Floors and Ceilings: State Intervention in the Dairy Industry

Originally appeared on Echelon

By Ravi Ratnasabapathy

Milking the consumer

The dairy industry has been promoted by the government with the objective of achieving self-sufficiency in milk products. The objective appears to be a moving target, with the most recent year for achievement being set to 2020. Currently, local production meets less than 40% of the total domestic milk requirement.

In 2015, local milk production was 374 million litres, a 12.1% increase from the previous year. In comparison, imports of milk and milk products grew 21.5%. Growth in imports of milk powder outstripped growth in local production over seven of the last ten years. Unfortunately, policy towards the dairy industry is a confused tangle of taxes and controls designed to achieve contradictory objectives. A bulk of the consumption takes the form of milk powder, most of which is imported. Local milk is mainly used for value-added products, and only surpluses are converted to milk powder. The policy is complicated because there are two administered prices in the value chain – a maximum retail price on powdered milk and a guaranteed farm gate price for liquid milk. Influencing the value chain and adding complexity are taxes on imports of milk powder. Milk powder prices are politically sensitive.

Policy is primarily geared towards the goal of protecting consumers, and interventions are made from time to time to set maximum retail prices. Farm gate prices of milk are mandated to encourage local production, with the objective of achieving self-sufficiency. Farm gate prices of local milk tend to be high; the cost of production of MILCO being the key determinant of price.

According to the FAO:
“The farm gate milk price is largely determined by state-owned MILCO’s processing and marketing costs, both of which are reputed to be relatively high. The government uses the farm gate price as a political tool because it needs MILCO to cover its costs. The large private firms engaged in milk product manufacturing follow the purchasing prices offered by MILCO.”

Naturally, this increases the cost of the final domestic product. Between 2010 and 2016, farm gate prices doubled from Rs34 a litre to Rs70. International prices of powdered milk halved between 2014 and 2016, but Sri Lankan consumers did not benefit, as the controlled prices of imported powdered milk were only reduced by 16% from Rs386 to Rs325 for a 400g pack.

There is an inherent conflict between the maximum retail price, designed to protect the interests of consumers, and minimum farm gate prices, aimed at encouraging domestic production. The contradiction between a floor price on liquid milk and a price ceiling on powdered milk means that producers have an incentive to produce items not subject to price control such as liquid milk, flavoured milk, butter, cheese and yoghurt. However, as the input cost is high, they can only retail at high prices and are not competitive compared to imported products.

The government resolves this particular dilemma by imposing punitive taxes on imported dairy products: Rs880/kg on butter, Rs625/kg on yoghurt and around 140% on cheese. This raises the price of imports, enabling local producers to compete, but as this has the effect of raising overall prices it is detrimental to consumers.

In a further contradiction, the government also taxes the import of powdered milk, even while it imposes a maximum selling price. The tax is designed to earn revenue for the state. Importers of milk powder are squeezed between the tax (which raises costs) and the controlled price, which sets a ceiling at which the product retails. The taxes change, depending on world market prices. In the past, when world market prices dropped, tax rates were increased (while retail prices were unchanged) to earn revenue for the government. When world market prices increase, the importers lobby for revisions to the controlled price, and the government responds either by raising the controlled price, or if a price increase is deemed to be politically unfeasible, reducing the tax temporarily. After a recent reduction, the current tax (approximately 28% of the import price) is relatively low, but historically it was much higher: as much as Rs350/kg in 2014.

The ceiling on milk powder prices also creates problems for local liquid milk producers, as they are unable to convert any surplus liquid milk to powder at a profit. The local dairy industry focuses on value-added products due to better margins, but the market is too small to absorb the entirety of liquid milk produced. As excess milk cannot be stored for long in liquid form, it must either be converted to powder or disposed of. It appears that although high taxes on value-added products mean that local production is encouraged, the resulting high consumer prices restrict consumption growth. Whenever a surplus of liquid milk is collected, producers face the dilemma of either destroying it or converting it to powder, both options resulting in a loss.

The government is committed to raising domestic production and competitiveness, but structural impediments mean the cost of local production is high. Prof. Sivali Ranawana of the Faculty of Livestock, Fisheries and Nutrition of the Wayamba University has identified some of the reasons for the low productivity, including lack of quality pasture/forage, small farm holdings and the climate (which restricts the breeds that can be used).

The best livestock, pure European breeds, can only be maintained in the hill country, and even in that region, there is a lack of forage of adequate quality. The FAO note that: “Animals are mostly fed on natural grasses available in common lands, such as roadsides, railway banks, fallow paddy fields, tank beds and other vacant lots, all maintained under rain-fed conditions.”

Although the good breeds in the upcountry have the potential to yield 20 litres of milk per day, a level achieved on some intensive farms; the average yield, even in the best climatic conditions, is only half this level.

According to the last comprehensive survey (conducted in 2008/9) by the Department of Animal Production and Health, average daily milk yields per cow were 10 litres in Nuwara Eliya, 5 litres in Kandy and 3 litres in Matale. Overall Sri Lanka’s cows produce a woeful average of 2 litres of milk per day. Given the problems facing the domestic dairy industry, it is not surprising that the costs of production are high. Government intervention in the dairy market is a game of political theatre. Price ceilings on milk powder placate the public, even while the government contributes to raise costs by taxing the input. Minimum farm gate prices please the dairyman, but squeeze value-added producers who then need protection from imports. Consumers are the ultimate losers, facing limited choice and high prices.