Tamil Nadu Government has decided to impose a 5% VAT on sugar. Industry sources said, already the industry is facing pressure due to competition from the mills in Karnataka, which is flooding Tamil Nadu market, and the increasing the VAT will put further pressure on the mills, as they will not be able to pass on the increase to the customers."The 5% VAT is for sugar of all kinds, that is to say, cane sugar, beet sugar, chemically pure sucrose in solid form and imported sugar of all kind," according to Tamil Nadu Government's go.

Reacting to the increase, industry sources said that in order to compensate the price hike, the companies need to increase the retail price by Rs 1.50, which they will not be able to considering the competition from Karnataka. It may be noted, Karnataka government which had of one% withdrew in November 2013.

They noted, already mills from Karnataka are flooding the Tamil Nadu market and they got price advantage. According to them, per quintal in Tamil Nadu is Rs 3,248 as compared to Rs 3,058.

As per the industry estimates, around 30,000-40,000 tonnes of sugar are coming into Tamil Nadu and this would increase further, due to the State Government's decision to increase VAT.

Mills in the State are already facing issue, due to the drought. Many sugar companies have went to CDR and defaulted payments to farmers.

Production of sugar has come drastically in 2006-07, mills produced 25.73 lakh tonnes of sugars, which has come down to 19.53 lakh tonnes last year and in the last season the production came down further to 14.73 lakh tonnes, said industry sources.

"Profitability of sugar mills based in Uttar Pradesh and Tamil Nadu has been affected due to the high cane costs and lower recovery rates when compared to other regions across the country," according to ICRA's report.

The report said, domestic sugar production has reported a decline of 3.5% during seven months (SY1)14 to 23.7 million MT from 24.6 million MT during the corresponding period last year. This decline was driven mainly by a decline in the cane crushing in key producing states - Uttar Pradesh (UP) on account of lower yields and higher diversion of cane crop to alternate sweeteners due to delay in commencement of cane crushing; Maharashtra on account of previous year drought; and Tamil Nadu due to continuing drought conditions.

Decline in Tamil Nadu was worst, according to ICRA. UP reported a decline in sugar production by 14.3%, Maharashtra by 4.1% and Tamil Nadu by 30% YoY during seven months SY14. However, Karnataka reported an increase in the sugar production by 22.6% on account of favourable monsoons.

Notwithstanding the decline, domestic production during SY14 is expected to marginally outstrip domestic consumption for fourth year in a row. Delayed monsoons and lower than expected rainfall during 2014 is likely to adversely impact the cane yields and recovery rates resulting in a decline in the cane availability and hence sugar production during SY15.

Industry sources said, sugar season 2014-15 sugar mills in Tamil Nadu face the double whammy under the continued onslaught of drought. On the one hand, sugar production in the State has fallen by about 50% in a matter of just two years leading to gross under- recovery of fixed costs. On the other, the neighbouring States of Karnataka and Maharashtra benefited by benevolent rainfall and bolstered sugar recovery would be able to sustain and further step up their sugar production.

Necessarily their surplus would be flowing into our markets, dampening the scope for rebound in local prices.