India's import swing raises concerns of a sugar rush

Any day now the sugar market will receive the answer to an eagerly awaited piece of news: is India, the world's largest consumer, going to have to tap the import market this year to compensate for a large drop in domestic production?

If New Delhi gives the green light to overseas purchases, prices are likely to rally, traders say.

Bullish sentiment has already filtered into the market, bringing speculative investors to what is usually a dull market handled by merchant and brokerage houses. New York-based raw sugar futures, the world's benchmark, yesterday rose to a two-month high of 13.05 cents per pound, up 10.5 per cent from the end of last year.

It is not a new market for the speculators. Investors were also attracted to the sweetener last year, with good results: prices rose 9.1 per cent in 2008, one of the few commodities to post an annual increase. Speculators - and some merchants - believe that this year will produce a similar result, as a large drop in Indian sugar production triggers the first annual supply deficit since 2006, when prices hit a 25-year high.

As the world's largest consumer and second largest producer, India's output swings, which move the country back and forth from exporter to importer, are a key factor in the world's sugar market. Sharad Pawar, India's farm minister, said his country's sugar output could drop to 18m tonnes in the 2008-09 season, down 31 per cent from about 26m tonnes a year earlier.

The drop in India's output, together with lower production in Pakistan, Iran and the European Union, will push the world's sugar output to about 158.7m tonnes for the 2008-09 season, which runs from October to September, down from 166.5m tonnes last season, according to the US Department of Agriculture. With global demand at 162.1m tonnes, the market will face its first deficit in three years.

"We need to fill that hole and that is the reason people are bullish," says Jonathan Kingsman, managing director of Lausanne-based sugar consultancy Kingsman.

The bulls believe India's drop in production will force the country back into the import market, pushing raw sugar futures as high as 15 cents per pound.

"The lower crops are already changing the shape of the physical market," says Toby Cohen, director at London-based merchants Czarnikow. "India is now an importer," he says. He also notes that the European Union will see imports of about 3m tonnes as the impact of the sugar reform - which in 2006 sharply lowered domestic prices to reduce the output of heavily subsidised local sugar beet - takes its toll in production.

"These two changes in trade patterns are extremely significant for global sugar prices," Mr Cohen adds. "Sugar prices could be set to rise."

The bulls have a problem, however. New Delhi has yet to approve duty-free sugar imports, although it has said it is considering such a move as soon as this week as the government battles to avoid raising prices ahead of national elections in May. India levies a 60 per cent duty on imported sugar for domestic sale.

But even if India goes ahead, some traders believe that talk of large imports is overblown. David Sadler, head of sugar trading at Sucden Financial, the London-based commodities house, says New Delhi could purchase as little as 200,000 tonnes overseas. "I will not get too excited about India's imports," he says.

Traders believe that if India does not authorise imports soon, prices will fall, potentially testing the 10 cents level. But if the green light arrives, signalling that New Delhi is concerned about domestic supplies, a rally to 15 cents is likely and prices could rise further if the spike attracts the attention of hedge funds.

The bulls face other obstacles. The principal one is the looming record sugar cane crop in central-southern Brazil, which combined with low oil prices could boost the production of sugar at the expense of ethanol.

In recent years, the Brazilian industry has diverted an increasing share of sugar cane towards ethanol production due to strong domestic demand, high oil and ethanol prices and less attractive sugar prices. Approximately 60 per cent of the cane was used for fuel last season. But some traders think that could be partially reversed this year because of low ethanol and oil prices, encouraging sugar cane processors to boost sugar output.

Hussein Allidina, head of commodities research at Morgan Stanley in New York, says low crude oil prices could force the Brazilian government to cut the local price of petrol, further dampening demand for cane-based ethanol.

"That is a risk for sugar prices," Mr Allidina says.

The other obstacle for the bulls is demand. Sugar consumption has been traditionally resilient during economic recessions and Leonardo Bichara, an economist at the International Sugar Organisation in London, predicts consumption will grow again this season by about 2.0-.25 per cent, similar to previous years, bucking the economic crisis. "This is the bullish element," he says.

But as the global economic downturn deepens and income growth slows, the bears' argument that sugar consumption will join other commodities and see a drop in demand is gaining ground. That is likely to act as a restraint on further price increases.