June 25, 2007

 

Mexico's milk price hike feared to spur inflation

 

 

A price buildup for milk in Mexico is feared to incite an economic inflation, a scenario similar to the "tortilla crisis" which hit Mexican economy last year.

 

Though the cost of both products are being driven higher by rising international corn prices, corn accounts for just 30 percent of milk production costs, compared with most of the cost of making tortillas. Thus, consumers have yet to see much of a change in the dairy section of their local supermarket.

 

A one-litre carton of milk sold by Lala, one of the country's biggest producers, costs 10 pesos (93 cents), up 9 percent since the beginning of the year and 15 percent from a year ago, according to federal consumer protection agency Profeco.

 

The fresh milk component of Mexico's Consumer Price Index, meanwhile, was running at an annual rate of 5 percent through May, about a percentage point above overall CPI.

 

According to some economists, milk and related prices are poised to move even higher, which could impact inflation expectations and central bank policy. Fresh milk alone accounts for more of the CPI index than corn tortillas, at 1.9 percent versus 1.2 percent, and all milk-related products make up nearly 3 percent of the index.

"I don't think we can forget about milk prices in Mexico," said David Franco, an economist at JP Morgan in Mexico City, estimating that the milk portion of CPI could hit an annual rate of 8 percent to 10 percent by September.

 

While milk prices are only increasing gradually at this point, Franco expects that portion to add an extra 0.15 percentage point to the index this month.

 

Most economists don't expect milk to have much impact on inflation data due out later Friday for the first half of June, with a Dow Jones Newswires survey predicting that the annual increase in CPI will remain just below 4 percent.

 

Concern about milk is one factor behind JP Morgan's call that the Bank of Mexico will raise rates again next month, following a surprise 25-basis-point increase in the overnight rate in April to 7.25 percent.

 

On Friday, the central bank left rates unchanged but also kept its official tightening bias in place, making specific mention of the growing dairy threat.

 

Noting that the risks to achieving its 3 percent inflation target had increased over the past month, the bank said that, "in particular, the increase in the price of grains has pressured the prices of other food products, such as dairy products."

 

Economists say the big concern is that high milk prices will be accompanied by increases in related goods.

 

"The main worry, rather than just the milk, is about the effect on other products, such as cheese, sour cream and yogurt," said Luis Flores, economist at Ixe financial group.

 

Ixe recently changed its call on monetary policy, now predicting that the central bank will raise rates in January instead of cutting them that month. The shift had more to do with the bank's adoption of an official tightening bias last month than with any fundamental change in the firm's outlook for inflation, however, said Flores.

 

Mexico's dairy sector is caught up in the same forces affecting global prices of grains and milk. Supply isn't keeping up with increasing global demand, which is being driven by a variety of factors ranging from new milk consumers in China and elsewhere in Asia to the diversion of corn into ethanol production.

 

That has pushed the global price of powdered milk up more than double over the past year and about 70 percent so far this year. Through Thursday, international powdered milk cost as much as US$5,400 a metric tonne, according to the US Department of Agriculture's Dairy Market News, compared with a little over US$3,000 a metric tonne at the beginning of the year and less than US$2,000 a year ago.

 

While local corn prices have come off their highs of a few months ago, they remain 50 percent above year-ago levels.

 

Jaime Yesaki, president of the National Agriculture Council, or CNA, expects corn prices to continue higher due to growing demand, and he's doubtful whether the costs can be passed on to Mexican consumers.

 

"That's the problem, that the market won't accept the price increases," said the head of the CNA, an umbrella organization made up of industry groups spanning the entire agricultural chain from producers to agribusiness.

 

With costs soaring and the consumer market showing little propensity to accept higher prices, local dairy farmers are getting squeezed, said Felipe Cedillo, treasurer and ex-president of the National Association of Dairy Farmers, which accounts for nearly 40 percent of the country's milk production.

 

His group has been trying to push through increases of 5 percent to 10 percent in the price of milk they sell to the dairy industry, ranging from milk retailers to producers of cheeses, yogurt and related goods.

 

Cedillo said some farmers have been successful in getting 5 percent price increases, to as much as MXN4.20 a litre, but that the process is happening much slower than they would like.

 

"The companies say they can't pay more because they can't raise their prices because the consumer won't tolerate it," he said.

 

For him, the rise in global powdered milk prices is a positive development, since it gives local farmers leverage to raise their own prices after years of having to compete with cheaper imported milk.

 

On the retail side, companies have found more success in passing on the rising cost to consumers for cheeses and other milk-related products.

 

Alvaro Madero, senior vice president of administration at Sigma, food division of conglomerate Alfa, said prices of some of the company's dairy products have already been impacted by rising global and local milk prices.

 

Sigma, the country's leading cheese producer with a 30 percent market share, has raised some cheese prices this year, and Madero said that more increases may be needed.

 

"It seems the raw material prices are going to increase more," he said, adding that as long as global and local milk prices are rising, "it's going to be pushing up prices of goods along the chain."

 

Jose Garcia, director of the National Dairy Industry Chamber, which accounts for 86 percent of the country's dairy production, said if the price of farm milk goes up much more, prices for consumers will also have to be increased.

 

At a gathering this week, the members of the chamber estimated that if milk coming from dairy farms rises above MXN4.50 a litre, many businesses would have to raise the price of milk they sell to consumers.

 

He isn't aware of any milk retailers raising consumer prices yet, though he noted that the cost of a liter from the farm now ranges from MXN3.80 to MXN4.45.

 

"If the trend continues as it has, I believe it is inevitable" that consumer prices will go up, said Garcia.

 

US$1 = 10.837 Mexican peso (MXN)