CHAPTER 3 Organization of the Sugar Industry and Impediments to Competition2007-08 PAKISTAN

This section of the report focuses on the economic issues confronting the sugar sector using mill-wise data for 2008/09. Major issues that hamper competitiveness and productivity levels are highlighted. Specifically, the following aspects that determine the industry‟s overall performance are discussed: - Overall organization of production, trade and market structure - Interrelationship between key variables impacting on sugar production - Variability in performance across mills - Economies of size and scale - Impact of the duration of the crushing season - Excessive cane cultivation and/or excessive expansion of industry - Cost structure of sugar production - Adverse selection problem in rewarding sucrose content 3.1 Organization of Production and Trade As discussed earlier, Pakistan has not yet achieved a stable pattern of sugar production for domestic consumption. The relative price structure of sugarcane and its competing crops, as well as the relative prices of sugar in Pakistan and neighboring countries determine the overall demand for sugar as well as sugarcane acreage. The relationship between growers and sugar mills, particularly with reference to the provision of credit and payment for sugarcane supplies also influences sugarcane acreage. As a matter of routine, sugar is imported to augment market supplies as well as to build stocks. Certain years have also witnessed the export of sugar. However, the rationale for export is based less on genuine surpluses than on the anticipation of a liquidity crisis for sugar mills in the wake of large, unsold stocks. Gaps in supplies have been bridged regularly through imports with low levels of sugar trade efficiency and with a somewhat cavalier disregard of their effects on mill-owners. Timing and quantity of exports and imports have not remained consistent either with domestic requirements or international market price variations. This simply reflects serious defects in the policies designed for the sugar industry. A heavier focus on trade to stabilize the domestic market tends to overlook the potential of a boost in the production of sugarcane and the opportunities available through technical advancement in sugar production world-wide. The notion of technical innovation, which should have been heavily focused, has largely been ignored. Currently, though the sugar industry has expanded rapidly, it still portrays a mix of traditional and non-traditional type of farmers using varying approaches towards the production of sugarcane. Similarly, sugar mills employ diverse production techniques and hence wide variations in efficiency levels are observed. Mills utilize varying levels of diversification through the utilization of by-products and production of derivatives. In this context, use of technology to improve production efficiencies at 20 the farm and mill levels is considered pivotal for the sugar industry‟s long term sustenance. Progress in this regard will also create the basis for achieving higher levels of trade-related efficiencies. Chart 3.1 Flow Chart Highlighting Inter-linkages between Domestic and International Factors in Determining Sugar Supplies in Pakistan Legends: By attributing a central role to technology, Chart 3.1 exhibits relationships that currently exist in Pakistan in determining sugar supplies for the domestic market. Technology is shown as the engine of growth; optimum benefits are received internationally. However, in Pakistan the bulk of the technology that is used generates low value-addition. The manner in which various factors are inter-related depicts the strength and direction of linkages. The sugar mills in the country, show low value addition and are predominantly traditional in their approach towards the production of sugar, its byproducts and derivatives. In this process, mills depend on cane supplies from farms of Strong Relationship / Impact One Way Relationship Two Ways Relationship Two Ways Weak Relationship Optimum Value Addition at International Level Level World Supply & Demand Levels Traditional Farmers Progressive Farmers Technology International Market Price Low Value Addition Imports Large Farmers Sugar Mills Raw Sugar Refined Sugar Processing Small Farmers Domestic Sugar Mills Imported Sugar Domestic Sugar Market 21 different sizes. The large farms seem to have better access and relationship with mills. A handful of large and progressive farmers attempt to use available technologies to improve farm-level efficiency by enhancing land productivity and sugarcane quality. Other large, but traditional farmers, who constitute a bigger proportion still employ primitive technology which exhibits low levels of land productivity. Small farmers, who have limited access to mills, are the major suppliers of sugarcane. A significant proportion of small farmers (particularly in Punjab and PK-NWFP) also process sugarcane in open pan units to produce gur and other sweeteners which have bigger markets in the rural parts of the country and Afghanistan. These small farmers are often confronted with the issue of late payments for their sugarcane supplies to mills which affects their capacity to plan for the subsequent cropping season. Most small farmers face credit constraints from formal sources as well. From the mid-1980s, zoning of sugar mills was introduced. All sugarcane growers in a particular zone were restricted to sell their cane supplies to a specific mill only. This competition-inhibiting practice has since been abolished. Over time, the rapid expansion in the number of sugar mills as well as enhancement in the crushing capacity led to the de-zoning of mills. Now each mill has to compete for the supply of cane. Newspaper reports suggest that farmers can charge up to 25 to 50 percent higher prices relative to cane prices fixed by provincial governments. Mills faced with excess capacity have an inelastic demand for sugarcane. Such mills end up paying higher prices for sugarcane. De-zoning was introduced largely in the context of excess capacity and not in the spirit of introducing fair competition among farmers in determining cane prices. In the process, prospects for technological progress were overlooked. A lack of technical support to farmers through public sector research organizations also contributed in pushing the farmers in the direction of technical inefficiency. The intent of the government to ignore efficiency parameters is evident from the fact that cane prices are still fixed each year, although such price fixation has been made largely ineffective by the cane growers. Had cane prices been linked to sucrose content along with weight, growers would have been encouraged to make farm level efficiency gains which would also have benefited the industry and society. In addition to domestic supplies, refined and raw sugar is also imported regularly to augment the market stocks and stabilize consumption requirements. Raw sugar costs relatively less foreign exchange per unit of import and utilizes part of the idle capacity of mills. On the other hand, it can be used as an instrument by the mills to exploit farmers. Instead, a higher focus on technological innovation would improve cane yield levels and sucrose content which are quite low in Pakistan relative to rival sugar producing countries. 3.2 Marketing System A number of factors reflect on the inefficiencies in the organization of production and marketing of the sugar industry. These factors jointly determine the competitive outlook of the industry, which is pivotal in attaining higher efficiencies in production and trade in the years ahead. At the beginning of the Report (in Chapter 1) it was posited that as a result of the cumulative interplay of three following factors, the industry appears as a quasi-rent seeking industry: i) The industry works with relatively old technologies; 22 ii) A continuation of political leverage restricts the emergence of entrepreneurial urge towards innovation; and iii) Adoption of extremely low levels of value addition. As a result, the prospects for future development through improvements in sugarcane yield levels and sucrose contents, optimal use of by-products and production of derivative products have been badly hurt. With such deficiencies in the overall organization of production, the industry largely operates on the basis of meeting the recurrent cost of production and income exceeding outlays. In doing so it adopts approaches that tend to create major distortions in its system of production and marketing. It avoids necessary costs for research and development, machinery upgrades and improved management to improve returns from sugar and its by-products. i) Barriers to Entry In strictly legal terms, there is no barrier to obtaining a license for setting up a sugar mill in Pakistan. However, as per practice it requires an unwritten and informal approval from the political and social elite of the area where the mill is to be established. The political basis for award of licenses to sugar mills has a long history in Pakistan assisted by a generous policy requiring a debt-equity ratio of 70:30 percent in the industry. A relatively weak and non-transparent approach followed by financial institutions in judging the feasibility of establishing sugar mills, particularly in areas which are technically not suited for sugarcane cultivation, has reduced the possibility of the longer term viability of sugar mills from the economic and social point of view. Furthermore, a weak and ineffective institutional framework in decision-making has not employed the active participation of civil society, research organizations and environmental agencies which could have averted the situation and carried out an unbiased cost-benefit assessment based on the principles of economics and natural resource management. Patronage of the state in expanding the sugar industry on political rather than on commercial and economic grounds has further aggravated the situation thereby creating an information gap which allows borrowers to exploit it in their negotiations with the lenders. Specifically, this exploitation takes the form of over-invoicing to artificially inflate estimates of the setting-up costs of sugar mills. It is generally believed that as a result of this distortion, the debtequity ratio of 70:30 effectively turns into a ratio of 90:10. The main escalations relate to the cost of land, plant and equipment. The government‟s policy response was negated by its own lack of accountability and transparency in the process. In most cases, an individual, or a group acquiring a license to establish a sugar mill invests only minimal equity in the venture. This phenomenon is the basic flaw in government efforts at the development of an economically viable sugar sector. It has led to a considerable change (if not a reversal) in the investors‟ attitude, characterized by a virtual elimination of an entrepreneurial urge. Due to political patronage, which has over- 23 shadowed the economic and social dimensions of any business enterprise, it may be regarded as a form of collusion between entrepreneurs and politicians. The nexus has caused intense damage to the long term competitiveness of Pakistan‟s sugar industry ii) Fixation of Sugarcane Prices The sugar industry has followed practices which are against the norms of free market behaviour and competition. Until the mid-1980s, when the industry comprised 36 sugar mills, each mill had been allocated an agricultural zone to acquire sugarcane supplies. The growers in a zone were linked to a specific mill for selling sugarcane at prices determined by the respective provincial governments annually before the start of crushing season, a practice contrary to competition norms. Whereas the fixation of cane prices itself is against the norms of a competitive environment, there was a further distortion in that cane supplies were priced on the basis of weight alone. A mechanism evolved, for premium payments to be made for aggregate sucrose content of a sugar mill exceeding a benchmark set by the provincial governments. It was exercised only in Sindh province. The mechanism was flawed since it was not based on individual supplies of cane. Rather, premium payments were made to all suppliers proportional to cane weight. Each supplier of cane, regardless of the sucrose level in his respective produce, was paid a premium on an equal footing. This typifies an adverse selection problem where efficiency is measured on aggregate performance rather than at an individual level. It sets perverse incentives for growers to improve cane quality. Eventually it also contributes towards inefficiency in the production of sugar. Although appropriate technology (Core Sampler) is readily available and extensively used in most countries, it is not utilized in Pakistan due to the lack of an entrepreneurial spirit on the part of the mill-owners. After the mid-1980s, the industry expanded at a rapid pace. By the early 1990s it comprised of 62 sugar mills as compared to 36 in the early 1980‟s. At present, a total of 85 sugar mills constitute the sugar industry. The geographic fixation of a mill zone was abolished apparently to provide greater freedom to growers to fetch a fairer price for their produce. Some regard it a natural consequence of the higher density of sugar mills which made it impractical to demarcate a specific zone to each mill. The fixation of sugarcane prices by the government has however continued along with the policy of premium payments. Fixation of prices favours sugar mills, whereas the farmers can receive a higher price for their cane supplies as an outcome of de-zoning. The government faces a complex situation. If it continues to fix sugarcane prices it would favour mills in stabilizing the cost of the production of sugar. On the contrary, if it allows competition among farmers and mills, (as an intended outcome of de-zoning) the price of cane may rise translating into a higher cost of sugar production. 24 Distortions are inherent based to the fact that sugarcane supplied is valued on the basis of weight only. Ideally, sucrose content needs to be included in the pricing mechanism. A fair method to determine sucrose levels shall convey appropriate signals to the farmer. Such an incentive shall ensure that mills receive a higher quality of sugarcane. A recent decision by the Supreme Court of Pakistan, based on the proposal by the Competition Commission of Pakistan that consideration be given to sucrose content in assessing a fair price for sugarcane appears to be an appropriate ruling from a competition standpoint. However, resolution of the issue of sugarcane price fixation alone may not significantly improve the overall performance of the sugar industry. A number of other policy issues need to be addressed (the following chapter focuses on this aspect in detail). An inquiry report8 , based on the study of various minutes of the meetings of PSMA and its various zonal committees and interviews of some of the officebearers of the association, provides evidence that hint at some degree of collective decision-making on the part of sugar mills to fix sugarcane and refined sugar price levels. This assertion if analyzed in tandem with the earlier discussion on sugarcane price policy sheds light on the possibility of collusive behaviour by sugar producers in their efforts to fix prices of sugarcane. PSMA contends that it merely provides mill-owners with a forum to discuss the problems facing the sector and/or to make a collective representation to the government on policy issues. CCP‟s tentative judgment is that response is not the whole story and that PSMA has also played a role in facilitating pricefixing by its members.9 Whereas sugar mills appear, on the face of it, to be involved in practices that distort prices, some mills in their individual capacity purchase cane at prices higher than those fixed by provincial governments. Newspaper reports suggest that in Sindh, some mills started crushing after receiving supplies at Rs 130 to 140 as opposed to Rs 102 per 40 kg fixed by the government. Similarly in the preceding year (2007/08) reports suggest that sugarcane price was fixed at Rs 82 per 40 kg., while mills continued purchasing cane at Rs 120 or above. If sugarcane prices do not stabilize within a reasonable range, the cost of sugar production and its price will inevitably rise. This will affect sugar mills and consumers adversely. Conversely, if the sugarcane price level is fixed and not based on the prevailing market situation, the farmers will be at loss. As a group, they may restrict supplies to mills and/or reduce cane acreage. The solution does not lie in replacing one group‟s collusive behavior with that of another. It either case, the market will not remain competitive, which is always an overall loss to society. The solution would seem to lie in setting a base price for sugarcane in the context of a specified level of sucrose content. The proposed action is quite similar to existing practice and only differs on account of suggesting a base price rather than a minimum price. Simultaneously, there needs to be a clearly 8 Competition Commission of Pakistan, Inquiry Report on Collusive Practices in the Sugar Industry” by Shaista Bano Gilani and Syed Umair Javed, October 2009. 9 The matter is sub judice. 25 defined system of rewards and penalties. Farmers supplying cane with sucrose content higher than the benchmark should be paid an additional price as an incentive. Similarly, farmers supplying cane with lower sucrose level be penalized by paying a price less than the base price. Sugarcane price needs to depend on weight as well as sucrose contents, without any upper or lower limit. Relative to the current situation, the proposed scenario should be more conducive to competition norms. However, in doing so, the following aspects need to be ensured: a) Since sucrose content is measured within the premises of the mills, transparency needs to be ensured. The measurement mechanism should be understood by the farmer. The marketing margins and deductions also need to be transparent. b) Sucrose measurement should be at the level of the individual farm and not at the level of the entire crushing season. This will help distinguish between good supplies and bad supplies for an individual farmer as well. c) The mills may also provide other non-price incentives to growers. With these corrective measures, the current imperfections in the sugarcane market can be reduced. The industry can be made to function on the basis of fairer competition, incentivizing farmers to grow better quality cane, as well as sugar mills to acquire higher quality of cane supplies with higher sucrose content. In this regard, the advantages and disadvantages of zoning are finely balanced. On the one side zoning is anti-competition; on the other, it encourages mills and farmers to look at each others needs and constraints and develop ways of dealing with the issues confronting them. By not advocating the reintroduction of zoning in this context, the reasoning is that a more competitive environment should emerge which will ensure transparency in transactions, easy entry and exit for farmers as well as sugar mills and greater efficiency in sugar production. A cane producer will be independent in selling his output to any mill, given the quality of his product. Similarly, a sugar producer will be independent in purchasing cane from any grower in any quantity based on its quality and price. iii) Inter-relationship among Key Variables Impacting on Sugar Production With regard to sugar production, certain key variables remain the subject of discussion such as levels of cane crushed, total sugar produced, sucrose content, length of the crushing season and working capacity of mills in crushing cane. Using PSMA data for 2008/09, the variability of these factors, their correlation and economies of scale are analysed in this Section. Table 3.1 shows the range and average levels of these variables. It depicts significant variation across sugar mills during 2008/09. The level of total cane crushed and sugar production show that these vary by a factor of 40 to 60 in the industry, implying significant variations in the capacity of sugar mills in the country. 26 Table 3.1 Descriptive Statistics on Level of Crushing, Sugar Production, Length of Crushing season in Pakistan (2008/09) N Minimum Maximum Mean Standard Deviation Cane Crushed “000” tone 76 36 1665 408.6 284.79 Total Production “000” tons 76 3.0 170.3 38.7 29.61 Season (Total # Days) 76 50 139 101.7 16.96 Average Recovery Rate (%) 76 7.5 11.3 0.093 0.009 Average Cane Crush/Day/Mills 76 0.71 15.42 3.89 2.54 Source: Derived from PSMA Data for 2008/09. Note: No. of mills is less than the total of 80 mills due to incomplete data. The length of the crushing season is associated with less variability. The length of the crushing season has been reduced in the country due to a variety of factors including rapid increase in capacity, failure to introduce early and late varieties of cane and competition for land for various other crops. The recovery rates, which have recently exhibited greater variability in the upward direction, show some mills achieving 11 percent recovery. Whereas a higher recovery rate is beneficial to all stakeholders, the low levels of 7 or 8 percent still point towards inappropriate and inefficient decisions of excessive cultivation of cane and extension in the number of sugar mills. A high variability in the level of average cane crushed per day per mill is not particularly surprising. Table 3.2 highlights the degree of correlation among these variables which are all statistically significant except the relationship between the length of the crushing season and recovery rates. As indicated earlier, a shorter crushing season is associated with higher sucrose content i.e., when cane is crushed in the peak season, the recovery rates improve. Since durations of the crushing season have been reduced in relation to the past, the variability in sucrose levels has also been reduced but the biological relationship between the two factors diminishes as they come closer to periods of higher recovery. Table 3.2 Correlation Coefficients among Specific Variables Crushed Production Season Average Recovery Rate Average Cane Crush Cane Crushed 1 Total Production “000” tones 0.990** (0.000) 1 Season (Total # Days) 0.247** (0.000) 0.392** (0.000) 1 Average Recovery Rate (%) 0.345** (0.002) 0.444** (0.000) 0.089 (0.446) 1 Average Cane Crushed/Day/Mills 0.986** (0.000) 0.981** (0.000) 0.297** (0.009) 0.360** (0.001) 1 Source: Derived from PSMA Data for 2008/09. 27 Table 3.3 shows the relationship between the length of the crushing season and average level of crushing for each category of sugar mills. It tends to suggest the crushing season of 90 to 120 days as optimal in improving the average crushing per day by individual mills. Table 3.3 Average Level of Cane Crushed per Day per Mill by Total Cane Crushed and Crushing Season (‘000 tons of cane per day per mill) Cane Crushed in thousand tones Crushing Season Mean N Up to 500 Up to 60 days 2.2765 3 60 to 90 days 1.6653 10 90 to 120 days 3.2668 39 Higher than 120 days 2.2686 5 Total 2.8462 57 500 to 750 90 to 120 days 5.7397 11 Higher than 120 days 5.0500 2 Total 5.6336 13 Higher than 750 90 to 120 days 10.0548 6 Total 10.0548 6 Total Up to 60 days 2.2765 3 60 to 90 days 1.6653 10 90 to 120 days 4.4799 56 Higher than 120 days 3.0633 7 Total 3.8921 76 Source: Derived from PSMA Data for 2008/09. Table 3.4 shows the relationship between the length of the crushing season and recovery rates for different categories of mill capacity. The data suggests only weak presence of economies of scale, as recovery rates increase only marginally as size increases. Table 3.4 Average Recovery Rate by Cane Crushed and Crushing Season (Percentage) Cane Crushed in thousand tones Crushing Season Recovery Rate (%) N Up to 500 Up to 60 days 8.74 3 60 to 90 days 9.43 10 90 to 120 days 9.01 39 Higher than 120 days 9.20 5 Total 9.09 57 500 to 750 90 to 120 days 9.78 11 Higher than 120 days 9.43 2 Total 9.72 13 28 Higher than 750 90 to 120 days 9.95 6 Total 9.95 6 Total Up to 60 days 8.74 3 60 to 90 days 9.43 10 90 to 120 days 9.26 56 Higher than 120 days 9.26 7 Total 9.26 76 Source: Derived from PSMA Data for 2008/09. iv) Excessive Cultivation of Sugarcane The earlier Section has shed light on the possibility of excessive expansion of the sugar industry, especially in the context of a stabilize level of sugarcane cultivation. This Section extends the discussion further by carrying out a district level analysis of cane yield levels, size of cultivation and number of sugar mills for each province. Tables 3.5 to 3.7 provide a provincial coverage of the issue. Table 3.5 District Level Production Status of Sugar Industry in Sindh Province (2008/09) District # Sugar Mills (in operation) (No.) Av. Recovery Rate (Sucrose Contents) 2008-09 (%) District Level Total Cane Area 2008-09 („000‟ Hectares) Crushing per Day per Mill (Tons) Av. Sugarcane Yield (Av. of 2006-08) (Tons/Hectare) 1. Badin 5 9.25 59.8 2422 63.4 2. Ghotki 1 10.55 8.4 5879 58.3 3. Hyderabad* 7 9.11 77.4 3601 63.0 4. Khairpur 2 8.50 24.6 2350 54.7 5. Larkana 1 8.80 0.6 1288 51.4 6. Mirpurkhas** 5 9.88 25.8 2960 54.1 7. Nawabshah 3 9.25 26.7 5527 60.0 8. Sanghar 1 9.50 13.9 4523 57.6 9. Thatta 4 9.20 41.0 3463 65.6 Total 29 9.33 308.8 3358 61.4 Source: Computed from: 1. Government of Pakistan, MINFAL, Agricultural Statistics 2007/08 (District Level Crop Data). 2. Pakistan Sugar Mills Association (PSMA), Mill-wise Final Statement 2008/09. * Includes T.M. Khan, T. Allahyar Khan & Matiari ** Includes Tharparkar & Umer Kot. 29 Chart 1.1 District-Wise Levels of Sugarcane Crushing per Day per Mill and Average Sugarcane Yield in Sindh Province Larkana (1) Khairpur (2) Mirpurkhas (5) Badin (5) Thatta (4) Hyderabad (7) Sanghar (1) Nawabshah (3) Ghotki (1) 50 1050 2050 3050 4050 5050 6050 7050 50 52 54 56 58 60 62 64 66 68 70 Sugarcane yield (tons per hectare) Crushing per day per mill (tons) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Chart 1.2 District-Wise Levels of Sugarcane Acreage and # of Sugar Mills in Sindh Province Larkana (1) Khairpur (2) Mirpurkhas (5) Badin (5) Thatta (4) Hyderabad (7) Sanghar (1) Nawabshah (3) Ghotki (1) 0 1 2 3 4 5 6 7 8 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 Sugarcane acreage (000 hectares) # of Sugar Mills Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Average Average 30 Chart 1.3 District-Wise Levels of Sugarcane Yield and Sugarcane Acreage in Sindh Province Larkana (1) Khairpur (2) Mirpurkhas (5) Badin (5) Thatta (4) Hyderabad (7) Sanghar (1) Nawabshah (3) Ghotki (1) 0 10 20 30 40 50 60 70 80 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 Sugarcane Yield (Tones/Hectare) Sugarcane Acreage (000 Hectares) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Chart 1.4 District-Wise Levels of Sugarcane Yield and Average Recovery Rate in Sindh Province Larkana (1) Khairpur (2) Mirpurkhas (5) Badin (5) Thatta (4) Hyderabad (7) Sanghar (1) Nawabshah (3) Ghotki (1) 50 52 54 56 58 60 62 64 66 68 70 8 9 10 11 Average Recovery Rate (%) Sugarcane Yield (Tons/Hectare) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Average Average Average 31 Based on average levels of cane yield in Sindh it shows that: i) District-level yield varies by as much as 30 percent in districts that have sugar mills. ii) A larger number of mills in a district is associated with low levels of crushing level per day per mill. iii) Recovery rates seem to be associated with higher levels of crushing per mill per day. In the case of Punjab province, Table 3.6 shows that: i) Higher recovery rates are associated with higher sugarcane yield levels but not necessarily with higher levels of crushing per day per mill. ii) Sugarcane yield levels vary by a large margin of 48 percent. iii) Southern and Northern districts have higher cane yield levels. Table 3.6 District Level Production Status of Sugar Industry in Punjab Province (2008/09) District # Sugar Mills (in operation) (No.) Av. Recovery Rate (Sucrose Contents) 2008-09 (%) District Level Total Cane Area 2008-09 („000‟ Hectares) Crushing per Day per Mill (Tons) Av. Sugarcane Yield (Av. of 2006-08) (Tons/Hectare) 1. Okara 2 8.2 25.5 3328 43.9 2. Sargodha 5 8.6 69.6 4234 48.7 3. Bahawalnagar 1 9.5 21.9 2486 48.2 4. Bahawalpur 1 9.7 12.2 3763 53.3 5. Kasur 3 8.7 52.2 3179 47.8 6. Faisalabad 6 8.6 125.1 4047 51.7 7. Toba Tek Singh 2 9.6 46.6 6431 52.7 8. Mandi Bahauddin 1 8.4 39.3 2909 45.3 9. Khanewal 1 10.2 18.6 2943 51.1 10. Rahimyar Khan 5 10.7 95.5 9430 64.7 11. Muzaffargarh 2 9.0 45.3 7148 54.0 12. Bhakkar 1 8.0 18.6 4156 40.6 13. Jhang 7 9.2 113.3 3266 47.9 14. Sheikhupura 2 9.1 2.0 2863 45.5 15. Rajanpur 1 10.6 13.8 5246 54.8 16. Pakpattan 1 8.7 11.7 3425 53.2 17. Khoshab 1 9.1 8.5 2726 47.5 18 Layyah 1 9.4 17.0 7242 49.1 19. Gujrat 1 9.3 2.8 6797 43.7 Total (Punjab) 44 9.5 827.2 4632 50.7 Source: Computed from: 1. Government of Pakistan, MINFAL, Agricultural Statistics 2007/08 (District Level Crop Data). 2. Pakistan Sugar Mills Association (PSMA), Mill-wise Final Statement 2008/09. 32 Chart 2.1 District-Wise Levels of Sugarcane Crushing per Day per Mill and Average Sugarcane Yield in Punjab Province Gujrat (1) Layyah (1) Khoshab (1) Pakpattan (1) Rahimyar Khan (5) Okara (2) Sargodha (5) Bahawalnagar (1) Bahawalpur (1) Jhang (7) Kasur (3) Faisalabad (6) T.T. Singh (2) Sheikhupura (2) M.Bahauddin (1) Khanewal (1) Muzaffargarh (2) Bhakkar (1) Rajanpur (1) 2000 3000 4000 5000 6000 7000 8000 9000 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 Sugarcane yield (tons per hectare) Crushing per day per mill (tons) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Chart 2.2 District-Wise Levels of Sugarcane Acreage and # of Sugar Mills in Punjab Province Gujrat (1) Layyah (1) Khoshab (1) Pakpattan (1) Rahimyar Khan (5) Okara (2) Sargodha (5) Bahawalpur (1) Bahawalnagar (1) Jhang (7) Kasur (3) Faisalabad (6) Sheikhupura (2) T.T. Singh (2) Khanewal (1) M.Bahauddin Muzaffargarh (2) Rajanpur (1) Bhakkar (1) 0 1 2 3 4 5 6 7 0 10 20 30 40 50 60 70 80 90 100 110 120 130 Sugarcane Acreage (000 hectares) # of Sugar Mills Note: Figures in parenthesis show # sugar mills in operation during 2008/09. * These include the following: 1. Bahawalnagar 1 2. Bahawalpur 1 3. Mandi Bahauddin 1 4. Khanewal 1 5. Bhakkar 1 6. Rajanpur 1 7. Pakpattan 1 8. Khoshab 1 9. Layyah 1 10. Gujrat 1 Average Average * 33 Chart 2.3 District-Wise Levels of Sugarcane Yield and Sugarcane Acreage in Punjab Province Gujrat (1) Layyah (1) Khoshab (1) Pakpattan (1) Rahimyar Khan (5) Okara (2) Sargodha (5) Bahawalnagar (1) Bahawalpur (1) Jhang (7) Kasur (3) Faisalabad (6) T.T. Singh (2) Sheikhupura (2) M.Bahauddin (1) Khanewal (1) Muzaffargarh (2) Bhakkar (1) Rajanpur (1) 0 10 20 30 40 50 60 70 80 90 100 110 120 130 40 42 44 46 48 50 52 54 56 58 60 62 64 66 Sugarcane yield (tons per hectare) Sugarcane Acreage (000 hectares) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Chart 2.4 District-Wise Levels of Sugarcane Yield and Average Recovery Rate in Punjab Province Rajanpur (1) Bhakkar (1) Muzaffargarh (2) Khanewal (1) M.Bahauddin Sheikhupura (2) T.T. Singh (2) Faisalabad (6) Kasur (3) Jhang (7) Bahawalpur (1) Bahawalnagar (1) Sargodha (5) Okara (2) Rahimyar Khan (5) Pakpattan (1) Khoshab (1) Layyah (1) Gujrat (1) 40 45 50 55 60 65 8 9 10 11 Average Recovery Rate (%) Sugarcane yield (tons per hectare) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Average Average Average 34 In the case of KP, Table 3.7 reveals that: i) Dera Ismail Khan (DIK) which has below average yield levels has four out of the total of seven mills in the province. ii) Mills in DIK are of a much larger size as compared to other districts as reflected through the levels of cane crushed per mill per day. iii) Sucrose level seems to be associated with higher cane yield levels. Table 3.7 District Level Production Status of Sugar Industry in KP Province (2008/09) District # Sugar Mills (in operation) (No.) Av. Recovery Rate (Sucrose Contents) 2008-09 (%) District Level Total Cane Area 2008-09 („000‟ Hectares) Crushing per Day per Mill (Tons) Av. Sugarcane Yield (Av. of 2006-08) (Tons/Hectare) 1. D.I. Khan 4 8.3 12.9 4969 44.1 2 Peshawar 1 9.7 11.9 1571 51.5 3. Mardan 1 9.2 29.5 1181 47.9 4. Bannu 1 7.9 0.8 1583 41.2 Total 7 8.4 104.8 3762 45.8 Source: Computed from: 1. Government of Pakistan, MINFAL, Agricultural Statistics 2007/08 (District Level Crop Data). 2. Pakistan Sugar Mills Association (PSMA), Mill-wise Final Statement 2008/09. Chart – 3.1 District-Wise Levels of Sugarcane Crushing per Day per Mill and Average Sugarcane Yield in KP Province Bannu (1) Mardan (1) Peshawar (1) D.I. Khan (4) 1000 1500 2000 2500 3000 3500 4000 4500 5000 40 42 44 46 48 50 52 54 Sugarcane yield (tons per hectare) Crushing per day per mill (tons) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Average Average 35 Chart – 3.2 District-Wise Levels of Sugarcane Acreage and # of Sugar Mills in KP Province Bannu (1) Peshawar (1) Mardan (1) D.I. Khan (4) 0 1 2 3 4 5 6 7 8 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 Sugarcane acreage (000 hectares) # of Sugar Mills Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Chart – 3.3 District-Wise Levels of Sugarcane Yield and Sugarcane Acreage in NWF Province Bannu (1) D.I. Khan (4) Mardan (1) Peshawar (1) 0 5 10 15 20 25 30 40 41 42 43 44 45 46 47 48 49 50 51 52 Sugarcane Yield (Tones/Hectare) Sugarcane Acreage (000 Hectares) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. Average 36 Chart 3.4 District-Wise Levels of Sugarcane Yield and Average Recovery Rate in KP Province Bannu (1) D.I. Khan (4) Mardan (1) Peshawar (1) 40 42 44 46 48 50 52 7 8 9 10 Av. Recovery Rate (%) Sugarcane Yield (Tons/Hectare) Note: Figures in parenthesis show # sugar mills in operation during 2008/09. The above analysis depicts inefficiencies and raises important policy questions, especially regarding the rationale of expanding sugar mills in different agro-climatic regions. v) Current Cost Structure of Sugar Production: (A Sensitivity Analysis) In the context of the recent sugar crisis in the country, an analysis of the current cost structure of sugar production was carried out. It starts with a base picture of 2008/09 as scenario-1 and builds ten additional scenarios by altering key variables like cane price, recovery rates, cost of conversion to judge the variability in the total cost of sugar production (i.e. ex-mill price) and consumer price level. The attached Table 3.8 portrays 11 different scenarios. The scenario1 depicts the baseline picture where modest levels of recovery and maximum cost of conversion were taken into account. The remaining ten scenarios are based on different assumptions related to: i) Sugarcane Prices: The reason for sensitizing this variable rests with the fact that sugar mills keep extending their crushing season and prefer to pay high prices for cane to achieve their private breakeven (Reference Scenarios 2, 3 & 4). Average Average 37 Table 3.8 Current Structure of Cost of Production of Sugar in Pakistan and Its Variability under Different Scenarios Status Difference Scenarios of Cost of Sugar Production Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6 Scenario 7 Scenario 8 Scenario 9 Scenario 10 (Bleak Scenario) Scenario 11 (Brighter Scenario) Baseline (as of 2008-09) Sugarcane price increased by 25% Sugarcane price increased by 50% Sugarcane price increased by 75% Keeping sucrose contents at 9.25% Keeping sucrose contents at 9.5% Keeping conversio n cost at Rs.3.50 per Kg. Keeping conversio n cost at Rs.4.0 per Kg. Keeping conversio n cost at Rs.4.50 per Kg Sugarcane price 175/40 Kg - Recovery 9% - Conversion cost Rs.5/Kg. - Sugarcane price Rs.105/40 Kg. - Recovery 9.5% - Conversion cost Rs.4/Kg. 1. Cane Prices (Rs./40 Kgs.) 100 125 150 175 100 100 100 100 100 175 105 2. Cane Prices (Rs./100 Kgs.) 250 312.5 375 437.5 250 250 250 250 250 437.5 262.5 3. Recovery Rate 9% 9% 9% 9% 9.25% 9.5% 9.0% 9.0% 9.0% 9.0% 9.5% 4. Sugar produced from 100 Kgs. of cane 9 Kg. 9 Kg. 9 Kg. 9 Kg. 9.25 Kg. 9.5 Kg. 9.0 Kg. 9.0 Kg. 9.0 Kg. 9.0 Kg. 9.5 Kg. 5. Cost of Sugar / Kg: i) Sugarcane Cost (Rs.) 27.8 43.7 41.7 48.6 27.0 26.3 27.8 27.8 27.8 48.6 27.6 ii) Conversion Cost (Rs.) 5.0 5.0 5.0 5.0 5.0 5.0 3.5 4.0 4.5 5.0 4.0 iii) Excise Duty (Rs.) 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 2.6 6. Ex-Mill Price (Rs./Kg.) 35.40 42.3 49.3 56.2 34.6 33.9 33.9 34.4 34.9 56.2 34.2 7 Marketing Margin including marketing, storage, wholesale profit (Rs./Kg.) 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 4.0 8. Consumer Price (Rs./Kg.) 39.40 46.3 53.3 60.2 38.6 37.9 37.9 38.4 38.9 60.2 38.2 9. Cost of cane in sugar cost (as per Ex-Mill Price) 78.5 82.0 84.6 86.5 78.0 77.6 82.0 80.8 79.7 86.5 80.7 Source: Computed on the basis of PSMA Annual Report, 2008, and field level data collected for the study. 38 38 ii) Recovery Rate: The latest unpublished data for 2008/09 shows significant variation in the level of recovery across individual mills, ranging from 7.5 to 11.3 percent. Based on this information, the variable was sensitized within a reasonable limit (Reference Scenarios 5 & 6). iii) Conversion Cost: It is a cumulative indicator of all other costs (except that of sugarcane) including wages/ salaries, chemicals, depreciation, repairs and maintenance and internally determined profits, etc. Currently it ranges between Rs 3.50 to Rs 5.0 per kg of sugar produced. Keeping in view this efficiency indicator, the variable was sensitized to assess its respective impact (Reference Scenarios 7, 8 & 9). Based on the above, scenarios 2 to 9 were prepared. Scenarios 10 and 11 were prepared to account for extreme situations. The sensitivity analyses show that efficiency gains (or losses) associated with each scenario depict obtainable levels of performance. These estimates, therefore, do not reveal the actual potential latent in the soil, climate and human resource capacity of the industry which are obtainable in the long run if drastic policy measures are taken by the government. In summary, the results of the sensitivity analysis show a range of sugar price levels for consumers. It shows that a tighter control over the length (as well as on the starting date for crushing) needs to be exercised in order to ensure that sugarcane prices paid to the growers do not exceed the competitive price level. This would require an appreciable increase in the level of cane crushed per day of the crushing season (i.e. rate of capacity utilization needs to be increased significantly from a low level of 50 to 60 percent as present). Since the cost of cane accounts for over 80 percent in the cost of sugar production, it is apparent that a hike in the cane price level may lead to substantial increases in sugar price. The improvements in sucrose contents may also reduce sugar prices. The efficiency indicator of management (i.e. conversion cost) shows that some reduction in sugar prices can still be achieved with improvements in technical management at the level of mills. More efficient use of by-products through establishing downstream industries to produce a large number of derivatives would also boost the income of sugar mills and would thus help reduce the cost of conversion of sugarcane into refined sugar. 39 39 On the whole, the analysis reveals that if sugarcane prices are determined by market forces through competition and based on sucrose contents, sugar price (i.e., consumer price) may remain well under Rs 40.00 per kilogram during 2009/10. vi) Mill-Farmer Interaction The de-zoning process in the cultivation and sale of sugarcane has provided free entry and exit to farmers but has reduced mill-farmer interaction. Although de-zoning did not aim at disturbing such interactions, in practice it did. The farmers and sugar mills both paid an invisible cost i.e., de-zoning led to de-linking of farmers with sugar mills. As a consequence, farmers did not receive the benefits of credit and extension services. The situation was further aggravated by the emergence of middle men who while ostensibly bridging the gap between farmers and mills in practice caused significant distortions in cane price levels and delays in shipment of cane to mills. Both these factors escalated the cost structure of sugar. The practice of collusive behavior started not only across mills in suppressing cane prices but also amongst farmers by dictating higher cane prices to mills. The role of the middlemen was quite apparent. A strict adherence to sucrose contents in the base price, instead of the minimum price, for cane supplies will not only harmonize the price structure but should create the basis for increased competition among growers to increase their income through qualitative improvements in cane production. Simultaneously, the mills would not hesitate in paying a higher cane price in exchange for higher sucrose content which would be advantageous for them due to the reduced cost of sugar production. Mill-farmer interaction would be promoted since the mills would like to encourage farmers to improve the quality of cane supplies. This should also reduce the role of middlemen. However, it remains relevant to point out here that pricing based on sucrose contents alone does not rule out collusive price fixing by the millers or the growers. 3.3 Taxation Policies i) Sugarcane Cess Fund The growers of cane have historically had to contribute to a sugar cess fund deducted from the cane price received by growers. The purpose was to establish a road infrastructure to facilitate transport of produce to mills, as well as to carry out research. It is evident that significant revenue was generated by the government through the cess fund. In the earlier period, it was kept by the district administrations, and after the establishment of local government system it was controlled by local government officials. The PSMA claims non-availability of money not only for improving the logistics of the industry - such as farm to mill 40 40 roads – but a lack of funds even to establish a „public good‟ in the form of a research and development institute at Gharo, Sindh10 . ii) Sales Tax and Excise Duty Historically, sales and excise taxes have been imposed on the industry in varying forms. For example, at times taxes have been imposed on production levels or alternatively on the basis of capacity of the mills. Until recently sales tax was levied at a uniform rate of Rs 4.62 per kg of sugar produced and has now been reduced to half i.e., Rs 2.31 per kg. This was done as an effort by the government to reduce the cost of sugar production and hence retail prices of sugar. It seems that succeeding governments have interchangeably used different taxation policies to impose sales taxes on sugar mills. A tax based on capacity of mills is easy to collect and carries a built-in incentive for mills to increase production level. This instrument did not work properly because of increasing discrepancies between actual and rated capacities (i.e., capacity as per record of the Federal Board of Revenue). Due to this tax evasion, the government often switched to impose sales tax on production levels. This approach requires a detailed daily record of production to be maintained and is inherently prone to corruption. Over time, with the rapid increase in the size of the industry both in terms of new mills and enhanced capacity of existing mills, the rate of capacity utilization of mills started declining below the 100 percent mark. This led to an exclusive selection of sales tax on actual production at the cost of ignoring incentives to increase production levels. This approach suited the sugar mills which were suffering from increased expansion of the industry. Excise duty is levied on the basis of 0.1 percent of the selling price of sugar after subtracting sales tax. Excise duty on sugar is a direct function of the price of sugar, whereas sales tax is levied at the prevailing rate of 16 percent under normal circumstances. 10 PSMA Chairman‟s Annual Review, 2008