On the 8th April 2016, the National Treasury released a statement which notified industry and other interested stakeholders of a review on the variable tariff formula for wheat, maize and sugar. The expectation was that, after soliciting for public comments, National Treasury would consider them and finalise the review process by the end of 2016, the conclusion of which would lead to necessary recommendations to the variable tariff formula in general, and the wheat duty in particular.
However, on the 23rd December 2016, National Treasury released another statement to inform interested parties that the review process would be extended up to the end of March 2017. It is now May 2017, and there is still no word from National Treasury regarding the conclusion and outcome of the review process.
This has obviously gotten the industry anxious, adding a degree of needless uncertainty to markets. What makes the tariff review process particularly tricky is the divergent views from different stakeholders in the sugar and wheat markets.
A Wheat Industry Perspective
The level of protection for wheat is determined by the difference between the world reference price and the 3-week moving average of the Chicago Board of Trade (CBOT) price, calculated on a weekly basis. When this deviation amounts to more than US$10 per ton for 3 consecutive weeks, a new duty is calculated and a new reference price is set.
The wheat industry has been concerned by the uncertainty that tariff adjustments bring to markets. While the wheat tariff remained unchanged for four years at null between August 2010 and October 2014, it has changed eight times between October 2014 and March 2017.
While farmers are content with the variable formula, traders are concerned that the tariff formula is exposed to currency risk, which has been particularly severe due to the volatility of the ZAR to US$ exchange rate.
Moreover, it takes about six to eight weeks for the tariff adjustment to occur – the lag period between the time the tariff adjustment conditions are met, and the time when a tariff change is effected by law. The average six to eight-week delay in the trigger causes a decline in volumes traded on the South African Futures Exchange (SAFEX). Industry experts point out that this decline in traded volumes on the market leads to a significant depletion in liquidity by a factor of 30%.
Meanwhile, data over the period October 2014 and January 2017 shows that, South Africa’s wheat imports during the “delay months” (320 910 tons) are three times the overall average imports of the other months (120 760 tons). This could be an indication of “stock-piling” by traders seeking to avoid tariff hikes.
An additional effect of the delay is that, in the past, the timing of the trigger was sometimes overtaken by events in the market, such that tariffs decline (increase) when current market conditions suggest that it should increase (decline). In this sense, the variable tariff model can be, at times, counter-intuitive because the slow trigger mechanism works against fast-paced and quick changing market conditions.
A Sugar Industry Perspective
The level of protection for sugar is determined by the difference between the world reference price (the London No.5 Settlement Price) and the 20-trading-day moving average of the London No.5 settlement price, calculated on a daily basis. When this difference amounts to more than US$20 per ton for 20 consecutive trading days, a new duty is calculated and a new reference price is set.
The sugar tariff has changed 12 times over a 36-month period – between April 2014 and May 2017 (see Chart 2). After the sugar tariff peaked to R3 040 per ton between October 2015 to November 2015, the tariff declined to zero in February 2017. This was the first time the tariff had reached null since April 2014. But since March 2017, the sugar tariff has been R63.63 per ton.
Like the wheat industry, sugar producers (cane producers and processors) do not have a problem with the existing tariff model. Although they are content with the overall framework of variable tariff formula itself, they hold a few reservations relating to specific variables used to calculate the tariff.
The dollar-based reference price calculation in the formula was based on a distortion factor of 7%, and this was drawn from a 2013 report by Patrick H. Chartenay. Some industry players believe that this 7% distortion factor was not appropriately quoted, as the true level of distortion – which captured both direct and indirect support in the Brazilian market for both ethanol and sugar markets – was in the order of 22%. As such, the dollar based reference price under-stated the true level of global market price distortion.
Sugar market stakeholders further argue that, the variable tariff formula does not contain an inflation adjustment factor, which would ideally capture the rising cost of production inputs. While one might argue that the exchange rate could be a proxy for an inflation adjustment, it is largely exogenous and its volatility present considerable risk.
With sugar producers and processors generally in favour of the variable tariff model, traders remain skeptical for the same reasons that wheat traders have. After peaking to 720 000 tons in the 2013/14 season, sugar imports declined by 24% in the 2014/15 season to 544 000 tons as the tariff increased from null to an annual average of R1 390 per ton. Imports fell further by 15% in the 2015/16 season to 462 000 tons as the tariff increased by a futher 80% to an annual average of R2 508 per ton.
Like in the wheat sector, a series of tariff hikes between April 2014 and October 2015 saw a peculiar trend of peaking sugar imports just before tariff hikes. There is evidence of traders stock-piling non-SACU originating sugar imports which are affected by higher tariffs.
The discussion above reveals two diametrically opposite views related to the variable tariff formula. One the one hand, traders generally favor the a departure from the variable tariff formula. Traders in the wheat market suggest that the it would be ideal to ditch the less predictable “complex variable” tariff formula for a more predictable much “simpler constant” ad valorem tariff. Further arguments to support this view suggest that such an ad valorem tariff could be adjusted every three to five years to reflect the most recent structural market conditions, and should also incorporate an appropriate distortion factor.
On the other hand, traders from both the sugar and wheat industry seem to favour the current structure of the variable tariff formula. Sugar producers have reservations on the variables contained in the formula, namely the selection of an appropriate distortion factor, as well as the need to incorporate an additional inflation adjustment factor, as previously discussed.
Traders, however, prefer to see a more predictable and certain tariff mechanism. Tariff hikes have significant implications on trader’s sourcing decisions. What makes it even more difficult is that the dates on which regulators decide to effect tariff hikes is never known until the day they are published through the Government Gazette. As a result, there are instances in which tariff changes occur when shipments are already in transit, which is problematic.
The divergent views between producers and traders in the sugar and wheat markets present an interesting dilemma for the National Treasury, especially given that both divergent arguments have merit.