The recent spike in milk prices in India can be linked to the shortage of fat in milk, leading dairies to implement measures like raising prices for full-cream milk or rebranding products to reduce fat content. This shortage of fat in milk is primarily due to multiple factors, including the decline in buffalo milk production and increased exports of high-fat dairy products, leading to a mismatch in supply and demand. Let’s understand this in depth:

Decline in Buffalo Milk Production and Its Effects

Buffaloes are known for producing milk with higher fat content compared to cows. However, the contribution of buffaloes to national milk production has been declining, which has led to a scarcity of fat in milk. The reasons for this decline include farmers underfeeding their animals and shrinking herd sizes due to low milk prices and escalating fodder costs during the Covid lockdowns. This has resulted in reduced milk production from buffaloes, exacerbating the shortage of fat in milk.

Increased Exports of High-Fat Dairy Products

Another factor contributing to the shortage of fat in milk is the increased exports of ghee, butter, and anhydrous milk fat from India. In 2021-22, India exported over 33,000 tonnes of these products valued at Rs 1,281 crore, which has impacted the domestic market and added to the supply-side pressures. The global prices of fat have also soared, further exacerbating the shortage of fat in milk and driving up prices.

Challenges with Importing Fat as a Solution

Importing fat as an alternative solution to the shortage of fat in milk may not be feasible due to prohibitive prices and government reluctance to lower import duties. While global prices of fat have dropped, the government has dismissed plans to lower the import duty on milk fat, which has limited the options for dairies to address the shortage of fat in milk through imports.

Alternatives to Imports and Current Industry Practices

Incentivizing farmers to invest more in their animals and ramp up milk production during the flush season (October-March), when supply exceeds demand, could be a potential alternative solution to the shortage of fat in milk. Dairies typically convert surplus milk into skim milk powder (SMP) and butter fat during the flush season to manage excess supply. However, the current shortage of fat has disrupted this process and contributed to the milk price inflation.

Impact on Demand for High-Fat Milk Products

The demand for high-fat milk products such as ghee, ice-cream, khoa, paneer, and cheese is growing in India. However, the supply of high-fat milk is coming more from crossbred cows that give low-fat milk, leading to a mismatch in supply and demand and pushing up fat prices. This has further contributed to the shortage of fat in milk and resulted in increased milk prices.

Milk Taxation Woes

The problem is that milk doesn’t have any goods and services tax (GST), but when milk is processed into solid milk powder (SMP) or milk fat, they are taxed at 5% and 12% respectively. This means that dairies have to pay GST on the solids they use to make milk, but they cannot claim input tax credit since there is no GST on milk itself. This tax burden increases as the fat content in reconstituted milk increases. The cost of fat and SMP required to reconstitute one liter of full-cream milk is approximately Rs 67.5, with a GST component of Rs 5.35 per liter, which is ultimately passed on to the consumer.

OFB’s Insight:

The surge in milk prices in India is driven by a shortage of fat in milk, with potential solutions including incentivizing farmers to invest in animal welfare and improving industry practices for managing surplus milk. Despite challenges, higher milk prices may encourage increased investment in milk production, reducing reliance on imports and supporting the growth of the dairy industry in India. Furthermore, the current GST structure on milk and milk products creates a tax burden on the dairy industry, and revising tax rates or allowing input tax credit could be explored as a solution to promote industry growth, though careful consideration and policy changes would be needed.