October 24, 2003
Outlook of China's Rapidly Expanding Dairy Industry
Situation and Outlook
China's dairy industry is rapidly expanding construction of new dairy barns and imports of live breeding cows, fueled by increased per capita consumption of dairy products. Milk output during 2002 in Inner Mongolia, China's second-largest dairy producing region, increased 143 percent from the previous year. This trend is forecast to continue in 2003 and into 2004. Domestic raw milk production cannot meet the growing demand, and the industry is striving to increase output through improved genetics, feed and management practices.
Australia, New Zealand and the United States are the primary beneficiaries of China's growing demand for imported breeder stock and livestock genetics. These same countries are also competing to sell China dairy products including fluid milk, powdered milk, and cheese and whey products. The United States is the largest whey supplier to China, accounting for 36 percent in volume during the first half of 2003, while New Zealand is the dominant powdered milk supplier. During 2003 U.S. breeding cow exports to China are more than double the previous year, reducing Canada's share after the BSE outbreak in that country.
The impact of WTO entry and the post-WTO tariff scheme has put pressure on domestic powdered milk production. Some companies are shifting production to the fluid milk sector, where imports are minimal. Despite the falling tariff levels, the effective tariff rate (MFN + VAT) still ranges between 24 and 47 percent for dairy products.
In response to insufficient domestic raw milk production, the Chinese Government announced a national strategic plan called the "Advantageous Cow Milk Production Area Development Plan, 2003-2007". It is difficult to estimate how effective the plan will be in increasing production, but in the long run the project could lead to import decreases.
Production: strong growth, industry concentration and investment to meet unleashed consumer demand for dairy products
China's dairy industry is rapidly growing in response to rising consumer demand for milk and yogurt products. In turn, the Chinese Government is announcing new policies that favor dairy sector development. Despite these efforts, the shortfall in milk supplies will result in continued imports of live cows and dairy products during 2003 and the next couple of years.
In the first quarter of 2003, cow milk production was 3.5 million MT, up 30.7 percent over the same period last year. The top three provinces are Heilongjiang, Inner Mongolia and Hebei. From January to June in 2003, the total output value of processed dairy products was RMB 19.12 billion (US$1.00 = RMB8.27), up 36.8 percent. The profitable dairy industry has attracted investment capital not only from the dairy sector, but also from other industries. During 2002, about 20 new fluid milk projects were completed with a total investment of RMB 1.9 billion. These new plants will produce a total of 4,300 MT of milk a day.
On the processing side, three new milk powder plants recently opened with a total investment of RMB100 million and a processing capacity of 25,000 MT a year. This capacity may not be fully achieved unless raw milk production keeps pace with processing.
China's large dairy companies and foreign joint ventures are battling for the limited supply of milk. Through mergers across the country, these large companies have quickly carved-up domestic milk sources. Small and medium-sized companies have turned to more use of imported milk powder, especially for fluid milk production. Inexpensive international dairy prices have also helped the margins of these smaller companies. This trend of using milk powder to blend fluid milk will continue unless new labeling regulations are implemented to indicate all ingredients.
National Milk Strategy: "Advantageous Cow Milk Area Development Plan"
In response to lagging raw milk supplies, the Ministry of Agriculture (MOA) announced a national strategic plan entitled "Advantageous Cow Milk Production Area Development Plan, 2003 - 2007". The three areas are the Northeast Area (Heilongjiang and part of Inner Mongolia), North China Area (Shanxi and Heibei), and Beijing-Tianjin-Shanghai Area. The purpose is to make better use of milk resources and increase production in these areas through improving genetics, feeding management and processing. By 2007, cow inventory in those areas will reach 2.8 million head and annual fresh milk production will increase by 15-18 percent.
China's Main Dairy Constraints: genetics, feed and management
Despite China's efforts to expand dairy production, genetics, feed and disease control pose significant challenges for the industry. China's herds lack purebred cows. Last year, the dairy industry estimated purebred cows were only about 50 percent. According to the Ministry of Agriculture, this number in 2003 is even lower and approaches one-third.
The need to upgrade China's dairy genetics has led to increased imports of breeding cows and higher cow prices. Domestic heifers of 3-8 months age cost RMB 2,000-2,500 per head, 8-8 months are RMB 2,500-3,500 and pregnant or milking cows cost RMB 5,500-6,500. Prices for imported cows are RMB 11,000-17,000 for Australian cows (5-6 MT milk a year), and RMB 35,000 for U.S. cows (8-10 MT milk a year). Most farmers cannot afford for these prices, one of the major constraints faced by the U.S. export industry.
China has limited production of crops used specifically for feed and forage. Natural grassland has deteriorated to 135 million hectares, and the deterioration continues at 3 million hectares a year on average. The MOA announced the first national "Grassland Law" at the beginning of this year to curb grassland deterioration. The new law will help improve the situation, but it will still take years to see any benefits.
Disease problems have received significant media attention. Recently, two outbreaks of Bovine TB and Brucellosis on a farm in Guangzhou impacted consumer confidence and reduced consumption of fresh milk. Milk sales in Guangzhou dropped 20 percent when the farm disclosed the inefficiency of disease prevention. Some farmers reportedly sell their cows to other markets when TB cases are discovered.
Processing: fluid milk increased output
For the next five years, post estimates strong domestic demand for fluid milk due to increased consumer demand for dairy products. In the first half of 2003, total processed dairy products reached 681,000 MT, up 30.87 percent. Fluid milk production was 2.46 million MT, up 63.27 percent over the same period in 2002. UHT (ultra-high temperature) milk demand is increasing faster than pasteurized due to China's school milk program as well as its convenience of storage and transportation.
China's WTO entry: hurting domestic milk powder production, but new opportunity for fluid milk
China's imports of dairy imports in 2003, including re-export from Hong Kong, are forecast to exceed $400 million. Low international prices, coupled with the lowered tariff rates, will likely lead to increased dairy imports in 2004.
Strong domestic demand and production constraints, combined with low international prices and lowered import tariff rate, drove-up imports of powdered milk in the first half of 2003 to 87,624 MT (up 76 percent over the same period of 2002). This figure accounted for about 18 percent of total domestic powdered milk production. Total imports are forecast at 110,000 MT for 2003 and 150,000 MT for 2004. The profit margins of producing imported powder into fluid milk means this trend will continue unless labeling changes are implemented.
The industry estimates that 5 percent of total fluid milk is produced using imported milk powder. These imports have negatively impacted domestic powder processors. Some large dairy companies object to this trend because they rely on raw milk as a raw material and their production costs are much higher. These companies have appealed to the Government to formulate a new labeling standard that indicates the source of the raw materials. However the appeal has not progressed due to different opinions within government organizations. There have been no updates of the national standard for dairy products.
Despite China's accession to the WTO, the effective tariff rate on imported dairy products is still double-digit, ranging from 17 to 47 percent.
Consumption: urban, wealthier consumers drinking-up
Dairy consumption increases lie mainly in urban, wealthier areas. However, per capita milk is still only around 11 kilograms (KG), much lower than the world average of 98 KG. The low average illustrates the tremendous potential for future growth in the dairy market.
From January to May 2003, monthly urban consumption of dairy products was 2.05 KG, up 20.2 percent over the same period of the previous year. Per capita fresh milk consumption accounted for 1.53 KG (up 24.4 percent), powdered milk accounted for 0.05 KG (no change) and yogurt accounted for 0.17 KG (up 21.4 percent).
China's skyrocketing economic growth and rising incomes are behind the country's rising dairy consumption levels. Beijing and Shanghai rank first (per capital over 42 KG) and second (over 35 KG) in dairy consumption. The sluggish dairy consumption increase in rural areas reflects the slower pace of income growth over the last couple of years. Some experts believe that if the rural dairy market cannot be developed, the overall growth pace of China's dairy market may slow down after 10 years. Rural farm incomes remain stagnant.
Foreign milk powder products dominate China's high-end market. Among the top 10 milk powder sellers in the Chinese market, six are foreign companies. Quality is a concern. Sampling inspection by AQSIQ, China's inspection and quarantine authorities, showed that only 65.8 percent of domestic powdered milk is qualified for consumption based on the national domestic milk powder standard. Small dairy plants produce almost all the unqualified product.
Trade: United States the largest whey supplier to China
China's whey production is very small, and demand must be met by imports. The United States is the largest supplier and will remain the largest for the next couple of years.
In the first quarter of 2003, U.S. whey export volume and value to China was 29,166 MT valued at US$ 12.45 million, accounting for 36 percent and 24 percent respectively of China's total imports. Although the effective tariff rate for 2004 will remain unchanged (23 percent), it is already one of the lowest among dairy products. The U.S. whey export growth rate in 2004 is forecast to grow about the same level as 2003.
Excellent opportunities for U.S. breeding cows, but marketing, education and negotiations needed
China exempts import tariffs for breeding animals, but the VAT is still 13 percent. However, it is still much cheaper than importing commercial animals. As a result, some dairy companies reportedly import cows under the HS code of breeding cows. They use some of imported cows as milking cows rather than breeding cows or they sell them for profit. Since import numbers are so large, these companies often ignore the quality of the imported cows. To address this problem and improve China's dairy herd, the Government now limits cow imports to breeding purposes.
U.S. exporters of high quality breeding cows will benefit from this enforcement. While Australian cow exports dominate China's live cow trade, U.S. breeding cow exports have been increasing from a couple of hundred in 2001 to a forecast of 2,000 this year at the expense of Canada's export share.
Despite this growth, U.S. exported cows face price and cattle import (health) protocol constraints compared with Australian cow exports. Although Australian milk cow production is far lower than U.S. cows, import prices are much cheaper and affordable for Chinese companies or farmers. Because of the blue tong problem, the U.S. exporters can only sell to China between October and April. The Chinese quarantine procedure requires two months of isolated quarantine before transportation to China and 45-days isolated quarantine after arrival in China. This procedure does not leave much time for choosing cows. Australia does not have blue tongue problem and its industry can export year round.
One of the greatest challenges facing China's small-scale dairy producers is the poor management condition to sustain high quality cows, in part due to insufficient feeding technology.
The bilateral protocol for cattle and cattle genetic trade was signed in 1995. Part of the protocol needs updating. USDA's Animal and Plant Health Inspection Service and the Foreign Agricultural Service are working together to push for re-negotiation of the U.S.-China Cattle protocol in hopes of relaxing the quarantine difficulties. A couple of years ago, China also put forward to negotiate bilateral protocol for importation of U.S. in vitro fertilization embryos. FAS/Beijing places a high priority on continuing AQSIQ/APHIS technical talks with China.
Hong Kong re-exports affected by SARS, but estimated to recover
The data of the World Trade Atlas for Hong Kong re-exports showed that re-export volume and value to China decreased by 59 percent and 65 percent respectively from January to June in 2003 over the same period of 2002. This was mainly due to SARS because Hong Kong was one of the most seriously hit areas and transportation was stopped for a couple of months. Hong Kong re-exports are forecast to return to normal in the latter half of 2003.
Large increases in cow imports will lead to reduced low-end beef imports
Normally, cows are slaughtered for beef after 6-7 years of milking. The beef is then sold to the low-end market. The large numbers of imported live cows and resulting increase in the cow inventory will likely lead to import decreases of low-end beef after 2010. On the other hand, steadily increasing beef consumption could result in most of this beef being consumed with room to spare for imported beef as well.
Export market flat and narrow
From January to June in 2003, China's powdered milk export volume and value was 9,236 MT and US$ 133.9 million, no increase over the same period of 2002. Hong Kong is China's largest export market accounting for 62.57 percent by volume and 54.87 percent by value of China's total powdered milk exports. This market may not change much in 2004.
Source: USDA
