EDITORIAL: Earlier this week, the federal government approved the establishment of a high-powered sugar reform committee. It has tasked the Federal Minister for Industries Hammad Azhar to formulate a long-term strategy to reform the sector in light of the inquiry commission's findings. It is a right move and the focus should be on deregulation of the industry and sugar market to gain efficiencies. Deregulation must be the first step towards de-politicization of the industry.

The so-called sugar barons' era began during the rule of General Ziaul Haq when ration card system was abolished. Till that time domestic sugar demand was tightly controlled. Thereafter, the industry partially liberalized, and sugar-value added industries flourished. With growing demand, politicians lobbied to obtain milling licences. Many fresh licences were issued by provincial governments to influential constituents - which were either politicians or eventually became politicians - due to the influence gained from sugar mill operations in areas where a sugar mill was located.

These licence holders also had loans sanctioned from banks to purchase plant and machinery. Since most banks were in the nationalized sector at that time and SBP was not a robust regulator, many politicians became industrialists and industrialist-turned-politicians abused their influence and willfully defaulted. Farm to mill value-chain generates economic activity in villages of mill-located region and surrounding peri-urban areas. Activities such as cane harvest and crushing are employment intensive. This further cemented politicians' interest in the sector.

During that time, the number of mills across the country - especially in Punjab and Sindh - soared, increasing the demand for sugarcane. The market is highly regulated. On one hand, farmers receive a government guarantee of support price and on the other hand, mill catchment area was also notified by the office of cane commissioner, that effectively rendered cane growers beholden to sugar mill owners in factory's home region to the mill owner.

Sugarcane crop's unique physiological resilience has also contributed to its higher acreage, often at the cost of competing crops. Unlike cotton, it can sustain under extreme weather. It also has a high-water delta - closer to rice - which due to mispricing that is endemic in the irrigation system, further increased the popularity of this water-guzzling crop.

By law, every mill is required to first buy cane from its allocated area from all growers willing to sell at a notified price. This means even process-efficient mills must first procure any low-quality cane in home region before procuring a high quality cane from free-zone or from the notified area of competitors. The high cost of transportation deters growers from selling their crop at competitive prices or to highest bidders at long distances. Millers exploit farmers by tactfully delaying crushing season. Post-harvest, cane is rarely stored, as high tonnage requires large storage areas, while storage for longer duration causes water content to dry out, lowering gross weight. Remember, the support price is based purely in quantity terms, and does not account for the quality or sucrose level of the crop. Nevertheless, the trade-off between plantation of weather-prone crops with volatile market-based prices (e.g. cotton, maize), and weather-resilient crop (e.g. sugarcane) with government fixed minimum price, often compels growers to prefer the latter.

These regulatory distortions have hindered much-needed consolidation in the industry. Pakistan has over 80 operational mills, majority of which are small, inefficient and lack economies of scale. A protectionist regulatory order has allowed these players to survive. Despite lack of competitiveness and financial weaknesses of many such small units, the opportunity to exercise political influence - due to employment generation - has turned mill licences into a prized commodity.

Exploitation of archaic regulations also helps. For example, the crushing seasons lasts for less than three months on average; the mill, therefore, operates for a limited number of days based on cane availability in the notified area. Many procure cane against issuance of purchase receipt (CPR) at government notified rates but withhold cash payments for indefinite periods, stretching, at times, over more than one crushing season before dues are finally settled. It is also alleged that many mills buyback CPR from cash-strapped growers through informal middlemen at steep discounts. Mills often exercise influence on the other side of the value-chain, driving wholesale and retail prices of sugar upwards through speculation (satta) in informal futures market.

Distortions such as support price, notified area, mandatory crushing, and informal satta can be addressed by liberalizing the industry. Textbook economics dictates that allowing this industry to operate on market-driven forces of supply and demand will lead to efficient allocation of resources. For example, once support price is removed and cane price left to market forces, farmers in climatic regions ill-suited for cane will switch to more viable crops.

Similarly, without a notified area, mills will no longer have the luxury of guaranteed supply at fixed prices. Moreover, inefficient players will face competition for crop procurement from efficient buyers outside the home region. Lastly, an end to sugar mill licensing raj will also turn existing licences worthless as new entrants will be allowed to set up units and expand capacity with better technology and equipment in regions best suited for cane cropping. This will lead to inevitable shutdown of inefficient players that have so far survived purely due to licences awarded on political patronage decades ago.

The trade regime also reeks of anachronistic protectionism. For example, customs duty of 40 percent is imposed on sugar import, allowing local industry to flourish. This would not be the case if the industry had to compete with commodity imported at regular tariffs. The industry also abuses archaic regulation of mandatory crushing, using it as a pretext to produce surplus output cyclically. In following seasons, inventory build-up is used as an excuse to demand subsidy for exports. Many believe that export quota policies are abused as tools to dish out patronage in key election years.

The rent seeking on display in the sugar industry has rarely been unlawful. The crisis is structural in nature, as the tentacles of distorted regulatory framework run deep. The world is fast changing, yet Pakistan has failed to keep apace. In fact, in many countries sugar consumption is now discouraged through taxation - environmentalists and scientists increasingly describe it as the next 'Big Tobacco'.

Opening old, murky wounds of how (some of) them managed to get hold of licences will serve little purpose, as many may cry foul and complain of selective accountability. What is clear, however, is that the value-chain in the southern Punjab-Ghotki belt - along with few other hubs in Sindh and KP - is now so well-developed that established units may be able to compete under free market rules. Long-term shifts in climatic patterns also indicate that the popularity of sugarcane crop in these areas is now well-entrenched, and the dream to restore historic cotton belt may remain confined to bureaucratic file rooms.

If the federal government is serious in reforming the industry, it must stop chasing after demons from the past. Instead, if it succeeds in eliminating rents from the industry by letting market forces to flourish, it will achieve a much more valuable public policy objective. Furthermore, forward trading in sugar be allowed through the platform of the Commodity Exchange to curb 'Satta'.

Copyright Business Recorder, 2020

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