Technical Efficiency, Capacity Utilization and Total Factor Productivity Growth in Indian Sugar Industry

CHAPTER 10
SUMMARY, CONCLUSIONS AND
RELAVANT POLICY IMPLICATIONS

In developing country like India, being the major agro-based industry, the sugar industry
facilitates the process of resource mobilization, employment generation (both direct and
indirect), income creation, and development of social and physical infrastructure. Recognizing its
importance in the rural economy, the policy makers recognized that the expansion of sugar
industry can tackle a large number of economic tribulations that are present in rural India. India
is world’s largest consumer of sugar and also second largest producer next to Brazil. At present,
453 (out of the total of 568) sugar firms are operating in India and the installed capacity of these
mills is ranging between below 1,250 tonnes crushed per day (TCD) of sugarcane and 10,000
TCD. These mills provide direct employment to 0.5 million skilled and unskilled workers and
engage 55 million peoples directly or indirectly in sugarcane cultivation, harvesting and ancillary
activities. The industry also contributes Rs. 25 billion annually to the center and state exchequer
in the form of taxes (ISMA, 2004). Further, with its potential to generate 5000 mega watt (MW)
surplus power through the process of cogeneration, the industry can ease the energy crisis of
Indian economy. In addition, the production of ethanol using molasses (the byproduct of sugar)
and blending it with petrol can also help to cut a fraction of rising balance of payments (BOPs)
deficit due to mounting imports bill for petroleum products.
Nevertheless, the statistics provided by Standing Committee on Food, Civil Supply and
Public Distribution (2003) explicitly describe the appalling status of the health of Indian sugar
industry. The Committee pointed out that 76 sugar mills of private and public sectors are sick
and 42 of these mills have remained closed for the last five sugar seasons or more. In addition,
123 cooperative sugar mills have also been observed carrying negative net worth. On the whole,
out of the 568 sugar mills, 199 sugar mills (i.e., 35 percent mills) are found to be running either
with the negative net worth or designated as sick units. It has been well acknowledged by the
industry experts that the dismal performance of sugar industry is the product of both internal and
external environmental factors. The external factors are primarily uncontrollable from
management point of view (like decreasing area under sugarcane cultivation, tight government
regulations in pricing and distribution of sugar, rainfall deficit, etc.) and their effect is almost

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uniform on the overall performance of the sugar industry. However, the internal factors which
are largely controllable in nature (like low level of capacity utilization, inefficient use of inputs,
labour unrest, and managerial underperformance etc.) also contribute to a dismal performance of
the sugar industry, but their effect varies from one sugar mill to another.
It has been felt by the government appointed committees and industry experts that an
improvement in the health of the Indian sugar industry is possible only through the efficient
operations of sugar firms with minimum wastage of key resources and almost zero excess
capacity. Against this background, any attempt to monitor the health of Indian sugar industry in
terms of productivity, efficiency and capacity utilization improvement over time would surely
help to understand the dynamics of growth and performance of the industry and shock absorptive
capacity of the industry against the odds like price spiraling in the global and domestic markets
and stiff government regulations. It is well acknowledged fact in the literature that the
implementation of the efficient production operations given the existing state of technology
ensures higher levels of total factor productivity (TFP). If the technology is not progressing in an
industry, improving the technical efficiency of the firms is usually a more cost effective and
desirable pursuit to experience TFP growth. On the other hand, if firms are reasonably
technically efficient then an increase in TFP requires shifting the production function upward so
as to attain a decent output growth. Given the dismal performance of Indian sugar industry in the
recent years, it is pertinent to know i) whether Indian sugar firms are efficiently using the
resources or not; ii) whether TFP is growing or not; and iii) whether excess capacity is reducing
or not. In the present study an attempt has been made in this direction. The major objectives of
the present study are outlined as follows:
1) To examine the inter-temporal and inter-state variations in capacity utilization of sugar
industry;
2) Measuring the extent of technical inefficiency in Indian sugar industry;
3) Identification of the sources of technical inefficiency in Indian sugar industry at
aggregated and disaggregated (state) levels;
4) Decomposing the sources of output growth in Indian sugar industry;
5) Testing of convergence in growth and efficiency levels in Indian sugar industry; and
6) Examining the macroeconomic nexus between the growth of sugar industry and
economic growth in 12 major sugar producing states;

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In order to present the findings of the study in a lucid style the entire study has been
organized into ten chapters. The Chapter 1 is introductory in nature and discusses the importance
and structure of the sugar industry of India. A thorough discussion regarding the development of
sugar industry during the plan periods depicts that India is the world’s largest sugar consumer,
second largest producer-next to Brazil, and remained the net exporter of the sugar during the
planning era. The analysis of the importance of the major byproducts of sugar reflects that with
its potential to generate 5000MW surplus power through the process of cogeneration, the
industry can ease the energy crisis of Indian economy. The diversification of the production
operations towards the production of ethanol using molasses (the byproduct of sugar) and
blending it with petrol can also help to cut a fraction of rising balance of payments (BOP) deficit
due to mounting imports bill for petroleum products. Moreover, the rationale of conducting the
present study has also been discussed along with the objectives and the null hypotheses to be
tested.
The Chapter 2 provides a theoretical framework of measuring technical efficiency. Both
parametric and non-parametric techniques of measuring technical efficiency have been discussed
in detail along with the pros and cons of each technique. Further, the techniques of stochastic
data envelopment analysis (SDEA) and DEA bootstrapping have been discussed to marry the
virtues of both DEA and stochastic frontier analysis (SFA) techniques. It has been observed that
DEA bootstrapping techniques are most superior to all other indigenous techniques and best
suited for the data sets to be utilized for the present study purpose.
In Chapter 3, the importance and methods to measure TFP growth have been discussed.
A survey of all the available techniques reveals that Malmquist productivity index enables the
researchers to decompose the TFP growth into efficiency change and technical progress. Further,
the component of efficiency change can be decomposed into pure efficiency change and scale
efficiency change together with the decomposition of technical progress into Hicks neutral and
non-neutral types of technical progress. The bootstrapping techniques given by Simar and
Wilson (1999) have also been discussed to check the significance of productivity scores.
The methods of measuring capacity utilization have been discussed in Chapter 4. The
theoretical survey of various methods provide that the existing literature on measuring CU spells
out two competing approaches to measure CU levels: i) engineering methods to measure CU;
and ii) economist’s approach to measure of CU. The engineering method is superior to the

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economists’ measure because of its feature to determine CU levels without the information on
input prices. Moreover, the literature supports the fact that when the cost curves are L-shaped in
nature (as empirically supported in Microeconomics text books), the engineering measure
approximate the economists’ measure of CU (Johanston, 1960). Thus, the engineering measure
of CU using the technique of DEA has been preferred for analyzing the inter-temporal and inter-
state variations in CU of Indian sugar industry at aggregated and disaggregated levels.
A detailed review of the literature on measuring capacity utilization, technical efficiency,
and TFP growth of Indian manufacturing as well as of Indian sugar industry has been provided in
Chapter 5. It has been observed that several Indian researchers have endeavored to estimate the
capacity utilization (CU) in Indian manufacturing at different levels of aggregations. Some of
these attempts examined the CU trends in Indian manufacturing at highly aggregated level
covering the given industry or All-India’s manufacturing sector [see e.g., Gulati (1959), Budhin
and Paul (1961), NCAER (1966), Koti (1968), RBI (1968), Divetia and Verma (1970), RBI
(1972), Paul (1974a), Karim and Bhinde (1975), Seth (1986), Azeez (2002)], some of the studies
analyzed trends in CU for an individual industry [see e.g., Nag (1961), Commerce Research
Bureau (1968), Sandesara (1969), Gupta and Thavaraj (1975), Sastry (1980), Bhanu (2006)],
Amongst all these, the study by Bose (1964) is an attempt to examine CU variations at regional
level. However, the literature on measuring technical efficiency has also been classified among
three categories. Some analyzing technical efficiency of single industry [see e.g., Subramaniyan
(1982), Jha and Sahni (1993), Majumdar (1994), Ferrantino and Ferrier (1995), Ferrantino et al.
(1995), Ferrantino and Ferrier (1996), Kumar and Pillai (1996), Murty et al. (2006), Singh
(2006a), Singh (2006b), Singh (2007), Singh et al. (2007)], some for group of industries at
highly aggregated level [see e.g., Goldar (1985), Nath (1996), Aggarwal (2001a), Aggarwal
(2001b), Parmeswarn (2002), Ray (2002), Goldar, et al. (2004), Ray (2004), Nikaido (2005),
Kambhampati (2006), Mahambare and Balasubramanyam (2005), Kumar and Arora (2007),
Kumar and Arora (2007)], and some other analyzing efficiency at regional levels [see e.g., Neogi
and Ghosh (1994), Gajanan (1995), Mitra (1999), Kumar (2000), Rajesh and Duraisamy (2002)].
Among all of these studies, some of the aforementioned research attempts have been made
corresponding to the evaluation of technical efficiency of Indian sugar industry in general [see
e.g., Subramaniya (1982), Jha and Sahni (1993), Ferrantino et al. (1995), Ferrantino and Ferrier
(1995), Ferrantino and Ferrier (1996), and Murty et al. (2006)] or of sugar industry of an

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individual state in particular [see e.g., Singh (2006a), Singh (2006b), Singh (2007), Singh et al.
(2007)]. However, a thorough analysis of the literature on measuring the TFP growth represents
some of the studies on measuring TFP at highly aggregated levels [see e.g., Neogi and Ghosh
(1998), Pradhan and Barik (1999), Singh (2000-01), Goldar and Kumari (2003)], at single
industry level [see e.g., Beri (1962), Sastry (1966), Mehta (1974), Gupta and Patel (1976), Singh
and Singh (1984), Dawar (1990), Sharma and Upadhayay (2003-04), Singh and Agarwal (2006),
Singh (2006c)], and at regional levels [see e.g., Singh (1964), Ray (1997), Mitra (1999), Ray
(2002), Kumar (2003), Chattopadhyay (2004), Kumar and Arora (2009)]. Thus, the analysis of
the existing literature reveals that still there exist a void on measuring the inter-temporal and
inter-state variations in CU, technical efficiency and TFP growth in Indian sugar industry in
general and sugar industry of 12 major sugar producing states in particular. The present study is
an attempt in this direction and tries to fill up the already existing void in the literature.
The empirical evidences regarding the inter-temporal and inter-state variations in CU
have been given in Chapter 6. A non-parametric model developed by Färe et al. (1989) has been
applied to attain the capacity utilization levels for the Indian sugar industry and sugar industry of
12 major sugar producing states. The major findings of the empirical analysis are:
1) The average amount of excess capacity (EC) in Indian sugar industry is about 13 percent
in the each year of the study period;
2) Excess capacity increased significantly by about 15 percent in the post-reforms period
(1991/92 to 2004/05) relative to the pre-reforms period (1974/75 to 1990/91);
3) Except two states, namely, Maharashtra and Karnataka, EC levels are found to be above
All-India level in remaining 10 states;
4) Barring the sugar industry of Rajasthan, an increase in the EC levels of remaining 11
sugar producing states have been observed during the post-reforms period in comparison
of the pre-reforms period;
5) Except the states of Gujarat and Rajasthan, decline in CU is statistically significant for
the remaining 10 sugar producing states and sugar industry of all-India;
6) The CU levels followed a path of deceleration (as ascertained by negative growth rates)
during the entire study period and the deceleration become more noticeable during the
post-reforms period;

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7) To operate on full capacity level, 46.04 percent of more intermediate inputs and 195.8
percent of more labour are needed, which indicates that, reaching at full capacity would
surely increase the employment in the industry;
8) Except the states of Karnataka and Rajasthan, each state has exhibited an increase in
potential intermediate inputs requirement during the post-reforms period as compare to
the pre-reforms period;
9) The potential labour requirement has increased for all states during the post-reforms
period;
10) The impact of environmental variable (K/L) on CU is negative and significant. Therefore,
an increase in capital-intensity found to be adding up the existing excess capacity levels
in the industry; and
11) The availability of raw material is a major determinant of capacity utilization.
In the light of aforementioned results, we reject the hypothesis of optimum capacity utilization in
Indian sugar industry at both national and state levels. Among the factors causing CU, shortage
of raw material has been identified as the major factor causing underutilization of capacity.
In Chapter 7, attempt has been made to analyze the inter-temporal and inter-state
variations in overall technical, pure technical and scale efficiency. Two DEA models CCR and
BCC with boot-strapping have been applied to attain the technical efficiency levels in Indian
sugar industry. Following are the major findings of the efficiency analysis:
1) A high average overall technical inefficiency (OTIE) to the tune of 35.55 percent has
been observed for Indian sugar industry;
2) Above 80 percent of the OTIE has been contributed by managerial sub-performance i.e.,
30.75 percentage points of 35.55 percent OTIE has been explained by pure technical
inefficiency (PTIE). Thus, managerial inefficiency is dominant and statistically
significant source and scale inefficiency is relatively scant and statistically insignificant
source of technical inefficiency in Indian sugar industry;
3) Dominance of managerial inefficiency (i.e., PTIE) is a countrywide phenomenon and not
limited to a particular state;
4) The economic reforms have found to be worsening technical efficiency levels in Indian
sugar industry and sugar industry of 12 major sugar producing states;

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5) The phenomenon of technical efficiency convergence found to be present during the pre-
reforms period, which goes disappear during the post-reforms period. Moreover, the TE
convergence hypothesis cannot be rejected for the entire study period too;
6) The panel data Tobit regression analysis about factors causing technical efficiency
reveals that the environmental variable SKILL is causing all the three measures of
technical efficiency positively and significantly. However, the variable RETURN is
although affecting the three measures of efficiency positively, yet its impact on scale
efficiency measure is statistically insignificant; and
7) The proxy variable of capital intensity i.e., (K/L) bears a negative and statistically
significant impact on three measures of efficiency. Such a negative impact of (K/L) is
despite of already existing excess capacity in the sugar industry of India.
The results, thus, illustrate an average inefficiency to the tune of 35.55 percent, which is high by
all standards and observed to be primarily caused by the managerial inefficiency. Also, the
hypothesis of efficiency catch-up has been completely rejected for the post-reforms period
whereas, for the pre-reforms period and entire study period, catching-up do exist in Indian sugar
industry. The lack of the skilled manpower and low profitability have been observed the major
factors responsible for rising technical inefficiency in Indian sugar industry.
Using the growth accounting framework, the Chapter 8 presents the decomposition of
output growth in two mutually exclusive components viz., inputs growth and TFP growth. The
non-parametric DEA based Malmquist productivity index has been operationalized to
decompose TFP growth into two mutually exclusive components viz., efficiency change and
technological progress. The efficiency change has further been bifurcated into pure efficiency
change and scale efficiency change whereas, the technical progress has been decomposed into
Hicks neutral and non-neutral types of technical progress. The following are the major outcomes
of the TFP analysis:
1) Output in Indian sugar industry has grown at the rate of 1.838 percent per annum;
2) The inspiration component i.e., TFP in Indian sugar industry has recorded a growth rate
to the tune of 2.43 percent per annum;
3) A negative growth of perspiration component i.e., factor accumulation has been noticed
to the tune of -0.592 percent;

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4) Thus, the analysis reveals that factor accumulation has restricted the Indian sugar
industry to achieve potential growth rates of output. If we assume that input growth is
zero, the industry must have grown at the potential growth rate equal to the TFP growth
of 2.43 percent. Nevertheless, if the inputs growth becomes positive, the industry can
record much higher growth rates of sugar output;
5) TFP is primarily attributable to efficiency change in general and managerial efficiency
change (PECH) in particular during entire period;
6) The decline in the growth rate of managerial efficiency during the post-reforms period
has been observed to be the major cause of sluggishness in TFP growth during the post-
reforms period;
7) During the post-reforms period technical progress is positive relative to a technical
regress for pre-reforms period. It is worth mentioning here that the negative technical
progress during the pre-reforms period seems to be the results of stiff and regulatory
environment imposed upon the industry during the pre-reforms period. Under adverse
environmental conditions, even the most efficient firms may face trouble in transforming
inputs into outputs at the rate to which they had previously been accustomed. Despite of
it, the observed level of best-practice technology may deteriorate, as reflected by a
downward shift of the industry’s production frontier (Ferrantino and Ferrier, 1996). This
technical regress is a different phenomenon from a decrease in efficiency as it also affects
the most efficient firms. Indeed, the measured efficiency level of the inefficient firms
may improve during the period of adversity due to the ‘regress’ of the most efficient
firms i.e., the frontier may move closer to the inefficient firms rather than the inefficient
firms moving closer to the frontier;
8) The nature of technical progress is Hicks neutral in nature;
9) The test of output growth convergence hypothesis completely rules out the existence of
catching-up or learning by doings process; and
10) The five out of 12 sugar producing states are found to be forming the convergence club.
The affiliates of convergence club are Gujarat, Haryana, Madhya Pradesh, Orissa, and
Rajasthan.
It is evident from above results that a regress in inputs (i.e., negative inputs growth) restricts the
potential output growth in Indian sugar industry. Thus, the null hypothesis that the inputs growth

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is positively contributing output growth is liable to be rejected. However, the null hypothesis of
the significant TFP growth cannot be rejected. The TFP growth in Indian sugar industry has been
found to be dominated by efficiency change in pre-reforms period and by technical progress
during the post-reforms period. Further, most of the output growth during the post-reforms
period is contributed by the Hicks neutral type of technical progress.
In Chapter 9, the long-run relationship between growth of sugar industry and levels of
economic growth in 12 major sugar producing states has been explored using the panel-data
cointegration analysis. The main observations of this chapter are:
1) There exists a significant long run nexus between the growth of sugar industry and
economic growth of the 12 sugar producing states of India;
2) Any increase in sugar output speed up the economic growth of the 12 major sugar
producing states;
3) The cointegration analysis about the importance of the each determinant of output growth
reflects that input growth is the most important and significant factor causing output
growth in long-run whereas, the impulse response analysis also reveals its importance in
short run; and
4) The panel data VECM based Granger causality analysis reveals that there exists
bidirectional relationship between output growth and inputs growth. The direct
connotation of this fact is that if the improvement of sugar industry requires the
substantial inputs growth then the inputs growth also calls for a substantial growth of the
sugar industry.
Therefore, a significant long-run sugar output elasticity of economic growth calls for an urgent
need of improving the health of Indian sugar industry. However, the input growth has been found
to be the most effective policy variable, both for long-run and short-run, to improve the growth
performance of Indian sugar industry.
In the present concluding Chapter 10, the findings of the study have been summarized and
the major policy implications of the study have been highlighted. The following suggestions
have been put forward on the basis of derived policy implications:
1) Attempts must be taken to enhance the productivity and quality (in terms of sucrose
contents) in sugarcane production at farm level. The following policy package can help
the farmers to improve the sugarcane productivity and its quality:

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a) Scientific techniques such as tissue culture farming, etc. must be followed;

b) Recommendations of Mahajan Committee regarding cane area reservation and cane
supply arrangement must be implemented properly (see, Indian Sugar Year Book,
2005/06 for detailed recommendations);
c) Proper irrigation facilities are needed to avoid the impact of rain shortfall on the
sugarcane quality;
d) Timely transportation and crushing of sugarcane is required to attain the maximum
possible sugar recovery from the sugarcane;
e) Contract farming must be encouraged and the contracts between the sugar firms and
the farmers must be for the long-run;
f) Although being less remunerative for sugar firms, statuary minimum price (SMP)
requires continuous upward revision for inducing the farmers to diversify their
production operations towards the production of sugarcane from the production of
indigenous crops wheat and rice;
g) Decisions of government to announce SMP before the start of sowing season should
be rigidly followed;
h) The sugar development funds (SDFs) can be utilized to pay the mounting arrears of
sugarcane payments; and
i) More research and development (R&D) on improving the productivity and quality of
sugarcane is required.
2) To improve the overall technical efficiency, sugar firms are required to improve their
managerial practices. As suggested by the Mahajan Committee (1997) that cooperative
sugar firms are not independent to take quick decision, despite of which the managerial
irregularities have been observed in the operations of these firms. Thus, these firms are
needed to pay back the state equity and provide full autonomy to the managers of these
firms.
3) To mitigate or reduce the extent of technical inefficiency, an improvement in the policy
variable RETURN (a measure of profitability) is mandatory. However, to improve the
profitability of the sugar firms, the following policy measures are recommended:
a) There must be a provision of sanctioning short-term loans from the sugar
development fund (SDF)1 for repaying the mounting arrears of sugarcane. These

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short term loans must be mandatory to be repaid in between one sugar year either
through installments or by lump sum payments;
b) The government must purchase the sugar for the levy quota at market prices and
support the public distribution system (PDS) through properly targeted subsidies;
and
c) Easy credit must be available for the rehabilitation of the sugar firms.
4) Diversification of sugar production towards the byproducts of sugar is necessary to
improve the profitability of the sugar firms. The following recommendations of the
High powered committee (Mahajan committee) must be followed:
a) Molasses is a major byproduct of the sugar industry. The estimated sale realization
from molasses by sugar factory is a part of yearly cash inflows of the project. Thus,
sugar firms must diversify their operations towards production of ethanol using
molasses via installing refineries. The ethanol can be sold to the petroleum
companies to execute 10 percent blending program;
b) Sugar firms must install the required machinery to generate and distribute steam
power (i.e., electricity) using bagasse, etc. With the installation of high pressure
boilers with high degree of efficiency, steam consumption in process must be
reduced leading to saving bagasse and the remaining bagasse can be sold to the
industries using it as raw material. Paper industry is one of the industries which can
utilize the bagasse to make paper from it; and
c) The production of bio-fertilizer through mix of spent wash of the distillery with
press mud from sugar mills must be encourage and farmers must be induced to use
such bio-fertilizer. The use of bio-fertilizer is more environment friendly as it
requires less use of water.
5) There is no need to increase the size of production, as the returns-to-scale in all the 12
major sugar producing states don’t found to be significantly different from constant
returns-to-scale (i.e., scale efficiency don’t differ significantly from unity). The need is,
therefore, to utilize existing plant and machinery up to its optimum extent.
6) TFP growth is substantial and statistically significant. However, to achieve the
maximum potential growth of output, a positive inputs growth especially of sugarcane

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is required. Thus, the steps given in the first policy implication must be followed to
improve the inputs growth.
In sum, because of inadequate supply of cane and excessive intervention of the government in
fixing the price for both sugar and sugarcane, most of the sugar mills are not operating at full
capacity and exhibiting considerable waste of resources. Further, low levels of profitability and
low sugar recovery from sugarcane add up to the excess capacity and inefficiency in the industry.
Besides this, the licensing policy system followed by the government until 1998 did not permit
the capacity expansion of the existing mills and thus, restricted them to avail economies of scale.
Even after the adoption of delicensing policy of September 1998, the industry is operating under
tightly regulated environment and carries a huge stock of underutilized capital or capacity. The
stiff government control over the sugar firms’ operations hinders their techno-economic
feasibilities and restricts them to expand their capacity per unit. Contrary to this, sugar industry
all over the world has been consolidating and moving towards larger capacity per unit. The
constraints on the capacity expansion and decisions of the government regarding the purchase of
sugar for maintaining buffer stocks and allowing the exports of sugar, further, restrict the sugar
firms to operate on efficiency frontier and limit the growth (i.e., output growth and TFP growth)
of sugar industry.

***************

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ENDNOTES

1
Sugar development fund (SDF) set up under SDF Act, 1982 is funded by transfer of proceeds of sugar cess levied
(Rs.14/-per quintal) and collected under sugar cess act, 1982, on sugar produced in the country. The fund provides
for sanctioning loans to sugar undertakings for rehabilitation of plant and machinery. The fund also provides for
payments of grants to established institutions connected with sugar industry for carrying out research.

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