First, let's have some historical perspective: Over time, sugar came to be the favourite crop of the 'kulak', the landlord-in-absentia. This was because it was a hardy crop which needed one planting for two crops (the second is called a 'rattoon'); it is after all really 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.
After Independence, the principal landlord-in-absentia is the politician-sardar, or the corrupt IAS/IPS officer. 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). This created a hugely powerful lobby that kept cane prices high, even as sugar prices fell over 2007-2015.
You wonder why sugar production is not falling, or cane acreage reducing, when 30 per cent of 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 labour 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 per cent, this has not happened with other crops. 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 smaller farmers that have now woken up the government. The looming threat that up to 30 per cent mills (about 120-150 out of 500) will not open for crushing this coming sugar year (Oct '15 - Sep '16) has forced the government to start thinking about reviving the sector.
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 production of cane (and therefore sugar) be increasing 20 per cent, even as prices are falling 30 per cent? Why doesn't the sector respond to price signals like any normal commodity? How can you see such a sustained downturn (six years) in a sector where inventory dynamics are supposed to correct themselves every year? In a year when cane arrears, at ₹21,000 crore, have reached historic highs, why has sowing acreage still not dropped?
The government has reacted with sops: Hold up ethanol prices through the oil-marketing companies, and give a 'back-door subsidy'. But this reaches only to those who have large ethanol capacities, which means large sugar mills. Interest-free loans come with such strings attached that again large, better-funded mills are eligible. The really weak players, who need the support, are left out in the cold. And the heart of the problem, which is that cane production must reduce, is not even being signalled. In a very perverse way, the commentary at the end of the meeting with the prime minister saying "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 the next year.
The only solution is the one thing the government is NOT prepared to do: tell 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 next year. So, let 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 sector.
To reduce this kind of cyclicality, there is only one solution: to create a revenue-sharing arrangement between 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. 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 pay-offs, 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 one-two 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 (of low maintenance, less labour, easier sowing/harvesting/selling).
The sugar company is helpless, transfixed by the train coming at it, with its feet stuck in the tracks. No new sugar capacity, no new player has entered the industry in the last seven years. All leading companies only want to reduce debt; nobody wants to expand. At least half the companies want to exit. Even the top companies are exploring sale of assets. Bajaj Hindusthan has notified nearly 20 per cent of its capacity, about 20,000 TCD, for closure - yes, closure!!!
Banks are the same. They don't want to fund working capital because inventories are valued at 30 per cent below the cost of production. In other words, they are funding a hole in the balance sheet.
Together, this configuration can only unwind under one condition: when the industry goes bankrupt, and (say) 30-40 per cent of the capacity closes down. Of course, this trend will overreach and run to excess, and sugar prices will run up more than necessary, creating another furore in the form of food inflation. But that is less noticeable to 1.2 billion customers than the current imbroglio, which is affecting five million farmers.
The long-term structural solution is to implement Rangarajan Committee norms to clearly signal to farmers that the 'moral hazard' of getting high profitability with low volatility (of prices) is over. Simultaneously, a buffer stock measured to create 'shock and awe' of, say, five million tons should be built. This buffer stock can be released as prices touch a point just below the cost of production, say, ₹29. This whole exercise can be done through FCI, thus evading the state governments.
An exit from the current policy regime by the five state governments that have fixed SAPs should be encouraged. The whole exercise would have minimal cost, just the cost of carrying about ₹15,000 crore of sugar inventory for about two-three 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 affordability of real estate; the same has to be done in agriculture. A country that overproduces unnecessary 'empty' calories in diabetes-inducing sugar but cannot produce enough protein through pulses has obviously 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 government 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 a Frankenstein till it engulfs at least the UP government.
The author teaches, trades and writes at spandiya.blogspot.com.
This column appeared in the September 2015 Issue of Wealth Insight.
This article was originally published on September 25, 2015.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
