugar production is not falling, or cane acreage reducing, in a world where 30% of the cane payables have not been paid for more than a year. What kind of (commodity) business could be so profitable that you could take a Working Capital cycle (i.e. receivables) of over a year? This is a business where the Capital Cost is zero (because the land is stolen wealth), the inputs are marginal (the cost of landless labor for sowing and harvesting, little maintenance cost) and the only cost is the cost of carrying receivables).

While SAP has been revised upwards by 70%, other crops have not. That is because these extra costs were being defrayed by private players, hence their pleas fell on deaf ears……till the entire industry went bankrupt. It was the build-up of Bank NPAs and the cries of the smaller farmers that have now woken up the Govt, till even the Prime Minister is sitting in on industry-specific meetings. The looming threat that up to 30% of the mills (about 120-150 out of 500) will not open for crushing this coming Sugar Year (Oct, ’15- Sep’16), has forced the Govt to start thinking about reviving the sector.

The Flowed Motivations

But what do they do? The core of the problem is that the flawed motivations of the political class (recounted above) have led to a systematic method of distorting the price signals sent out by the sector. How can the production of cane (and therefore sugar) be increasing by 20%, even as prices are falling by 30%? Why doesn’t the sector respond to price signals like any normal commodity? How can you see such a sustained downturn (6 years) in a sector where inventory dynamics are supposed to correct themselves every year? In a year when cane arrears at Rs.21,000 cr, have reached historic highs, why has sowing acreage still not dropped?

The govt has reacted with sops: hold up ethanol prices through the OMCs, and give a ‘backdoor subsidy’…..but this reaches only those who have large ethanol capacities, which means the large sugar mills. The interest-free loans come with such strings attached, that again the large, better-funded mills are eligible. The really weak players, who need the support, are left out in the cold, hence perpetuating a misery that seems to know no solution, And the heart of the problem, which is that cane production must reduce, is not even being signaled. In a very perverse way, the commentary at the end of the meeting with the Prime Minister, saying that the “farmers’ interest had to be looked after”  was laughable…..who will now tell the farmer that he has to produce LESS cane, and how will you do it? If farmers get paid even after producing a record surplus, why should they shy away from over-producing next year?

The only solution is the one thing the Govt is NOT prepared to do……signal to the farmer to shift acreage away from cane. So perversely, the best solution is to do nothing. The inevitable bankruptcy of the sugar sector will ensure that enough mills will close down to signal to the farmer that he should not plant cane for the following year. So let the Banks do what they want to do….i.e. shy away from offering Working Capital lines to the sector, and you will find that production will fall steeply, to correct the inventory overhang that is clouding the industry.

To reduce this kind of cyclicality, there is only one solution……to create a revenue-sharing arrangement between the mills and the farmer, as recommended by the Rangarajan Committee. And to allow mills to (long) lease land for cane farming, so that they are committed to growing cane if they have a mill in the area. But that would mean reducing the effective nominal price that the farmer gets, and who has the guts to stand for elections after that?

The funny thing is that there is no link between fixing high cane prices and winning elections, ask Mayawati. But the fear that WHAT IF there is a link, is going to distort political action. So there is a classic stalemate, where doing nothing will solve the problem, but doing ANYTHING will create a loser.

Let’s look at the payoffs, quadrant by quadrant. The farmer can do nothing. As long as cane remains the most profitable crop, he will suffer the long cash recovery cycles, but he has offtake and he gets his money 1-2 years later. Cane profitability, adjusted for longer holding periods, is still many TIMES the profitability of other crops, especially if you factor in the non-financial advantages (low maintenance, less labor, easier sowing/harvesting/selling).

The sugar company is helpless, transfixed by the train coming at it, its feet stuck in the tracks. No new sugar capacity and no new player has entered the industry in the last 7 years. All leading companies only want to reduce debt, nobody wants to expand. At least half the industry wants to exit, even the top companies are exploring a sale of assets. Bajaj Hindusthan has notified nearly 20% of its capacity, about 20,000 TCD for closure,  yes, closure!!!

The Banks are the same. Wild horses would not drag them anywhere near a sugar company. They do not even want to fund Working Capital, because inventories are valued at 30% below the cost of production, in other words, they are funding a hole in the Balance Sheet. If I were a Bank funding the sugar industry, I would demand a 50% margin against my WC lines. Do you think a near-bankrupt sugar company can come up with that kind of equity?

Together, this configuration can only unwind under one condition……when the industry goes bankrupt, and (say) 30-40% of the capacity closes down. Of course, this trend will over-reach and run to excess, and sugar prices will run up more than necessary, creating another furor in the form of food inflation. But that is less noticeable to 1.2 bn customers, than the current imbroglio which is affecting 5 mn farmers.

The long-term structural solution is to implement Rangarajan Committee norms

The long-term structural solution is to implement Rangarajan Committee norms, to signal to the farmers that the ‘moral hazard’ of getting high profitability with low volatility (of prices) is over. Simultaneously, to build a Buffer Stock measured to create “shock & awe”, say, 5 mn tons. From the very next day, this Buffer Stock is to be released as prices touch a point just below the cost of production, say, Rs.29 just now. This whole exercise can be done through FCI, evading the State Govts.

GST-like, an exit from the current policy regime by the 5 State governments that have fixed SAPs, should be encouraged. The whole exercise would have minimal cost, just the cost of carrying about Rs.15,000 cr of sugar inventory for about 2-3 years. Doing only one leg and not the other will just kick the can down the road, till the next boom-bust cycle.

The big picture is the systematic distortion of price signals in the agricultural commodity markets. As Mr. Modi goes after big corruption, he has (as an unintended consequence) triggered a fall in Delhi real estate prices and a rise in the affordability of real estate; the same has to be done in agriculture. A country that over-produces unnecessary ‘empty’ calories in diabetes-inducing sugar, but cannot produce enough protein through pulses, has got something wrong. This is not just a sector-specific problem, it affects the system of allocating land to the ‘right’ crop. Right now, the very basis of deciding acreage is distorted by who owns the land, why he owns it, and how he uses it. The Govt needs to clear the ‘messaging system’ to the farming community, so that demand-supply imbalances can be communicated to the farmer, to be incorporated into sowing decisions for the next crop. Until this happens, the problem will grow like Frankenstein, till it engulfs at least the UP Govt.

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