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A shortfall in sugar supply is slowly brewing on the cauldron. But it is not the one you will hear about on the news. Away from the sugar producing hubs of Punjab and Sindh, the milling units in Peshawar valley have been non-operational since the beginning of crushing season in December.

Is the situation not serious enough to set off alarm bells? Consider that Peshawar valley (consisting of Charsadda, Mardan, and Peshawar) have three milling units with an aggregate capacity to produce hundred thousand tons of refined sugar per season – that is, ten percent of average national demand.

However, over the past ten years, sugar production in the region has been on a steady decline thanks to shifting cropping patterns, lower cost of production in adjacent regions, and surplus availability of sugar in Punjab.

Geographical disadvantage of the three units in the valley has been so striking that between MY12 and MY19, valley’s share in provincial output fell by half – from twenty percent to just under ten, with mills shutting down altogether in the just began crushing season.

But does the shift in geographical origin of sugar necessarily translate into lower provincial output; and consequently, a shortage? Enter gur producers.

According to statistics provided by PSMA, between MY04 and MY19, utilization of sugarcane grown in KP by crushing mills has averaged under 60 percent, even as volume of cane crop produced in the province grew by 1.6 times during the intervening 15 years.

Remainder two-fifths supply of sugarcane has historically been diverted towards gur-making, a budding ‘cottage’ industry - that no surprises - thrives on lack of documentation and enjoys exemption from sales tax.

In fact, despite availability of comprehensive data on sugarcane production, no reliable estimates exist for national gur output. Extrapolation is a tough business, since industry insiders comment that gur-making is a very traditional – but highly inefficient process – that results in significant loss of sucrose syrup due non-mechanical methods and tools employed.

Nevertheless, why is diversion of sugarcane for production of gur a problem, consider it is very much equivalent to product substitution, and one that may also stabilize prices of refined sugar owing to former’s sales tax-exempt status?

Because unlike the gur produced elsewhere in Punjab and Sindh, the target market of gur producers in Peshawar valley is Afghanistan, owing to proximity to Torkham border (under 60 kilometers). According to Iskandar M. Khan, chairman of PSMA-KP zone, majority of the gur produced in Peshawar valley makes it way across the border. While gur trade – unlike refined sugar – is not controlled through export quotas, according to Iskandar Khan export controls would make little difference, considering that most of the trade is through grey channels.

If the consumption of sugar in Peshawar valley is in line with national levels – at 25kg per capita – total demand for the sweetener in the region would come out at close to two hundred thousand annually. In comparison, the regional output is much lower – at just twenty percent. This indicates that even if half of the local consumption is fulfilled by gur producers – a generous assumption, the region would still rely on supply from cross-regional trade.

And the shortfall is already showing. According to PBS-CPI data, back in October 2018, refined sugar prices in the Peshawar valley trailed prices elsewhere in the province – such as Bannu – but have since increased by as much as four percent.

Similarly, gur price in Peshawar, which back in April 2019 had fallen below country average are on the rise again, meaning that price of both substitute commodities is hovering above national averages.

In previous years, this would have been of little concern, considering the differential is not large enough. However, sweetener prices across the country are already under pressure due to shortfall in raw material, increase in cane support price, and distorted export policy that have created a steep decline in domestic sugar stocks.

This means that the shutdown of milling units in the valley risks adverse signalling to the market, by creating an arbitrage opportunity for cross-region trade. This may further create demand-side pressures on refined sugar price elsewhere in the country, as was recently seen in cross-border wheat trade between Punjab and Sindh.

The Peshawar valley mills shutdown is so far only a blip; that can be managed well without creating panic across the value chain by placing appropriate checks on gur export to Afghanistan through grey channels. One possible tool could be removal of sale tax distortion between the two substitutes that may eliminate smuggling, although its extent remains unknown.

The consequences of mill shutdown are still unfolding, and it is likely that it the problems may be self-contained. However, markets prices tend to be forward-looking, and fears of supply shocks tend to send markets into panic even when the volumetric effect is not substantive.

The issue, therefore, offers a good opportunity for the provincial government to demonstrate its governance capacity, and handle problem proactively, instead of responding reactively as was witnessed in the case of wheat and flour shortage last month. Fingers crossed.