January 14, 2015
Indian dairy's supply / demand paradox
Booming incomes and population growth are coinciding with societal changes that boost demand for high-end dairy products by 10% or more annually. Unfortunately, a relatively slack supply-side response implies that painful policy decisions must be made.
By Eric J. BROOKS
An eFeedLik Hot Topic
India's dairy market is the fastest growing large dairy market, it could grow a lot faster and more efficiently. Although it will probably produce more fluid milk than the entire EU within a year or two, India's dairy sector continues to be devilled by a variety of infrastructure and quality control issues. While India remains the world's largest dairy producer with respect to total fluid milk production, by any measure, the market remains both underdeveloped and full of latent, pent-up demand. Our survey of the situation implies that unless politically painful policy decisions are made, this situation may persist or even worsen.
Fluid milk production increased by 5% annually from 2005 to 2010, before decelerating to about 4.7% from 2011 through the end of 2015. But this lower growth rate has very little to do with the sector approaching maturity. On the contrary, from 2010 to 2014, with fluid milk consumption growing 4.6% annually, butter by 4.5% and value added products by over 10% annually, India could easily absorb milk production increases of up to 6% annually. Unfortunately, Indian society's booming dairy consumption needs are outpacing its capacity to supply more sophisticated, value added products.
Already the world's largest dairy producer, its 17% share of world output is slightly lower than its 18% share of the world population but production is rising quite strongly. At 147 million tonnes, 2015's 4.6% fluid milk output increase compares favourably with comparably large but stagnant western markets, and exceeds even China's dairy growth rate.
Rural disparities vs. unmonetized consumption
Moreover, with over 60% of India's population still living in rural areas, there promises to be years of strong growth ahead. For example, according to Indian government statistics, the top 8.5% of the population by income (which is almost exclusively urban) spends 40 times more on dairy products than the lowest 8.5% of the population, which is almost entirely rural based. While such raw monetary comparisons are simplistic, even when we qualify this figure with additional details, it shows that the market's potential for exceptionally rapid growth spans decades.
Mind you, this does not mean that a wealthy Indian city dweller eats and drinks 40 times more milk, butter, cheese and yogurt than the poorest rural residents. -India's urban dairy consumption is highly monetized and commercial, whereas rural dairy consumption is informal. Dairy consumption does not require a monetary expenditure when milk is produced on the rural residents' own farm or bartered from neighbouring farms for grains and pulses.
Such poor rural areas do not monetize a large part of their dairy production and consumption. The countryside still accounts for over 60% of India's population and well over 90% of rural dairy consumption is accounted for by just milk, raw butter and ghee (traditional clarified butter). With a large proportion of rural milk and butter being consumed without money changing hands, an urban resident can spend several dozen times more on milk and butter while only consuming twice as much as his rural counterparts. Therefore, to a certain extent, differences in the degree to which urban and rural dairy consumption are monetized exaggerates consumption disparities.
Nevertheless, while a wealthy urban resident may only consume two or three times as much milk, butter and ghee as his rural counterpart, chances are he really does consume ten times or more of high-end products such as infant formula, ice cream, probiotic dairy drinks, fruit flavoured milk-based beverages or the processed cheese found in fast food pastas, pizzas and burgers.
Immature production, consumption profile
Lacking a cold chain distribution networks as much as farmhouse refrigeration or electricity, infrastructure deficits hold back consumption processed, high-end dairy products as much as low rural incomes or a lack of familiarity with non-traditional foods. According to India's National Dairy Development Board, 46% of dairy demand is accounted for by fluid milk consumption. In fact, fluid milk, ghee (clarified butter) and raw butter make up 80% of India's dairy demand, a much higher proportion than that found in other large dairy producers.
Compared to other large dairy producers, it is the Indian dairy market's lack of sophistication and infrastructure that skews its product mix towards simple, unprocessed products.
For example, America produces only 66% as much fluid milk as India. Despite their many differences, both the America's export-oriented dairy sector and India's self-contained dairy industry are relatively self-sufficient, with imports making up very little of their overall dairy supply
Therefore, all things being equal, with 50% more fluid milk production, India should have the capacity to produce 1.5 more times more of any dairy commodity than America does. Instead, the vastly different product mix of the US and Indian dairy industry reflects not just cultural preferences, but each markets' relative maturity.
On one hand, with Americans cooking with a wide variety of vegetable oils and most Indian households relying on ghee (clarified butter), it is not surprising that despite having a population 4 times larger, in 2014, India produced 4.887 million tonnes of butter, 5.7 times more than America's 0.855 million tonne output.
On the other hand, with only 2/3rd of India's fluid milk production, the US produced 1.0 million tonnes of non-fat dry milk (NFDM) powder , nearly twice as much as India's 0.52 million tonnes -even though India has four times as many people. Due to their use by food processors, India's relatively low production of non-fat milk powders and whole milk powders is a symptom of its dairy sector's lack of high-end, value-added products.
Even when compared to other developing countries, India dairy sector comes up short. China, for example, has no tradition of mass dairy consumption and almost the same population size as India. Producing only 26.7% as much fluid milk as India but allowing milk powder imports, China's NFDM powder consumption has been growing far more rapidly than India's NFDM production. In fact, on the basis of present trends, China's NFDM powder consumption will overtake India's within a year or two. This is happening even though dairy's central role in Indian culture goes back millennia but it was never part of the traditional Chinese diet.
The relative immaturity (and high growth potential) of India's dairy industry can also be seen in when comparing the production of a simple dairy good to the feedstock for high-end dairy products: While NFDM powders are equal to 115% to 125% of America's butter production in any given year, India's NFDM powder output went from 7.7% of butter production in 2000 to an estimated 11% this year.
Therefore, even if cultural differences mean India never gives up its love of (butter-based) ghee, it will be decades before India's NFDM output exceeds a third of its butter production, let alone anything like 100% or more as is the case in western countries. As NFDM powder consumption is a proxy for the production of processed dairy items ranging from infant formula to yogurt and fast-food cheeses, India's low output of this product points to several supply-side deficiencies -and huge demand side opportunities.
Demography drives powerful value-added trend
The latter is more hopeful, because coinciding rural-to-urban migration, rising educational levels and social changes imply that years of 10%+ growth in demand for high-end, non-traditional products lie ahead.
According to an October 2014 USDA report (GAIN Report #IN4089: India Dairy Products Annual), "More women are pursuing careers, especially those living in urban areas. With less time to cook meals at home, more families are buying ready-made dairy products like table butter, yogurt, paneer [traditional Indian cottage cheese], and other ethnic dairy desserts. Others are trying new, processed products that were never traditionally made in the home such as processed cheese, flavored milk, probiotic drinks, ice cream and baby foods [infant formula]."
In particular, the ascendancy of educated working women is also powering another important dairy demand segment. Although infant formula sales are only a fraction of China or Indonesia, urbanization, education and female labour force participation have caused the rate of infant formula consumption increase to double from its former 5% annual rate. According to a study by Zenith International, although it only accounts for 5% of Asian infant formula demand at this time, "India has the largest population of 0 to 4 year olds in Asia." It added that, "the infant formula market developed relatively recently and is growing by 10% to 12% a year."
Even so, infant formula demand is now merely keeping pace with the fast rising yogurt consumption; it is not the fastest growing dairy market segment. According to the USDA, cheese consumption is rising by at least 15% annually and by up to 20% in some years.
The move towards value added products can be seen in the market for yogurt, where western style packaged, frozen yogurt was introduced several years ago. At this time, it only accounts for less than 10% of overall yogurt sales, as the traditional, unfrozen Indian variety still dominates consumption.
But while overall yogurt demand is expanding a healthy 11% annually, according to Pratichee Kapoor, associate vice president for food services and agriculture at Technopak, the frozen yogurt segment is expanding by 18% to 20% annually. Similar hyper consumption growth numbers are reported for products such as ice cream, condensed milk and the processed cheese used in fast food.
With processed dairy product consumption growing faster than that of milk or butter, Rabobank Food & Agribusiness Research and Advisory estimates that, from an under 10% market share at the turn of the century, value-added dairy products made up 21% of the market in 2013 and will comprise 31% of consumption by 2020.
Can supply keep up? Exports fall under strain
Although they still make up about 80% of dairy consumption, since 2010, fluid milk consumption has increased by an average of 4.6% annually and butter by 4.5% annually. However, while milk consumption increased 4.8% in 2014 and is expected to do so again this year, butter consumption is closer to saturation levels and only increased by 3%, which is probably its new, longer term growth rate. Although fluid milk consumption is levelling off among wealthy urban residents, large consumption increases among its rural poor will keep it growing at near 4.5% annually for the next few years.
Based on the above assumptions, these two basic dairy products which make up 80% of its current dairy demand will see their overall annual consumption increase by an average of 3.9%. On the other hand, the other 20% of dairy consumption is accounted for by product lines such as yogurt, infant formula, condensed milk and processed cheese, which (with the exception of non-fat dry milk powders such as NFDM) are all expanding at 10% to 20% annual rates. Generally, high value, processed products have both the smallest market niches and the fastest growth rates.
For traditional and processed high value dairy products to keep expanding at these respective rates, we estimate fluid milk feedstock must expand by 5.5% annually, which is slightly faster than the 5% rate the USDA estimates that India's fluid milk production needs to increase to meet demand for processed products. This year for example, the USDA expects NFDM powder production to rise by 5.8% while its consumption rises 6.7%
With fluid milk production currently expanding by less than 5% annually, the shortfall created by skyrocketing processed dairy demand is being bridged by falling milk powder exports. Traditionally supplying neighboring South Asian countries with dairy powders, India's NFDM exports fell from 130,000 tonnes in 2013 to 120,000 tonnes in 2014. With consumption of processed dairy goods and NFDM demand rising faster than production, NFDM exports are being slashed even more this year, to 70,000 tonnes.
Of course, once domestic supplies are fully augmented by depleting exports and inventories, there is no answer as to how the gap between processed dairy demand growing in excess of 10%, milk powder consumption rising by 5% to 6% annually and fluid milk output increasing by less than 5% a year will be bridged.
Nor will the increase in fluid milk demand fall significantly below 5% for some time: Even as high-end dairy product consumption starts to expand at a slower pace, they will make up a larger proportion of overall consumption, thereby keeping the rate of fluid milk demand growth roughly constant.
Productivity, feed shortages, food safety hinder milk supply
But while decades of pent-up demand is assured, it is not certain if the supply-side response will let the industry grow as quickly as it should. Despite the import of many advanced breeds, Indian dairy cattle productivity languishes at about 15% to 20% of US levels for several reasons.
None is more telling than the fact that despite all the progress that has been made, in any given year, only 42% to 45% of India's fluid milk comes from cows -the same proportion as was the case in the year 2000, 2005 or 2010, for that matter. Native buffalo, which have far lower productivity, account for most of the other 55% to 58%, with nominal supply contributions from goats and sheep.
Moreover, the 0.5% to 1.0% gap between the growth in overall Indian dairy demand and that of its milk supply (which is expanding by a little over 4.5% annually) is made worse by input shortages. Although it has a long tradition of substituting other oilseeds, pulses and even farm scraps when necessary, without high-nutrient feed ingredients, both the quantity and quality of milk is compromised.
Unfortunately, with no mass imports allowed, India's 2014 soy harvest was no bigger than it was in 2010. The all-time largest soy crop of 2012 was only 6% larger.
Amid flat soy harvests, from 2010 to 2014, feed demand has grown by more than 7% annually. During this time, the amount of soy used in all types of feed increased by 31.5%, from 0.92 million tonnes to 1.25 million. With imports effectively blocked, more soy would have been used by India's dairy sector, especially its larger enterprises, if they could source it at an affordable price.
As a result, India's dairy farms must compete with equally fast-expanding poultry sector for scarce soy supplies and dogged by soy costs far above the world average. Pushed up by feed costs, from 2010 to 2014, the cost of fluid milk increased by approximately 40%.
Furthermore, these supply-side milk production issues are also matched by monumental quality control problems. The Food and Safety Standards Authority of study recently collected random milk samples from India's 33 top milk producing states. Not only was 46% of all milk collected watered down, an additional 22% of samples were found to be adulterated with detergent, urea or fat. In all, 68.5% of all the milk it tested was found to be watered down or adulterated in some way. Although no deaths have been officially traced to the deliberate adulteration of milk, the scope of India's dairy's quality control problems rival the contamination issues that occurred in China and may well exceed them.
This is partly due to the fact farmers are paid by milk volume, and not strictly by its fat or protein content, but there are also other factors in play.
Ultimately, both fluid milk supply deficits and quality control issues are rooted in the same causes: The sector's tiny scale economies, shortage of quality feed materials and lack of consolidation. The formal dairy sector only produces 20% to 30% of fluid milk. The other 70% is produced by mostly family-based, small holder farms that have, on average two hectares of land and anywhere from 1 to 3 cows.
While the lack of industry scale keeps unit production costs higher than they would be, in some ways that is the least of its challenges. The low education level of the average dairy farmer is compounded by his poverty and lack of capital resources to procure more productive modern breeds in place of traditional cows and buffalos.
All this makes a large proportion of dairy producers unresponsive to many of the government programs designed to boost the quantity, quality and safety of India's milk supply. When new government policies are rolled out, whether to improve dairy cattle breeds, prevent disease outbreaks or stop the adulteration of milk, the fact that cattle ownership is so widely dispersed among millions of impoverished, capital-scarce backyard operators makes it impossible to consistently implement such programs.
Painful choices ahead
Consequently, despite the existence of subsidies designed to modernize its dairy sector and boost cattle productivity, India must confront two serious structural issues. The first is the need to boost productivity by encouraging the kind of painful, years-long consolidation that China's dairy sector underwent (and is still undergoing). Only when the majority of cattle are in the hands of well-capitalized, consolidated integrators will the ease of monitoring milk quality coincide with suppliers' motivation to produce the greatest amount of safe milk possible from the most productive dairy cows available.
Even after very strict food safety laws were passed, it took five years of this type of consolidation to get a handle on China's milk quality problems. Hence, would not be surprising if the price of dairy safety and self-sufficiency involves the politically unpopular decision of transferring dairy production from informal, subsistence farmers to consolidated enterprises with deep pockets.
Second, even though consolidation will boost productivity and quality, it will still fail to reach its full potential until the quantity and quality of feed inputs rises -and their cost (particularly that of soy) falls. China was forced to allow the mass importation of soya beans to keep its feed costs under control and per capital protein consumption growing in the mid 1990s. Soy import liberalization may well be needed to similarly enable for the continued, efficient growth of India's protein lines, dairy included.
In the long run, India is faced with a painful choices. It can consolidate its dairy sector and liberalize mass soy imports. This will modernize its dairy industry and profoundly lower its production at the great political cost of peasant farmers' livelihoods.
It can also opt to not consolidate its sector and reduce tariffs of 30% or more it currently has on dairy powders and allow mass imports like China does. This could keep its backyard dairy farmers happy but at the cost of import dependence and a dairy sector that never becomes fundamentally competitive.
Finally, it can allow the supply of fluid milk and milk powders used by dairy processors to keep trailing demand, see its consumption and production of high-end dairy products fall below expectations, with the gap between itself and China's dairy industry continually widening. Amid one of the most lucrative dairy markets in the world, painful supply side choices await.
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