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February 14, 2014

Reforming the dairy industry

As per capita consumption of milk increases, it will require the creation of new institutional structures and priorities to protect against runaway inflation.

milk industry

Inflation in the price of milk in recent years has been sharp and surprising. It has been persistent now for some time. The questions to ask are Why? What can be done? and Why is it important? Before we answer these, here is some background. India is the world’s largest milk producer, accounting for 16 percent of global production. It is also the world’s largest consumer of dairy products, consuming almost all of its production. Dairy products are a major source of protein for a population that practices wide spread vegetarianism.  Culturally, the Indian diet has a special place for dairy products.

India is estimated to produce 137 million tonnes of milk in 2013-14. Milk production has grown at an annual rate of about 4.2 percent over the last 20 years. This increase of 4.2 percent comes largely from the increase in the number of animals and only to a limited extent from productivity increases. However given the robust increase in production, the per capita availability of milk has bucked the international trend and increased at a 2 percent CAGR from 178 gms/day to 290 gms/day over this 20 year period. This aggregate number masks a wide range in per capita milk availability in states that ranges from a low of well under 100 gms/day in North Eastern states to 930 gms/day in Punjab.

Globally, the dairy sector is one of the most distorted agriculture sectors. Producer subsidies are in place in many developed countries encouraging surplus production. Export subsidies are paid to place this surplus on world markets and tariff and non-tariff barriers are erected to protect domestic producers from ‘unfair’ competition.  The European Union (EU) alone spends about Euro 20 billion each year on dairy subsidies.  Despite this, the dairy sector is a very localised business because it is a bulky and perishable product. Only 7 percent of the global annual milk production of 800 million tonnes is traded.

Animals are fed either by cereals (US, Japan), on grasslands (Australia, Argentina, New Zealand) or by crop residue (India). The ratio of productivity between these three types is about 6:3:1, that is an animal fed by cereals on average produces six times the yield of an animal fed on crop residue. However, grasslands and crop residue are a far more environmentally sustainable ways of maintaining large dairy animal populations.

Operation Flood from 1970 to 1996 revolutionised milk production in India. It transformed India from being a milk deficient country to the largest milk producer in the world. The foundation of Operation Flood was to organise milk producers into co-operatives, increase milk production, augment rural incomes and provide fair prices to consumers. Technical inputs on animal husbandry, breeding, rearing, animal feed and disease control were made widely available. The result was literally a flood. From deficiency to self-sufficiency, the supply and demand of milk was nurtured and managed.  Thereafter, steady growth at steady and affordable prices was the magnificent result.

Returning to the questions at hand.  In the last few years, dairy products (particularly milk) have been one the main contributors to inflation in India. Vegetable, fruits, cereals, eggs, fish, meat and milk have had double-digit inflation over the last year ending in December 2013. Milk is among the largest components of the food consumption basket in India (second only to cereal, whose consumption is dropping among urban households). High inflation combined with a significant weight accounts for a meaningful impact on consumer inflation.

On the face of it, there should not be a significant price rise for dairy because demand and supply have been growing at a roughly 3.5-4 percent rate per year.  Cost of production has indeed gone up, but not to the extent of the observed inflation in retail prices. With rupee depreciation and large domestic supplies, many producers have begun exporting milk powder.  Received international prices have doubled to Rs 250/kg of skimmed milk powder in the last year. In the North, price realised by the dairy farmer has varied from Rs 22 per litre to Rs 32 per litre over the last year. In that time, the price to the consumer has steadily risen. Milk and products processors and other intermediaries are making excess profits.  While processors and their profit motive have played an important role in growing the dairy sector in India, the volatility in prices is being felt by the farmer and the cost of inflation largely borne by the consumer.

The dairy industry in India has grown strongly for a long period of time despite the benign neglect of the dairy industry after the Operation Flood years (some may say this it is because of the Government’s lack of interference that it has grown). However, this growth has come in an ad-hoc manner and without the institution building that will benefit farmers, processors and consumers.

Dairy products are very important to the economic health of this country. 73 percent of rural households own livestock and use it as a way to smoothen their cash flows through crop cycles. Large-scale investment in improving the prospects for the dairy industry stopped when the Operation Flood programme slowed down. For both cultural and economic reasons, dairy and dairy products growth is likely to continue at a 4-5 percent annual rate. The industry is now decentralised and spread between cooperatives, producer companies and private producers. This decentralisation has been at the heart of why supply and demand have been quite balanced and the industry has grown robustly.

However, the time has come for some institution building and for measures to be taken to mitigate milk price inflation.  Inflation can be tackled by creating a cushion in the short or medium term and by improving productivity over the longer term. In order to balance the volatility of prices that comes about because of annual and seasonal variation in milk production, a method has to be devised to create a strategic reserve (SR) for milk powder.  This strategic reserve could be organised on a zonal basis under the regulatory authority of the National Dairy Development Board (NDDB).  The SR should be built up when there is excess production and also as a percentage of exported milk powder.   NDDB would then have the authority to release the powder during lean times in order to smoothen the availability of milk and dampen price volatility.  SR’s purchase and release of milk powder can be done at market milk prices that are averaged over more than one cycle.  The SR can over time be augmented with a liquid futures market in dairy and dairy products.  Such futures have been launched in the United States and have gradually taken over the role of the buffer stock programme.

To improve the outlook for the longer term, Operation Flood needs to be reborn as Operation Yield.  NDDB’s animal husbandry assistance including insemination, breeding and rearing should be extended to all industry players, not just cooperatives.  Cattle feed that is a judicial combination of crop residue and supplementary cereal fodder should be made available throughout the country both in terms of product and know-how.

To extend the lives of animals and improve their yield, deworming of cattle should be widely encouraged.  Since there are regional variations in the types of bacterial contaminants, veterinary assistance for medicine and dosage is required.  Foot and mouth disease (FMD), a viral disease, is still unfortunately endemic in South Asia.  The Food and Agricultural Organization’s protocol to handle FMD called Progressive Pathway to Control (PCP) should be embraced and implemented systematically.  This is a non-trivial task, because benefits to producers and regions of mitigating this virus may take two or three cycles.  The benefits of collective action that span an entire region can be great, but it requires producers, governments and countries to come together.  In addition to extending productive lives of animals, farmers should be encouraged to purchase insurance on their animals to protect their livelihoods.  The typical premium cost of insuring an animal is 4-5 percent of its market value. For illustration, a robust native cross-bred buffalo in Central India costs about Rs 60,000.  Insurance premium is therefore about Rs 2,500 per year.

Milk and milk products are very important to the Indian consumer.  It has both cultural and nutritional significance.  As per capita consumption of milk increases, it will require the creation of new institutional structures and priorities to protect against runaway inflation. Knee jerk reactions like export bans jeopardise long-term investment and threaten the viability of milk industry participants. Better to make structural changes and design mechanisms that are tailored to cushion the volatility while allowing the market to function.

Photo: ILRI


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