Sugar inquiry: which ex-factory price

Over the last two weeks since the publication of FIA’s inquiry report into sugar sector, this space has sought to conclude that crucifying export policy may be a bad idea, and that both federal government and the industry association need to acknowledge failure on their part to address the resulting price volatility of 36 percent during 2019.

While the media has occupied itself with subsidy and its beneficiaries, consider that the subsidy announced by Punjab government last year was only half of the amount announced by PML-N government in the season before. At that time, while the subsidy allowed the surplus in domestic market to ease, retail price remained stable, as the previous government relied on strict district level measures to ensure price control.

Consider also that the PML-N era export set a ceiling of $499 per ton for subsidy eligibility, which it defined as the cost of domestic production based on prevailing exchange rate at the time – Rs 52.6 per kg  (Oct-17). International price at that time in rupee equivalent terms ranged between Rs 40 – 42 per kg ($360 per ton). Fast forward 15 months, and Punjab government set subsidy ceiling at $435 per ton; while international price had climbed up to Rs 47 per kg (or $340 per ton, miracles of currency devaluation).

The puzzle is missing two more pieces. First, of the total export of 691 thousand tons last year, more than 40 percent took place between Jun-Dec 2019 after the subsidy was revoked. And two, ISO white sugar index (used by SBP officially to review subsidy applications) during Jun-Dec 2019 ranged between Rs 52 – Rs 55 per kg, dollar equivalent.

While the FIA and PSMA fight over which definition of cost of production to use or whether the industry created shortage by exporting ‘too much’ or hoarding, simply consider the following. Each time the industry has utilized export quota to the fullest during the past 30 months, exports have fetched them at least Rs 50 per kg, and a maximum of Rs 55 per kg, with or without subsidy.

While the investigating agency may claim that it has failed to access the ‘true’ ex-factory price data and is thus forced to use cost of production as a proxy, the industry association is correct in claiming that the two variables are not correlated. Instead, export selling price is a good indicator of what ex-factory selling price looks like – or the price at which sugar producers happily sold their output between Jul-Dec 2019 without any subsidy. Only that the buyers were foreign and not local.

Gross the same up by Rs 10.6 of GST on domestic sales, and one may reasonably conclude that even if exports were banned, as profit maximizing agents, mills would try their very best to sell at least at a price of Rs 65 per kg in domestic market, which represents their opportunity cost of not being able to sell to foreign customers (in addition to any upside of favourable currency movement).

FIA report concludes that the difference between ex-mill and retail price ranges anywhere between Rs 5 – 7, historically. Although, it may be argued that given the uncertainty that prevailed over supply of sugar in domestic market last year, a higher margin may be allowed for speculation at wholesaler level.

Even so, the export selling price between Jul-Dec 2019 – more correctly, the rate at which export proceeds for the period were realized – should give the government a good proxy of what ex-factory price in domestic market should have looked like for the period under investigation. And to avoid frenzy of shortages/surpluses in future, instead of placing restriction on foreign trade, the government can adopt a forward-looking approach and develop a practice of following international prices.

Asking frivolous questions whether export led to price increase will get the investigation nowhere. Using export as a tool to ease supply will always lead to price increase unless price controls are introduced in tandem (as PML-N did between 2013-17). But that only leads to calls for more subsidies later. It can instead use data to make forecasts based on global market price trends; that may go a lot further in subduing price volatility than forensic audits by criminal investigators.