Despite the fundamental underlying role that Brazil’s exchange rate and sugar-ethanol tradeoff play in shaping world sugar prices, a more immediate factor contributing to the sugar price spike in 2009 and 2010 was the decline in production in Asia in 2008 and 2009, particularly in India, the worlds’ largest sugar consumer. Sugar production in India, China, and Pakistan fell by a combined 15.9 million tons (33 percent) between 2007/08 and 2008/09, contributing to an unprecedented decline in global sugar stocks. This decline altered trade flows and led to higher prices around the world. Brazil increased its exports in response to the higher prices and greater returns for sugar, but it could not fully compensate for the production shortfalls elsewhere, particularly since production in Brazil was held stagnant in 2008/09 by weather problems.

Weather played a role in Asia’s decline in production, but policies also influenced the outcome, and global markets were highly susceptible to perceptions about how production would respond to the economic and policy levers affecting output from this region. China, Pakistan, and India together account for over 25 percent of global sugar consumption, a share that has been growing since 2005. India is the largest consumer, with sugar consumption totaling an estimated 23.5 million metric tons in the 2009/10 marketing year, more than twice the projected U.S. consumption of 9.2 million metric tons. China consumes 14.9 million metric tons of sugar and Pakistan, 4.2 million metric tons.

These countries also account for 20 to 30 percent of global sugar production, depending on the year, but are subject to volatile production cycles. Over the past 10 years, Indian sugar production has ranged from 14.1 to 30.8 million metric tons. Production variability has also increased in China and Pakistan over the past 10 years, although the cycles are not as large as in India.

The result of steadily growing consumption but volatile production has been large swings in net trade for the region as these countries, particularly India, shift from net exporter to net importer and back again. The magnitude of these shifts has increased as production cycles have become more exaggerated. Most recently, India switched from a net exporter of 5.8 million metric tons in 2007/08 to a net importer of nearly 4.5 million metric tons in 2009/10, representing about 11 and 9 percent of global trade, respectively.

Asian production is expected to increase 23 percent in 2010/11, and pressures on price due to tight supplies are already beginning to wane. However, continued cyclical production patterns will mean ongoing risks of sudden world sugar price increases, particularly if global demand growth and Brazil’s exchange rate remain strong and if sugarcane for ethanol becomes more lucrative.

Indian sugar policies exacerbate cyclical patterns

While weather is a critical determinant of output patterns, India’s sugar policies are a major factor behind the production cycles among Asian producers. Most notably, price-setting policies for sugarcane and refined sugar often create conflicting incentives for India’s sugarcane producers and sugar mills. The production cycles filter into global markets when excess production leads to large exports or when deficits in production call for heavy imports to meet consumption needs.

Both the central and state Governments of India have policies that affect sugar storage, pricing, and trade. The Indian Agriculture Ministry recommends annual support prices funded by the central Government. State Governments then set a price, known as the State Advised Prices (SAP), which sugar millers pay sugarcane growers for their cane. The Government also regulates the price of sugar for consumers using marketing quotas and centrally managed stocks.

The relationship between changes in SAP levels and harvested area is clear: reductions in SAPs generally correspond with decreases in sugarcane area harvested, while increased SAPs tend to bring more land into production. However, there is a lag in this relationship due to yield patterns that vary over time. In India, a sugarcane plant is typically harvested for 3 years, rather than 5 or 6 as in many producing countries, with the first year of growth providing the highest yields. Production depends not only on sugarcane area harvested but on how much of that area is in its first year of growth.

Acreage responses are typically stronger in the years following a change in the SAP than in the first year. The result is that price signals affect consumers and producers at different times. For example, in 2005/06, the Indian Government began decreasing the SAP for sugar and increasing the support prices for rice and wheat. However, harvested sugar area did not decrease until 2007/08.

These policies, designed to support growers and consumers, have caused financial stress for India’s sugar mills, particularly when sugarcane prices are kept high and sugar prices low. The market factors that affect the cost of sugarcane and the price of refined sugar are not aligned. In surpluses, mills face weakening sugar prices but fixed costs based on the SAP. Mills have to defer or default on payments to sugarcane growers. In response, growers will divert sugarcane to the production of alternative sweeteners, such as khandsari and gur, which are not subject to Government restrictions. When producers divert land away from sugarcane, the loss of production is exacerbated by the decrease in yields that results from fewer first-year plantings. The central Government, in turn, often modifies its trade policies to encourage exports in surplus years and imports in deficit years.

Global price swings affect U.S. sugar market

World raw sugar prices have abated on the prospect of increased global production in both 2009/10 and 2010/11. Brazil is expected to produce 28 percent more sugar in 2010/11, and the Asian countries of India, China, and Pakistan are expected to raise production 30 percent, compared with the low 2008/09 production levels, which should reduce their import demand. Some relief may also come from rising exports out of traditional exporters Thailand and Australia and countries attempting to increase their export potential, such as Colombia.

Although many countries attempt to insulate their domestic markets from dramatic price fluctuations like those in the past 2 years, any country that imports sugar is in some way influenced by global price swings. The U.S., for example, supports domestic prices at or above 20 cents a pound through domestic marketing allotment quotas and through tariff-rate import quotas. The U.S. is still heavily reliant on these imports even though it now imports duty-free sugar from Mexico under the North American Free Trade Agreement. When world sugar prices are close to or above the U.S. base support price, U.S. sugar prices have to be, at minimum, slightly higher than world prices to cover marketing expenses involved with importing tariff-rate quota sugar. Therefore, U.S. sugar prices react to changes in world prices, although not necessarily on a one-to-one basis.

So what are the implications of changing world prices for the United States? World prices appear poised to remain at a higher plateau than in the past. Consistently high prices could undermine the rationale for policies that support domestic producers, as well as lower the opportunity cost of Government support policies. However, volatility in the global market, such as that caused by Asian production cycles, would still leave U.S. sugar producers vulnerable to low prices without the domestic programs currently in place.