The recent removal of the levy sugar obligation and the abolition of the quarterly release mechanism will likely provide immediate relief to a segment that is currently burdened with US$1.95bn in sugarcane arrears.
After months of deliberation, the Cabinet Committee on Economic Affairs, headed by the Prime Minister Manmohan Singh, approved partial decontrol of the Indian sugar sector as of the current sugar season.
Positive climate
According to a report from Rabobank, partial de-control is expected to create a more positive operating and investment climate for sugar companies.
Asitava Sen, head of food and agribusiness research at Rabobank India, said: "These developments will bring greater freedom for domestic sugar players. It will allow them to sell more sugar in domestic markets and export at will, leading to increased revenues and improved operating margins.”
However, Sen cautioned that the recent reforms still sidestep the major structural problems in the sugar sector concerning the value chain of key raw materials, including the procurement price for sugarcane, command area and minimum distance between mills.
“Overall we project an optimistic, although cautious, outlook for the industry in the wake of these reforms,” said Sen.
The levy sugar obligation, which required companies to sell 10% of their production to the government for supply to the public distribution system (PDS) at around a 40% discount, has ended, freeing Indian sugar mills from this social responsibility. The government will now buy sugar from mills at market price, although the policy change is subject to review at in two years.
Free market
In the short-term, Rabobank expects sugar mills to benefit directly from the lifting of the levy obligation as they will be free to decide on the quantity and destination of supply based on market factors.
The withdrawal of the release quota will give sugar companies greater flexibility in managing inventory and will also improve liquidity. However, with the decontrol of the release mechanism, sugar mills with significant debts could potentially offload stocks to pay for cane arrears, applying further downward pressure on sugar prices in the short term.
Indian sugar company revenue is expected to increase by at least four per cent for what is left of this sugar year. Based on approximately 2.7m tonnes of sugar supplied to the PDS annually, this amounts to adding US$581m in revenues to the sector. Assuming sugar companies retain their profits, Rabobank anticipates average operating margins to improve by 110 to 130 basis points.
The agribusiness bank views the medium-term sugar outlook as moderately positive. It says that partial decontrol of the sector will bring in better demand and supply visibility for sugar mills and improve the overall investment sentiment in the sector. This is expected to drive forward contracts, greater competitiveness and industry consolidation.