Bitter Truths
An acute overproduction crisis has revealed the inefficiency of the way the state controls the Russian sugar market. A tariff quota policy based on production promises to create the most favorable conditions for industry growth.
Galina Kostina
Russian sugar companies have been in a mournful mood for the last three weeks. Market prices have collapsed below cost. Supply significantly exceeds demand. Companies are unloading their accumulated stock. The panic is exacerbated by the fact that companies cannot simply hold onto their product and wait until prices rise. Sugar beet processing is beginning and they have to empty their warehouses. In addition, the government hasn’t released its conditions for raw sugar import for 2004 yet, which makes sugar producers even more nervous.
More beets
Sugar consumption in Russia is estimated at 5.7-6 million tons. Only 1.6 million tons are produced from beets and the rest is made out of imported raw sugar. Refined sugar is officially imported only in small quantities, now that imports have been restricted by prohibitive duties. In the Soviet era, Russia produced up to 3 million tons of beet sugar but in the early nineties, production fell to 1.3 million tons due to cheap imported sugar. At that time, the decline in the sugar beet industry sparked heated debates in economic circles about whether the state should bother with beets at all, which kept prices for refined sugar high, instead of importing cheap raw sugar and consequently getting cheap refined sugar. The liberals believed that Russia should produce only what is economically sound. The champions of domestic commodity producers argued that not only Russian agriculture, but also many other industries would be out of work then. The sugar market throughout the world is one of the most regulated. Even at negotiations between WTO member countries, sugar remains taboo. As a result, advocates of the Russian agriculture won. Raw sugar imports should exactly match production and consumption so that any surplus doesn’t put pressure on prices. At first, the government tried to manipulate duties, gradually increasing them. This didn’t bring the desired result: the barriers were still too low. In 2000, the government decided to introduce tariff quotas.
There were quite a lot of proposals for how to allocate the quotas among companies, but as many of them could have theoretically led to corruption, the Ministry of Finance suggested that an auction would be the best method, and that’s just what happened. The first quota auction for 2001 turned out like the first pancake, a flop. The companies were anxious to buy as much raw sugar as possible, and as a result, too much sugar was imported. This resulted in price collapse and losses, a scene reminiscent of the industry today.
Nevertheless, the companies, which came to believe that the government seriously intended to support domestic producers, began to make more investments in sugar beets. They bought good machinery, seeds, fertilizers, and pesticides. They began to work to increase crop yields and reduce costs. The quota auction for 2002 was an uncommon success. The lot prices were not very high, and the difference in prices for quota raw sugar and non-quota raw sugar enabled the companies to profit from refining.
Greed strikes
When quotas were being allocated for 2003, the companies had their appetites whetted again. They even succeeded in lobbying to increase the quota. Bankers, guided by the sugar producers’ strong performance in 2002, were readily giving loans. About $1 billion went to the banks under the auction, enough to buy from 5 to 8 million tons of raw sugar. The established market price for refined sugar at the beginning of the year was $510-515 a ton, dangerously near the cost of refining sugar from raw sugar imported within the quota. This forced some companies to try and get around the trade barriers, specifically by importing sugar syrup, which is more profitable to refine than raw sugar. The high market price resulted in duty-free import of refined sugar from Belarus and Ukraine. Ukrainian companies also smuggled refined sugar into Russia.
This influx of supply collided with considerably reduced demand. Because of the cold summer of 2003, there was little produce for canning or making preserves. Soft drinks, which require a lot of sugar to produce, also saw weak growth. Companies sold less than half of what they had expected to sell during the peak summer season. Even worse, the market is overstocked and sugar producers, who had already paid for the privilege of importing raw sugar, have not even imported their entire quota yet.
There is no reason to expect a rise in sugar prices until the end of the year, and prices continue to fall. If prices are not stabilized soon, the market will stay in its slump all next year as well.
Time to choose
The past three years have demonstrated that the state has yet to develop an efficient mechanism for maintaining equilibrium on the sugar market. Unstable company revenues won’t allow them to keep up with investments in sugar beets, although their initial investments amounted to tens of millions of dollars. The sugar companies themselves haven’t managed to come up with quota allocation alternatives to the auction. They all thought only of themselves, ignoring the market as a whole. This July, most companies requested to keep the auction procedure for 2004.
In August, the Ministry of Economic Development opposed the auction, as it contradicts WTO norms, and suggested that the tariff quota policy be abolished. In future, it proposed to restrict import of raw sugar via duties. The Ministry’s initiative aroused a storm of indignation among sugar companies, since they consider such a restriction inefficient.
“It is naďve to set high barriers and think everyone will follow the rules, especially as the smuggling problem has not been solved. It would be tantamount to a suicide,” believes Gleb Tikhomirov, Deputy General Director of Sucden Russia. Igor Khudokormov, Chairman of the Board of the Prodimex Group, which owns 21 sugar refineries and sugar beet farms, thinks that with a duty in place companies won’t have any incentive to invest in farming. And finally, if the tariff quota policy in the sugar industry is abandoned, the state will likely be reluctant to use this method in other sectors of agriculture. “Large integrated holdings involved in agriculture are not only in the sugar business but also in the grain, meat, and dairy industries that also require protection,” Khudokormov says.
However, though unanimously supporting the tariff quota system, the sugar companies disagree on how quotas should be allocated. Some suggest that quotas should be allocated by the historical principle (in proportion to import volumes over the last three years). Others insist on the production principle (in proportion to the output of beet sugar).
Denis Sokolov, head of the Analytical Department at International Sugar Company, notes that the historical principle will give the advantage to importers without production facilities who do not invest in sugar beets. Khudokormov agrees: “The idea of tying a quota to beet sugar production meets the industry’s goals. It’s a good incentive; we’ll be able to boost production considerably.” Sergei Mironov also supports this principle. He believes that it will promote investments in sugar beets. A conceptual approach needs to be in place so that long-term strategies can be developed. “We’ll support any option that will provide companies in agriculture with a clear outlook and will enable them to earn money on sugar beets and increase output,” Alexei Knyazev, General Director at Sugar Trading Co, states.
Production, after all
The government will have to make a strategic decision. It concerns more than the sugar market. Of course, no method of quantitative or tariff control of the market will equally suit all companies. Nevertheless, judging by our survey of the sugar market, long-term tariff quotas based on production would create the most favorable conditions for industry recovery and could play a part in a development program for Russian agriculture. 
Vertically-integrated companies contributing to the revival of this economic sector and most agricultural producers believe that before joining the WTO, Russian agriculture should be allowed to stabilize after its collapse during post-Soviet reforms. In their opinion, it would be a great mistake to surrender Russian agriculture with its 60 billion in revenues to Western agro-giants as a concession for immediate entry into the WTO.
As for the current crisis, it can be resolved by making a conceptual decision on raw sugar import regulation for next year. The brighter future will stop the panic and plummeting prices.
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