Efficiency and integration in the Zambian sugar market: analysing price transmission, price formation and policy

Zambia ranks as one of the lowest cost producers of sugar. However, Zambia‟s domestic sugar price has been high and volatile and is substantially higher than the world price. This has raised concern among stakeholders and further raises questions about the efficient functioning of the market. The study sought to determine and explain efficiency and integration in Zambia‟s sugar value chain by analysing price spreads, price formation, and price transmission through a price transmission and partial equilibrium model. The study hypothesised that the Zambian sugar market is both inefficient and it is not integrated with the world market. This was tested through the price transmission and partial equilibrium models. Price transmission is conceptually premised on the Law of One Price (LOP) which postulates that in a frictionless undistorted market, the difference between markets spatially separated should only be explained by transaction costs. To test the hypothesis long-run equilibrium between prices was tested through a series of cointegration tests and an Error Correction model (ECM) was built for cointegrating price series. Model simulations were run and tests for asymmetry for cointegrating price series were conducted. A partial equilibrium framework was developed to determine price formation for Zambia‟s sugar market from a number of behavioural equations. - v - The study establishes cointegration in the spatial price transmission (between world sugar prices and Zambia‟s wholesale prices) and vertically (between the domestic wholesale prices and sugarcane prices). The ECM for the spatial price transmission reveals low integration and efficiency evidenced by the low speed of adjustment, the Error Correction Term (ECT) of -0.09 and the model simulation, which shows that it takes approximately 3 years for the markets to revert to long run equilibrium after experiencing a price shock. The study also establishes that the spatial price adjustment is asymmetric. The vertical price transmission analysis reveals that it is relatively more integrated and efficient as it has a higher speed of adjustment (ECT of 0.199) which is twice that of the spatial price transmission. The model simulation reveals that it takes about 1 year and 6 months to revert to long run equilibrium after experiencing a shock. The vertical price adjustment is also found to be symmetric. A negative short-run elasticity of -0.29 is found for the spatial price transmission while the long-run transmission is found to be inelastic (0.91 ) which is close to unitary elasticity. The short-run vertical transmission is found to be very inelastic (0.009 ) while the long-run transmission of 0.94 is similar to the spatial transmission (inelastic but close to unitary). Farm to Retail Price Spreads are found to be widening with growing volatility owing to the volatile nature of the Retail Value. While the Farm Value has been increasing, recent spikes experienced in the Retail Value have resulted in an overall widening of the Farm to Retail Price Spread. The partial equilibrium analysis indicates that the price formation in Zambia‟s sugar market is determined by the world price through the export parity price, domestic demand, supply conditions as well as policy. The elasticity between Zambia‟s sugar price and the export parity price is found to be unitary (1.09). The price space analysis reveals that although Zambia‟s domestic price is correlated with the export parity prices it is trending closer to the import parity price. This suggests that there are distortions in the sugar market, which may include high transaction costs, high concentration in the market structure as well as inappropriate policies such as high taxation, high interest rates and a policy requiring fortification of all sugar with Vitamin A, which are driving the domestic price upwards to exceed the export parity price. The sugar baseline for Zambia is generated for 2012 to 2015 based on a number of assumptions in the exogenous variables. - vi - Sugar production domestic use and exports are on the rise while the domestic price rises in 2011, falling between 2013 and 2014 then rising in 2014 to 2015. Model simulation of the removal and/or modification of the policy requiring sugar fortification reveals that there is an increase in the flow of imports to about 25,000 tons per year. This results in a 3.2 per cent loss in production and a 6.1 per cent gain in exports while the domestic sugar price falls by 23.9 US Cents/kg (18.8 per cent). Thus Zambia gains in terms of increased consumer welfare and producer welfare because production losses are offset by revenue gains through exports since the world price also increases. The study recommends that transaction costs which include transportation costs, energy, taxation which are pushing the domestic price upwards need to be lowered. The study emphasises the need to promote investments in the sugar industry especially for smaller emerging sugar mills by lowering interest rates and taxes as well as a need to strengthen competition laws governing the industry which will protect consumers,would-be- investors and cane producers from uncompetitive pricing. It further recommends the lifting and /or modification of the barrier on imports of unfortified sugar but stresses that government can allow raw sugar imports which can be fortified in Zambia. A more open and undistorted sugar market in Zambia will result in a competitive, efficient and integrated market governed by market dynamics. MSc. Agric (Agricultural Economics) Department: Agricultural Economics, Extension and Rural Development. Degree Supervisor : Dr Ferdinand Meyer