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According to latest private sector loan data published by SBP, outstanding working capital finance to sugar industry saw a precipitous month-on-month decline of Rs39.5 billion in July 2021. This is the largest month-on-month decline in outstanding credit to the industry ever since SBP revised its loan classification as per ISIC-4 standards (and likely the largest ever). In fact, decline in finance to sugar contributed a whopping 39 percent of the Rs102 billion net reduction in outstanding credit to private sector between June and July 2021!

Last month, BR Research had pointed out that “even though sugar production during marketing year 2020-2021 is 16 percent higher than last year, volume of sugar pledged with the banks appears to be much lower” (for more, read “Sugar: cease & desist” published on 27 July 2021). Latest data indicates that stock pledged with banks as at July end may be less than same period during last two years. What gives?

To answer this question, BR Research made a deep dive in historic financials of several listed companies. Here, financials of one of the top 3 sugar producers is presented for illustrative purposes only.

Despite third-highest sugar production in history, stock pledged with banks – an indicator of stocks available with mills that excludes those already sold in open market – appear to be at their lowest ever for July end. This is counter-intuitive, as low financing rates due to the ongoing monetary easing should theoretically incentivize mills to increase their holdings, and capitalize on rising prices. Retail prices have already increased by 15 percent in the ongoing calendar year, and, show no sign of easing so far. Why then are mills betting short on sugar?

Firm level analysis shows that the steep rise in cost of raw material has significantly increase industry’s liquidity requirements. Working capital requirements have been further exacerbated by administrative enforcement of “15-day payment rule” to farmers. But shouldn’t higher working capital requirement lead to increased dependence on banking lines?

It did, but only to the extent of in-season settlements. Although industry’s borrowing against seasonal financing (as of March end, when crushing closes) was highest in history, mills appear to have readily sold the pledged stock in open-market. In fact, outstanding against cash finance borrowing saw record decline between March and June quarters, second only to 2019 when freight subsidy had made exports more lucrative.

It is not hard to understand why. Repeated attempts by provincial and federal governments to fix ex-factory, wholesale and retail prices has greatly increased uncertainty in the market. Anticipation of further hostile action by administrative machinery appears to have convinced the industry that prices may have peaked. But is it a wise course of action for the government?

Consider that as mills engage in sell-off of their remainder inventory, stock will enter open market, where stockists and dealers own the turf. If administration couldn’t put a cap on prices while stocks were under bank pledge and duly accounted of, what are the chances that prices will calm down once mills are out of stock, giving free rein to traders and stockists?

Once again, it needs to be reiterated that frequent government intervention in any marketplace is the detrimental to price discovery of any commodity. Although government claimed second-highest cane crop, consumers are still paying a higher price for the commodity, as market is unable to perform its price discovery function. There may be still time for course correction, before speculators run amok come Sep-Oct.

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