Are we nearing the end of Sugar's boom days? - Views on News from Equitymaster

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Are we nearing the end of Sugar's boom days?

Jul 12, 2010

Sugar is one of the most important commodities for consumption. In India, the sugar industry is heavily regulated by the government. This is done to prevent excessive volatility in sugar prices. However, the prices have surged in the recent past due to erratic monsoon and reduced cane acreage.

One needs to understand the sugar cycle in order to understand the factors that govern prices. Here is our take in the same.

Sugar cycle explained: The sugar cycle typically starts with a bumper harvest resulting in higher inventory levels. Excess supply leads to correction in prices. Declining prices pressurises the profits of sugar companies. Consequently, the millers delay payments to farmers for sugarcane procurement. As a result, farmers reduce cane acreage and shift their focus to alternative remunerative crops. This results in production shortfall leading to increase in prices. This is termed a sugar cycle upturn.

Right now, the sugar industry in India is witnessing a cycle upturn. And since sugar cane is a long duration crop, farmers take 2-3 seasons to adjust the plantation cycle. This further aids the rise in prices. In contrast to a cycle upturn, a sugar cycle downturn is characterised by declining prices and higher production.

Cane pricing mechanism in India: In India, the central and state governments fixe the price of sugar cane. They do this by announcing the Statutory Minimum Price (SMP, also known as Fair Remunerative Price) and State Advised Price (SAP). Major sugar producing states, such as Maharashtra and Karnataka, follow the SMP. The state of UP follows SAP. During FY09 (ended September 2009) the SMP announced by the central government was Rs 1,298 per tonne. The UP government announced SAP of Rs 1,650 per tonne during the same period. With the increase in cane pricing, farmers planted more cane which has led to minor correction in prices from their peak. It should be noted that traditionally SAP is higher than SMP. Thus mills in UP are burdened with higher cane procurement price. Higher SAP has always been a political issue. But the UP government has always maintained its stance for higher SAP. It has done so to incentivise farmers for cane cultivation. It should be noted that UP is the highest sugar cane producing state in India.

Apart from this, sugar companies are also required to sell certain percentage of their produce through the public distribution system. This is as per the prices set by the government. In addition to this, the government also decides the stock holding limits of the bulk consumers. Thus the industry is characterised with too many regulations. We believe that the government should decide on easing some of the restrictions on the industry.

The way ahead: Sugar production in India is likely to touch 25 m tonnes in the current fiscal. This will be over the expected 17 m tonnes due to increased planting. Even Brazil's sugar production is likely to surpass initial estimates by over 10%. Thus buoyant production estimates are likely to keep the prices under check. The government may also consider imposing import duty on sugar following increased production estimates. Thus after a secular increase in the sugar prices over the last one to one and half years, one may wonder if the sugar cycle downturn is just around the corner.

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