Decontrol sweetener for sugar stocks

In an overall bearish market conditions, the upside in sugar stocks is quite tempting

The partial decontrol of sugar has been a long time coming. Obviously, it has huge financial significance and it is also politically sensitive. Agricultural commodities like sugar are necessary goods, often with discontinuous seasonal production.

Demand is not very price-elastic in sugar. Consumers don't cut back willingly on consumption if prices jump, nor do they gorge themselves if prices fall. As a result, a small excess of supply over demand can lead to a big fall in price while a small excess of demand over supply can lead to a big price rise. Due to seasonality, supply-demand imbalances persist for months.

These imbalances trigger large production swings. The farmer plants a lot of cane one year because prices were good in the last season. There is excess production and prices fall. Next time, he plants less cane. There is excess demand and prices rise. He plants more cane the next year and again, prices fall. In reality, sugar production does not follow a simple alternating cycle. But a pattern of say, two years of over-supply followed by one or two years of under-supply is common.

Well-regulated commodity markets and commodity futures trading exchanges help in price discovery and these enable farmers and mills to hedge price risks. Sensible procurement and public distribution policies and efficient spot market mechanisms also reduce cyclical variation.

But poor policy makes things worse. Unfortunately sugar is the most politically sensitive agro-commodity and the temptation to meddle is high. Changes in the sugar and sugar-cane cycle affect livelihoods and by extension, votes in hundreds of assembly seats across several states. Political parties and individual politicians also rely on the industry for funding.

India is a major global sugar producer and consumer. Surplus sugar production in India often leads to global glut with low international prices. Conversely, international prices rise when India imports. This also leads to regular flip-flops with regard to export and import policy.

The industry faces multiple controls at both state and central level. Those have also changed many times in knee-jerk fashion. States set cane procurement prices. Sometimes, states have also been known to ban molasses being sold beyond their boundaries.

Until the decontrol last week, a certain percentage of sugar (it varied from mill to mill) had to be sold at the fixed "levy" rate for the public distribution system. Even in the open market, there were government-imposed quotas with companies not allowed to sell ("release" is the official term) more than a certain quantity of sugar in a given period. Mills used to be banned from picking up cane beyond set catchment areas. Ideally, cane has to be crushed within 24 hours anyway and poor road infrastructure places natural limits on sourcing beyond a certain distance.

Complete decontrol was attempted only once, by the Janata government in the 1970s. The result horrified politicians. Open market prices crashed, dropping well below PDS rates, as more supply came to the market. Mill owners, who feared going bankrupt, lobbied for controls to be reimposed!

The very broad description above should give the reader some idea of how complex policy has been and how arbitrary the changes. Certainly, partial decontrol with levy and release quotas abolished should help mills.

But cane procurement prices and other restrictions remain. The Centre will also have to reorganise its PDS subsidy mechanism and the way in which it shares sugar subsidies with states. It is possible that there will be a rollback of some description if politicians fear adverse reactions to decontrol.

In the short-term, there is an upside for sugar stocks. Some of the good news has already been factored into current prices, both by investors buying on actual news as well as speculators acting earlier while the CCEA was debating decontrol. Technically, several of the more liquid stocks could still see upsides of 20-30 per cent. That is tempting in a market, which is now looking increasingly bearish.