India is the second-largest producer of sugar in the world, after Brazil, and the world's largest consumer. About five million farmers cultivate sugar cane, while 500,000 workers are employed in sugar mills. Many more have jobs in ancillary industries such as molasses. Regulation of the sector originated in the need to address three issues - protect farmers' interests against the superior bargaining power of mill owners, deliver cheap sugar to poor households, and mitigate price volatility.
The Essential Commodities Act (ECA) of 1955 is at the heart of the sugar regulatory framework. According to the provisions of the Act, the central government, through the Commission for Agricultural Costs and Prices (CACP), fixes a "fair and remunerative" market-linked procurement price (FRP) that sugar mills must pay farmers for their harvested cane. Some states retain the right to fix a state advised price (SAP) at an arbitrarily higher level than the FRP. In addition, sugar mills have, for years, had to pay an implicit tax by being obliged to sell 10 per cent of their sugar production as 'levy sugar' at a below market price to the central government. The government then distributes this to households under the Public Distribution System (PDS). Levy sugar has been a way to get mill owners to cross-subsidise PDS consumers and defray the fiscal cost of the scheme. The government has tried to mitigate the volatility of the market price by controlling the sale of non-levy sugar only through periodic 'release quotas' through the year.
As a quid pro quo for this burdensome regulation, each mill was given sole access to all the cane harvested in a specific geographic catchment area assigned to it. The idea of "cane reserve areas" is to help each sugar mill receive an assured supply of cane, without competition. According to a 1966 notification, the power to allocate cane reserve areas for individual mills was delegated to states. However, the central government retained full control over mill production capacity through a tight licensing regime. For the longest time, no new mills could be set up and no existing capacity could be expanded without the approval of the central government. Hence, both the Centre and the states have had the discretionary power to endow monopsony power on sugar mills in return for burdening them with a bunch of regulations.
Regulatory intrusion extends beyond cane and sugar to ancillary activities as well. Although molasses is not subject to central controls, draconian state-level sales quotas and restrictions on physical movement apply, and these create perverse opportunities for rent seeking.
This array of interventions reflects a mindset deeply suspicious of markets. What is disconcerting is the price we continue to pay for this legacy.
Sugar cane is a water-intensive crop which should be farmed in eastern UP and Bihar. Instead, Maharashtra, a water scarce state, has become the country's sugar bowl. In the fifties, Maharashtra was the cradle of the cooperative social movement, the goal of which was to give poor cane farmers an opportunity to overcome exploitation by becoming stakeholders in sugar mills. Cooperatives did not take hold in other cane growing regions. Consequently, Maharashtra became the largest beneficiary of the central government licensing policy which was ideologically biased in favour of cooperative societies. Maharashtra accounts for almost 40 per cent of the country's sugar production. Although centralised licensing was scrapped in 1998, sugar cane still covers four per cent of the cultivable land of Maharashtra, but consumes about 70 per cent of the state's irrigated water resources. Cane in Maharashtra requires twice the water and is only a third as productive as in Bihar. It is ecologically disastrous. Yet, it enjoys heavy government support because 1.2 million farmers, comprising a formidable political lobby, have become dependent on the crop. Further, the industry in the state has been corrupted, with the governance of cooperative sugar factories captured by a small number of farmers that have amassed huge wealth by stripping the factories of resources transferred from a complicit state government apparatus in the form of subsidies, tax exemptions, loans and equity contributions that have never been serviced. The state has over 200 registered sugar factories, of which 165 are cooperatives and 40 per cent of which are chronically "sick".
Despite the delicensing of sugar, most other sugar producing states have hung onto the system of cane reservation areas, Hence, farmers are still not free to sell their harvested cane to just any sugar mill. This has bred inefficiency and prevented sugar mills from pursuing potentially significant economies of scale. Although following delicensing the industry has expanded over 20 per cent through the entry of new private sugar mills, the productivity of the Indian sugar sector has stagnated, if not declined since 1998.
The convoluted system of levy sugar and "release quotas" did not reduce price volatility. If anything, cyclicality has become more accentuated. Overregulated mills continue to accumulate "cane arrears" in years of excess production when the FRP/SAP is above the market price, prompting cash starved farmers to cut back on cane acreage, which in turn, triggers shortages the following season and sets up the next phase of the cycle.
It was not until earlier this year, following the recommendations of the Rangarajan Committee Report1 of 2012, that the system of levy sugar and release quotas was finally abolished. The states are now expected to procure PDS sugar from the open market. However, the central government has not had the courage to raise the price of PDS sugar which remains frozen at its highly subsidised 2002 level. The immediate consequence of this partial decontrol has been a reduction in the burden on sugar mills through the elimination of the levy, but a rise in the central government's subsidy bill by Rs 3,000 crore. Even as central government regulations have been slowly dismantled, states have not relinquished the discretionary controls delegated to them. For one, they retain SAPs fixed well above the market price of sugar to appease the cane farmer lobby. This triggered the recent revolt by sugar mills, which refused to crush cane this harvest season. And now, to break the stalemate, the states are trying to pressurise a politically weakened central government into funding a bailout package.
States continue to meddle in the molasses market. The liquor industry in UP, for example, receives a large quota of molasses, by a state government fiat, at a fraction of its market clearing price, allowing liquor barons to enjoy super-normal profits at the cost of sugar mills that in turn are unable to pay the high SAPs fixed by the same state governments in the name of helping cane farmers.
The sugar industry is an egregious example of the democracy of vested interest. New strategies are needed to overcome political resistance and build consensus between the Centre and states.
The author is executive chairman, IDFC