Return of government controls a risk for sugar shares
The strings attached to the government’s relief measures for sugar mills are becoming visible. On Wednesday, shares of sugar mills fell after news that the government may impose stock limits. This is a regressive step, moving away from decontrol, but is not a surprise altogether.
Stock limits will mean sugar in excess of the limits will be sold, leading to more supply and lower prices. The government’s concern must be rising sugar prices. But they have been rising since end-September, so why the late reaction?
The increase in recent months has been rapid. Since end-January, wholesale sugar prices are up by as much as 17%, while they are up by 39% since end-September. Globally, sugar prices have risen because of bad weather affecting the sugar cane crop in major producing countries such as India, Brazil and Thailand.
That stress is visible in India’s output. Sugar production as of 15 April is down by 8% at 24.3 million tonnes (mt) from a year ago, says the Indian Sugar Mills Association (Isma).
Whether Isma’s estimate of 26 mt will be met remains to be seen, as only 117 mills are operating as of 15 April, compared with 245 a year ago. Prices may keep rising, as this situation unfolds.
So what? Prices rise and fall in a free market, sugar is a decontrolled sector, and prices had been lying low for years. Why deny mills a year or two of good profit growth in a cyclical industry?
The government may think it has the moral right to keep prices in check. Sugar mills in India have wrung concessions from the government, in return for paying a higher price for sugar cane. Although the Rangarajan committee has advocated linking sugar cane purchase price to the price of sugar and by-products, major sugar producing states such as Uttar Pradesh have not implemented it.
Mills in Uttar Pradesh are forced to pay a state-determined price. In turn, they delay payments to farmers, leading to huge arrears, resulting in a confrontation between mills and state governments. Over the past few years, the Uttar Pradesh government has given some concessions to mills.
The central government too has taken a number of measures for the sector. These include levying higher import duties on sugar, making it mandatory for oil marketing companies to procure ethanol (including fixing the purchase price), soft loans and an excise duty exemption on ethanol.
The idea was to give some financial support to sugar mills, and the government even looked the other way as sugar prices rose. The government asked sugar mills to export 4 mt of sugar by September 2016. The money realized was to be used to cut down cane arrears and limit domestic supply. However, exports have been below targeted levels as domestic prices were higher. That is unlikely to have gone down well with the government.
Rising sugar prices are a bigger pain. People will complain, state elections are under way and it could push up inflation as well. Maybe, the government is only sounding a warning and does not actually intend to impose stock limits. If sugar prices cool down, it may hold back. Otherwise, stock limits are just one weapon in its arsenal.
In the past, the government has come down heavily on rising sugar prices. It can do so again. Government controls are a risk in sugar shares that investors have to now watch for.