Executive Summary

  • The combination of the 2008 melamine crisis and the lack of transparency regarding domestic milk quality standards led to a flood of cheap, high quality foreign dairy imports into China from 2008 to 2014
  • After 2014, China experienced a decline in powdered milk imports as Chinese dairy firms not only had cheap domestic milk available, but also a record amount of imports on reserve ready for use
  • In terms of liquid milk, imports are likely to remain strong thanks in part to the growth of e-commerce, allowing consumers outside Shanghai and Beijing greater access to foreign-produced milk
  • Nevertheless, the Chinese government views the rise of e-commerce dairy imports as interfering with domestic products and is streamlining e-commerce while simultaneously restricting the number of dairy companies that can sell milk products in China
  • Overall, the combination of China’s new registration system, new international e-commerce tax, and the D20 summit selection of Chinese-only dairy companies will have a cooling effect on the influence foreign suppliers will have on the market

Introduction   

Last year, on a mild mid-August day in Beijing, business leaders representing China’s top 20 dairy firms met in a spacious and well-lit conference hall to layout the framework of the industry’s future. The summit was a coronation as such for the chosen attendees in that numerous smaller Chinese dairies, along with all major foreign suppliers, were purposely excluded. China had carefully picked its twenty dairy companies, after all, the task of supplying the nation with fresh pasteurized milk, ultra-high temperature (UHT) milk, milk powder, and infant formula was and is a serious matter. Just seven years earlier, China was rocked by an infant formula melamine scandal that affected more than 300,000 children, causing six deaths. A chasm of distrust between Chinese consumers and producers opened up in the scandal’s wake which, as of 2016, has yet to be bridged. To jumpstart this mending process, last August, representatives from China’s 20 chosen dairies signed the Beijing Declaration, an agreement to strengthen self-regulation and revitalize the dairy industry. The agreement and summit itself received widespread publicity from various state news agencies. Even dairy signatories themselves, such as New Hope Dairy, have touted recent strides in modernizing production since its signing. This was progress in a sense when considering the most significant industry-wide dairy agreement prior to the Beijing Declaration was held in secret and resulted in China considerably reducing its dairy quality standards well below international norms.

One Step Backwards…Two Steps Forward?

In 2010, at least 70 individuals representing Chinese dairies, industry associations, academia, and government took part in the country’s National Food Safety Standard Raw Milk conference series, ultimately leading to the adoption of lower quality milk standards for both bacteria count and protein content.[1] Despite lawsuits and public pressure, notes from the meetings have never been made public, but the impact of the new standards has been widely felt. Bacteria count measures the post-production quality of collecting, processing, and storing raw milk. Healthy cows typically produce milk with bacteria counts of roughly 1,000 parts per milliliter or less, with bacteria counts subsequently increasing to varying degrees depending on udder health, milking procedures, and equipment sanitation. On the international market, bacteria counts of 100,000 per milliliter and below are generally accepted norms. Running counter to this, Chinese standards were actually pushed from 500,000 to 2 million. This rolling back was a clear admission that the country’s industry collection and storage infrastructure was in a poor state. Protein content, a metric used to determine the overall health and quality of the cow and milk it produces, was lowered in China from 2.95% to 2.8%, whereas the general internationally acceptable minimum is at least 3%. The Chinese media bluntly summed up the retrograde quality standards as “a 25-year step backwards.”

Despite the assumption that China’s step backwards in milk quality standards was a move in the wrong direction, the decision was a rare instance of market forces dictating the development of the country’s dairy sector. Prior to the 2008 melamine crisis, the Chinese government began emphasizing milk protein content as a key metric for the industry. In reality, supply of high-protein milk simply could not meet demand, and melamine milk adulteration began in earnest in late 2007 with the subsequent fallout occurring less than a year later. The Chinese government was not going to repeat its previous mistake of promoting unattainable quality standards that would not only lead to increased adulteration, but also lock out much needed producers from the market. China’s Secretary General of the Dairy Association of Inner Mongolia put it succinctly that if international milk standards were applied in China, “70% of the country’s milk producers would be forced to slaughter their livestock.” Inner Mongolia, China’s top milk producing region, accounted for 25% of the country’s raw milk output in 2011. In total, dairy farmers in northern China (Inner Mongolia, Heilongjiang, and Hebei) accounted for more than half of China’s milk output at the time, giving them greater influence over quality regulations. Southern Chinese milk producers, whose milk quality was closer to international norms, were outraged by the adoption of lower standards. The Guangzhou Dairy Association and Shanghai’s Bright Dairy and Food opposed the standards, with the President of Bright Dairy lamenting publicly that “what is produced from garbage is garbage.” Regardless, the new standards were adopted. Curiously, in October 2012 a Beijing court ordered the Ministry of Health to release the 2010 minutes of the conference series only to later reverse its decision in December 2013, simply noting that the Ministry of Health does not have to reveal such details.

Boom and Bust

This lack of transparency and earlier melamine crisis set the stage for high quality, and often cheaper, foreign milk imports to flood the market. By sheer coincidence, just as the melamine scandal was reaching its apex, China and New Zealand solidified a Free Trade Agreement[2] that ushered in a new era of commerce between the two countries. Fonterra, New Zealand’s largest company by revenue and the world’s largest dairy exporter by volume, was well-placed to take advantage of this new development. From 2008 to 2014, Chinese (incl. Hong Kong and Macau) imports of milk powder increased from ~181,500 MTs to more than 1 million MTs, with New Zealand accounting for nearly 70% of this supply. The majority of these imports were comprised of whole powdered milk (fat content >1.5%), a key ingredient used in China to produce infant formula, milk beverages, reconstituted milk and yogurt, as well as confectionary products. In 2014, the peak of Chinese powdered milk imports, the largest Chinese importers were the port cities of Tianjin (30% of imports by volume, northern China), Shanghai (20% of imports, eastern China), Hong Kong (13% of imports), Hangzhou (9% of imports, eastern China), and Gongbei (9% of imports, southern China). In 2015, Chinese powdered milk imports significantly declined, dropping to ~692,500 MTs. This drop in Chinese demand sparked a serious downturn within New Zealand’s dairy industry. Called “Black Friday” in New Zealand, in early August 2015 Fonterra cut its farmgate milk price forecast to NZ$3.85 per kg, its lowest level since 2002, and a significant drop from May 2015’s price of NZ$5.25 per kg (the break-even point for New Zealand farmers). On the back of sliding Chinese demand, New Zealand’s dairy industry was in full retreat.China Powdered Milk Imports

The origins of China’s 2015 decline of powdered milk imports can be traced back to 2013, when small Chinese dairy farmers began culling their dairy herd over a combination of low domestic milk prices and high beef prices. In early 2013 (raw milk price of CNY 3.42 per kg), Chinese farmers reportedly culled ~2 million dairy cows, equivalent to a ~15% drop of the country’s total milk output. The resultant drop in production led to a spike in domestic milk prices. The remaining Chinese dairy farmers sought to take advantage of rising prices and ramped up production. Meanwhile Chinese buyers rushed to purchase cheaper imports. By February 2014 (milk price of CNY 4.26 per kg), the price bubble peaked and then burst as cheaper imports continued to flood in, driving down local prices. As a result of import growth, China’s stockpiles of whole powdered milk, a product that can be stored for one to two years depending on product quality and storage conditions, more than doubled from 2013 to 2014 (130,000 MTs to 300,000 MTs, ending stocks). By March 2015, Chinese raw milk prices had plummeted back to early 2013 levels, meaning Chinese dairy firms not only had cheap domestic milk available, but also a record level of stocks on reserve ready for use. Chinese demand for powdered milk imports won’t regain its footing until 2017 at the earliest, once stocks have been sufficiently drawn down.China Milk Powder Stocks

Got Milk?

Liquid milk imports shared a similar growth path with powdered milk following China’s melamine crisis. In fact, from 2008 to 2014, liquid milk imports increased at a faster rate (by a factor of 9.5) than powdered milk (increased by a factor of 5). But whereas Chinese powdered milk imports topped an impressive US$6 billion 2014, liquid milk imports totaled just under half a billion dollars during the same year. Chinese demand for liquid milk imports, primarily in the form of UHT milk, is smaller than powdered milk owing to its shorter shelf life and niche product use (i.e. direct to consumer). Luckily, as a fast-moving consumer good, constant imports are needed to maintain a steady supply regardless of a previous years’ import volumes. Together with stagnant domestic production, low UHT milk prices in Europe, and consumer preferences for foreign brands, Chinese imports of liquid milk did not suffer the same fate as powdered milk. From 2014 to 2015, Chinese liquid milk imports increased from ~379,900 MTs to ~519,700 MTs, with Shanghai being the top destination (48% of all imports in 2015), followed by Hong Kong (11% of imports in 2015), Beijing (8% of imports), and Shenzhen (8% of imports). Unlike powdered milk, which is dominated by New Zealand, liquid milk arrives from a variety of suppliers including New Zealand, Germany, Australia, and France. Chinese liquid milk imports are likely to remain strong thanks in part to the growth of e-commerce, allowing consumers outside Shanghai and Beijing greater access to foreign-produced milk. Future growth for international suppliers will be dependent on their ability to expand outside China’s traditional Tier-1 city markets.China Liquid Milk Imports

Digital Milk

China’s e-commerce industry has been a boon for foreign dairy imports and already accounts for a large share of the country’s dairy market. As of early 2016, China’s 5,000 e-commerce distributors were responsible for as much as 66% of dairy product imports. These e-commerce dairy imports, particularly powdered milk, UHT milk, and infant formula products, are typically shipped in parcel-sized boxes that bypass import tariffs and duties that are levied at Chinese ports. This makes e-commerce purchases cheap as they only pay a postal tax or simply no duty at all if the tax totals less than CNY 50 (~US$7.60). Not only are e-commerce shipments cheaper than traditional bulk trade, but customers are more confident that these dairy products are genuine since they are being procured from reputable markets in New Zealand, Australia, and Europe. On the supply side, dairy producers are able to export their products cheaply and to a growing network of e-commerce users that is fast expanding beyond the traditional markets of Beijing and Shanghai.

Despite these financial and perceived quality advantages, the Chinese government views the rise of e-commerce dairy imports as occurring at the expense of domestic production. To make matters worse, the Chinese economy experienced a shock in mid-June 2015 as the Shanghai and Shenzhen stock markets suffered substantial losses. In the months that followed, the government devalued its currency and dipped into its foreign currency reserves to shore up economic losses. In order to not only counter cheap foreign dairy imports, but also open up new revenue streams for its beleaguered economy, in April 2016, the Chinese government instituted a new tax on e-commerce parcel imports. The new tax imposed duties of at least 11.9% on dairy imports, as well as value added tax (VAT) and consumption tax. One of China’s largest e-commerce companies, Alibaba Group’s Tmall, lamented that the new taxes would increase the financial burden on infant formula products purchased online. However, it is unclear if the new tax will significantly impact Chinese demand for foreign dairy products as Chinese preferences for foreign imports are fairly price inelastic. Chinese parents and consumers in general have preferred quality over price since the 2008 melamine crisis. What is more likely is that a much larger impact will be felt by China’s ~5,000 e-commerce sites. The new tax may streamline the industry by forcing companies dependent on avoiding import tariffs to go out of business. This streamlining of the e-commerce industry also coincides with the government’s policy initiative of limiting the number of dairy companies that can sell milk products in China.

Thinning of the Herd

The first dairy companies squeezed out of the market were foreign suppliers. In early 2014, approximately 900 different foreign infant formula brands were imported and sold within China. To curtail this figure, in June 2014, China’s Certification and Accreditation Administration (CNCA) instituted new regulations that decreased the number of permissible foreign infant brands sold in China to 94. The majority of CNCA-approved foreign infant formula suppliers were based in New Zealand, Australia, USA, and Europe, with Singapore and South Korea being the only Asian approved suppliers. With international suppliers in check, China turned to its domestic market. As of mid-2015, China had an estimated 2,000 different brands of infant formula products being sold nationwide. In October 2015, a new food safety law drafted by the China Food and Drug Administration (CFDA) came into effect. The new law stipulates that infant formula producers must register their powdered milk formula with the CFDA and limit the number of different product brands they sell. The CFDA would also issue production certificates (valid for five years) and increase fines for adulterated products/ingredients. The new law makes it easier for the government to eliminate companies and is expected to more than halve the number of Chinese infant milk powder brands to approximately 600-800. The law has since been expanded to include foreign suppliers. In April 2016, China’s Ministry of Finance clarified that all infant formula imports, including e-commerce shipments, must be registered with the CFDA by January 1, 2018. It appears that all dairies, whether on the mainland or abroad, will have seek to government approved registration if they wish to succeed in China.

Going Forward

The combination of China’s new registration system, new international e-commerce tax, and the D20 Summit selection of Chinese-only dairy companies will have a cooling effect on the influence of foreign suppliers on the market. China is in the midst of scaling back the number of market participants while attempting to scale up domestic production of high quality raw milk. The year 2014 was not only the high-water mark for milk product imports by China, but also for live heifers that produce the milk itself. In 2014, China imported a record 200,000 heifers (primarily from Australia and New Zealand) for use by its dairy industry. By 2015, Chinese raw milk prices had completely bottomed out, and taken together with the country’s overall economic slowdown, Chinese dairies began reducing imports of expensive live heifers. The D20 Summit’s Beijing Declaration, an agreement among China’s top dairies to strengthen self-regulation and revitalize the industry, will have to overcome worsening market conditions to achieve these government dictated mandates. This will not happen in the short run, as China’s dairy sector is still years away of achieving any form of parity with Western suppliers in terms of quality. In the long run, the melamine scandal has left a scar on the industry that may not heal for a generation. Perhaps by that time, Chinese raw milk standards will have risen to international norms, and consumers will be able to purchase high quality Chinese-produced milk products that are cheaper than their foreign counterparts.

[1] It should be noted that limitations on mycotoxins, residual pesticides, and other pollutants were also adopted.

[2] In 2008, China and New Zealand signed a FTA that set in place the removal of tariffs on 96% of New Zealand exports. This removal has been staggered over time, with certain agricultural exports being tariff free by 2012-2013 (infant formula, wine, apples, etc.), 2016 (edible offal, oranges, beef, etc.), 2017 (butter, cheese, liquid milk), and 2019 (whole/skim powdered milk). New Zealander wheat, sugar, and rice will not have receive reduced tariffs. https://www.mfat.govt.nz/en/trade/free-trade-agreements/free-trade-agreements-in-force/china-fta/#facts

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