Sugar commission report - what to do?

Market reforms will bring transparency, remove some of system’s ills

ISLAMABAD: The sugar commission report has implicated Pakistan’s sugar industry in what in many civilised countries would be considered a crime worthy of severe penalties and jail terms.

The charges include double book-keeping, falsification of record, price-setting, cartelisation, avoidance of taxes, Benami transactions, Satta (speculation), under-payment to farmers and fleecing them on many counts, unauthorised capacity extension, its diversion into black market, etc.

People fed up with inflation have generally acclaimed the report and the electronic media has launched a campaign. Farmer groups have welcomed the report, calling it a victory for them. The opposition has rejected the report, while it has no business to do so.

Pakistan Sugar Mills Association (PSMA) has also rejected the report, calling it contradictory, speculative and misleading.

It will be very difficult for PSMA and its members to prove that it is not a cartel engaged in anti-competitive practices. The Competition Commission of Pakistan (CCP), although a sleeping organisation, had earlier taken them to task, raided their offices and tried to correct the situation. They went to court and got a stay order. The matter is lying with courts, now for many years.

There are two issues that we would like to take up in detail – freeing up the sugar sector from over-regulation and Satta.Freeing up the sector would mean doing away with price support and restrictions on import and export of sugar and would include many other regulations.

Satta, forward contracts and spot market have acquired bad reputation in Pakistan, although in other countries these are quite legitimate practices. The difference is that they are done there in an organised system of commodity exchanges and here these are being done informally in WhatsApp groups and Benami transactions.

Commodity exchanges

Even commodity exchanges are susceptible to abuse and anti-competitive conduct but due to strict monitoring and rules, its scope and possibilities are severely controlled.

There is Cotton Exchange in Pakistan where cotton trade is done in an organised fashion under the control of Securities and Exchange Commission of Pakistan (SECP).

There is another commodity exchange which is almost under-utilised where sugar trade can be transferred and conducted safely. It would be highly desirable to shift sugar spot trade to the commodity exchange.

Even sugar futures and forward contracts can be introduced. Sugar mills may be obligated to sell almost all of their production through the exchange.

As revealed by the report, there is a thriving community of brokers which is well versed in spot and forward contracts, which should be readily available to work under a formal exchange system.

The exchange system would improve lives and businesses of this community as it is under perpetual threat from the investigating agency and has to face many risks such as confiscation of advances in case of not lifting the contracted sugar.

Exchanges, through transparency, reduce risks and thus prices – higher the risks, higher the margins and profits. Additionally, the market is not monopolised by a small coterie, hopefully, and ordinary people can also participate in sugar trade as they do in shares buying and selling.

Risks

However, there are some risks in totally opening up the sector. Sugar is an essential item of human consumption. Its availability has to be ensured at reasonably affordable and stable prices.

Exports may not be made free but imports can be made free under the Trading Corporation of Pakistan (TCP). In fact, in order to ensure that competition takes place and prices are held at reasonable levels, there has to be excess supply in the market.

The reason prices go up whenever exports are allowed is that the excess goes away. There is no way of accurately assessing demand and inventory levels. Imports would allow the government to intervene in the market whenever there are shortages and prices go up.

Sugar prices are seasonal. There is a heavy working capital requirement in the sugar industry. Sugar reaches the retail market through a cobweb of brokers, wholesalers, transporters and dealers of sorts.

Also, there is a peculiarity of sugar. It is produced in only three months and is sold in nine months out of inventories. This costs money in terms of financial and storage management costs.

Such costs are financed out of hidden money or forward contracts or both. Informal money is expensive and money coming out of formal channels is cheaper and reduces cost and prices.

Amazingly, retail sugar prices in India and Pakistan are comparable, despite twice the support price of sugarcane and highly subsidised fertiliser in India – INR44 in India and PKR85 in Pakistan.

Support price

The issue of doing away with support price for sugarcane is a difficult one. It is said the support price system has been responsible for a rather undesirable expansion of sugarcane production capacity.

Pakistan is a water-stressed country and with the passage of time, it is said, water stress would increase with the increase in population. It may be desirable to depend on a degree of imports in case of water-consuming crops such as sugarcane, and may be rice.

Perhaps, in order to discourage further expansion of sugarcane production, support prices have not been increased for the past many years. It may be quite possible that by lifting movement restrictions on sugarcane, farmers may be able to get fair prices and better treatment.

It has been observed that higher prices have been obtained by the farmers in some instances.

While market manipulation and price conspiracy, if not cartelisation, is possible in quite competitive situations as well, if bad and non-transparent practices, as are common in the business environment, are not controlled.

We would like to analyse here, for understanding purposes, a quantitative measure of competition and monopoly of the sugar market. Monopoly or a lack of competition, among other tools, is measured by the well-known Hirschman- Herfindahl Index (HHI).

There are 89 sugar mills in Pakistan and the HHI comes out to be 692.

The US Department of Justice, while analysing the potential monopoly and antitrust cases, considers any market with HHI lower than 1,500 to be in a state of healthy competition.

The Department of Justice also analyses corporate mergers for the change in HHI that the merger would trigger – any merger that would result in a change in HHI of 200 points or more raises serious antitrust concerns.

One would not be sure, if this would be applicable to the situation in Pakistan. Some research would be required in this respect by organisations such as the SECP and CCP.

The proposed market reforms will bring transparency and may be able to remove, at least, some of the ills of the system, although we can count on the creativity of businessmen to find new ways of beating the system.

Let’s do business as it is done elsewhere in civilised societies. The volume of sugar business in Pakistan is large enough to warrant an organised market system.

The writer is former member of the Planning Commission

 

Published in The Express Tribune, June 1^st, 2020.

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