Reuters had reported on Wednesday that the government was planning to discourage the diversion of sugar for ethanol production as part of efforts to ensure sufficient supplies of the sweetener in the local market.

Fuel retailers, under current contracts, are permitted to keep their procurement of ethanol derived from B-heavy molasses, a byproduct with higher sucrose levels, the government said.

It would also allow the diversion of 1.04 million metric tons of B-heavy molasses for ethanol production under existing contracts, government officials said.

The moves will help to reduce diversion of around 2.14 million tons of sugar for ethanol-making from cane juice, they said.

An industry official had said on Wednesday the government would allow mills to produce ethanol only from C-heavy molasses, a cane by-product that has hardly any sugar content left in it.

Shares of Indian sugar and ethanol makers such as E.I.D.-Parry, Balrampur Chini Mills, Shree Renuka , Bajaj Hindusthan, and Dwarikesh Sugar closed up to 6% lower on Thursday.

India's fuel retailers buy ethanol from sugar mills to blend with gasoline and pay a higher price for ethanol produced from juice and B-heavy molasses.

Patchy rains in the top sugar cane-growing western state of Maharashtra and southern Karnataka state have raised concerns about this year's sugar output.

The Indian Sugar Mills Association, a producers' body, last month said sugar production is likely to fall 8% to 33.7 million metric tons in the 2023/24 marketing year.

The likely production drop has lifted local sugar prices to their highest levels in nearly 14 years.

(Reporting by Rajendra Jadhav and Mayank Bhardwaj ; Editing by Emelia Sithole-Matarise)

By Mayank Bhardwaj and Rajendra Jadhav