>Thematic: Milk Inflation (MACROCENTRIC ISSUE)

Its cost and not affluence that is causing inflation shocks

Protein consumption has declined structurally: In spite of higher economic growth, per

capita calorie and protein consumption during the past 27 years has declined. Between 1983 to

2004-05 per capita daily protein intake fell 12.1% in rural areas and 4.6% in urban (as per NSS).

Milk & milk products contribute only a part of protein intake (9.3% in rural areas and 12.3% in

urban, 2004-05) and has been growing only modestly in per capita terms: CAGR 1.25% in rural

and 0.95% in urban between 2004-05 and 2009-10. Incorporating the rise in proportion of

households consuming milk we estimated that overall growth in milk consumption (NSS based)

may have grown at 4% CAGR during FY05-FY10. While this may be to an extent an

overstatement, we believe production growth far exceeded consumption: Total consumption

multiplied 1.6x during the survey periods 1993-94 & 2009-10 while production multiplied 1.9x.

The implausible excess demand argument: Contrary to the NSS data, expenditure GDP

shows a structural decline in growth of real expenditure to 3.5% during FY02-FY10 (high GDP

per capita growth phase) vs 6.6% during 1990’s. Trend decline in consumption growth is

accompanied by a decline in production growth. Hence, the declining trend in milk inflation

from an average of 10.7% during FY89-FY94 to 2.6% during FY02-06 seems natural. Therefore, from a structural standpoint the sudden spike of 20% in milk inflation during FY10-FY11 seems abnormal. Importantly, 3.8% production growth during FY07-FY10 was higher than consumption growth at 2.7%, which should ideally imply excess supply.

Sustained net exports of milk products indicate surplus: Sustenance of net exports of milk

powder during 2000’s coincides with declining milk production and consumption growth,

thereby corroborating the presence of excess supply. Since FY00 India has been a net exporter

of milk powder. It averaged 17.3% of total production during FY01-FY10 and domestic

consumption declined to 75% of total supplies during FY05-10. Significantly, despite the large

import of milk powder by government in FY11 in the wake of rising domestic milk prices, India

still remained trade surplus in milk and milk products.

Our empirical analysis and survey refute the affluence syndrome: Our long term empirical

analysis shows that real per capita GDP growth is not relevant in determining milk consumption.

The correlation (FY84-FY10) between real per capita GDP growth and milk inflation is found to

be negative. The negative coefficient (-0.41) for milk inflation in consumption function indicates

that rise in milk inflation causes a decline in milk consumption growth, thereby refuting the

view that milk inflation is caused by a rise in consumption. Our inflation function highlights the

predominance of various cost variables. The feedback from our primary survey of cattle sheds in

Mumbai corroborates our empirical findings. In particular, steep rise in costs, rising land prices

and limited pass-through are making milk production unviable.

Cost linkage in protein inflation: As per NDDB (Jun 2011) the cost of inputs like dry fodder, oil

cakes, and cattle feed have grown at a much higher rate compared to the price which farmers

gets for milk from either cooperatives or other milk procurers. Oil seed cakes, an important

component in cattle feed and key source of crude protein that gets converted into milk protein

have seen a steep rise in prices. Similarly other fodder components have also undergone

significant price escalation: price of de-oiled rice bran nearly doubled in 2011, since 2005-06,

molasses increased 140%; rape seed extraction increased 130%.

Burst of income flows do not cause enduring rise in demand for milk: Increase in public

consumption spending through fiscal stimulus, employment guarantee programs (NREGA),

farm debt waiver as well as salary hike of government employees (Sixth Pay Commission)

resulted in sudden burst of income flows which collectively caused a surge in consumption in

the past and may have spilled over to demand for milk as well. But such sudden spurts in

demand do not cause permanent rise in consumption as price shock neutralizes the positive

income effect quickly, without adding to absolute consumption of milk. The slowing of real

expenditure on milk & milk products in FY10 corroborates this phenomenon.

To read the full report: MILK INFLATION