Ali Ahmed Khan is currently the chairman of Pakistan Dairy Association (PDA), the umbrella trade body of firms operating in the formal sector dairy value chain. PDA members include corporate dairy farms; packaging manufacturers; dairy processing units in UHT, pasteurized, and powdered milk categories; value added dairy products; and flavoured drinks.

Khan is also the Managing Director of FrieslandCampina Engro Pakistan Limited (FCEPL), a market leader in UHT milk category. He has over 20 years of leadership experience in FMCG industry. Prior to joining FCEPL, he had served as CEO at Iffco UAE, and Reckitt Benckiser Pakistan.

Pakistan’s dairy industry is back in the news after 17 percent sales tax was proposed on value-added dairy products in the federal budget for financial year 2021-22. In his conversation with BR Research, Khan explains how excessive taxation disincentivizes investment in the agro-dairy value chain and encourages consumption of unsafe loose milk and dairy products. Below are the edited excerpts:

BR Research (BRR): News reports prior to budget announcement had indicated that the government had agreed to restoration of zero-rated tax regime for the dairy industry. What seems to have changed minds in Islamabad?

Ali Ahmed Khan (AAK): Although Pakistan Dairy Association has been making presentations to policymakers for the last three years, the change of gears in Islamabad - especially government’s pro-growth agenda - inspired hope that zero-rating would no longer be a taboo.

This year, the industry’s point-of-view was also well-received. Prior to the budget announcement, the industry received assurances from various stakeholders that favourable revisions would finally be wrought into the tax regime. The industry made commitments in writing confirming that benefits accrued from tax relaxations would be spent on consumer education regarding safety and hygiene of processed dairy products.

Not only was zero-rated taxation not restored, additional taxes of up to Rs6 billion have been proposed on dairy products. This has left the industry in a state of shock and dealt a blow to our confidence.

BRR: The objective of proposed zero-rating is to facilitate consumer conversion from loose milk to safer substitutes in the processed category such as UHT. How does imposition of GST on value added products such as tea whitener hurt that goal?

AAK: Since the removal of zero-rating, the dairy business has suffered losses for three years, breaking-even only during last year. UHT milk volume shrank for three years before inching back up due to Covid-led rise in offtake. Within the tea-whitener segment - which once made up more than half the industry volume - offtake is down by almost 90 percent.

At a time when industrywide capacity utilization is less than 50 percent, dairy companies cannot be expected to put money behind category conversion. When volumes are on a declining trend, the industry does not have the desired economies of scale to drive category growth.

BRR: You noted that UHT volumes have recovered over last year even though zero rating was not restored. The budget proposal is tax neutral viz processed full cream milk. Is there any reason to believe that the category volume won’t continue to grow at its current trajectory?

AAK: Milk volumes have slightly recovered because the industry has embraced margin attrition in the face of cost escalation. In fact, most dairy processors did not pass the adverse impact of zero-rating removal onto consumers. However, the industry cannot subsidize safe-milk consumption in the country indefinitely.

Four years ago, dairy processors procured raw milk from farmers at Rs 45 per litre, while packaging cost stood per litre at Rs 15. Today, ex-farm raw milk price has reached Rs 75 per litre, while packaging cost is no less than Rs 25 per litre. Meanwhile, total volume processed has declined due to a slump in tea-whitener segment. The unit economics has changed dramatically over the years. Dairy companies either stand to lose volume substantially if they increase prices to maintain profitability or bear significant financial losses if they sell at existing prices to retain volume. We are in a lose-lose situation, and the government is bent on making things worse.

BRR: Is it fair to place blame for decline in tea-whitener volume squarely alone on unfavourable tax regime?

AAK: Tea-whitening volumes declined because regulatory authorities under previous regime went on a rampage against its perceived safety and hygiene. Later, the issue was taken up by the judiciary, where it was argued – without any scientific evidence – that tea-whitener is unsafe for human health. This misguided campaign that received regulatory backing wreaked havoc with tea-whitener volumes, damaging its acceptance among consumers irreversibly.

BRR: In hindsight, was it a mistake to invest in tea-whitener segment, instead of putting money behind promotion of full cream milk category?

AAK: Let’s not forget that milk use for tea-creaming accounts for more than 50 percent of milk consumption in the country. As long as tea-whiteners pass the regulatory and scientific definition of safe-milk, it is a wonderful business opportunity.

Processed tea-whitener is a much more nutritious and healthier substitute to the unhygienic loose milk traditionally used for tea-creaming. Coffee mates and tea creamers are common choices available to customers around the world, both in developed and developing markets. The opportunity still exists, as evidenced by success of powdered tea-whiteners. Sadly, the regulatory witch hunt has had a lasting impact on consumer perception of tea-whiteners in liquid form.

BRR: Do you believe a partial zero-rating regime – where only full cream milk category is zero-rated – is a more realistic resolution to this problem? Especially considering that the federal government is resource starved and can ill-afford tax breaks?

AAK: The industry will not say no to any part of the problem that the government agrees to address. However, we will continue to fight for what we believe is our right. Does Pakistan need cheaper cars and cell phones; when affordable, safe, and healthy nutrition is out of the reach of millions of Pakistanis?

Full cream milk alone is not the only source of healthy nutrition. A slice of cheese and a glass of milk have equal amounts of nutrition. Nutrition also comes from powdered milk, cheese, butter, as well as flavoured milk. If the current administration is serious about eradicating malnourishment from Pakistan, it must remove GST from all dairy and dairy based products.

BRR: A granola bar may be more nutritious than both a glass of milk and a slice of cheese. Surely, nutritional composition alone cannot determine which goods or services should face consumption tax.

AAK: Indirect taxes on consumption reduce demand. Moreover, the GST imposition will render the nascent dairy value-add segment uncompetitive in face of cheaper imports.

Three years ago, the then finance minister declared that tariffs on imported cheese were raised to support local industry and import substitution in dairy value-added products. Now that the domestic industry is finally expanding into value-added sector, GST has been raised which will hurt price competitiveness prohibitively.

The size of domestic cheese market is close to 12 thousand tons per annum. 99 percent of domestic cheese consumption targets middle-income segment, where retail price is no more than Rs 30 – 35 per cheese slice.

Although it is true that the number of domestic artisan cheese producers has mushroomed, it mainly consists of small, cottage industry. And while their target market may be high-end customers, the government will struggle to collect any taxes from them because of their undocumented nature.

So, why is only healthy nutrition-based consumption for the middle-income segment being penalized?

BRR: What commitments did the industry make in exchange for restoration of zero-rated regime?

AAK: The industry committed to spend Rs1 billion annually on educating consumer regarding the safety of processed, and dangers of loose milk. This would have promoted category conversion and deliver a win against stunting and wasting; an agenda championed by the honourable Prime Minister himself.

Furthermore, we committed to spend an additional Rs1 billion on dairy development, and another half a billion rupees on regulatory capacity development for milk safety testing. But most importantly, the industry promised collective investment of Rs8 billion on capacity expansion and BMR.

In exchange, the industry demanded restoration of zero-rated regime; legislation for safe-milk consumption such as minimum pasteurization laws; and, for public officials to participate in consumer awareness campaigns promoting consumption of safe, processed milk.

BRR: What will be the impact on demand for processed dairy products if the GST is not reversed?

AAK: It is pertinent to note that GST has been increased from 10 percent to 17 percent on all dairy value-added products, including powdered milk. This includes essential food items such as fortified powdered milk consumed by children. Remember that powdered milk such as Nido are part of Sensitive Price Index (SPI), which is the official classification of essential goods for bottom-of-the-pyramid customers. If eradication of stunting and wasting is an objective for current administration, should it be increasing taxes on powdered milk for children?

Similarly, other essential products that will now face 17 percent GST include processed yoghurt, butter, dairy cream, liquid tea-whitener, tea-whitener in powdered form, fortified powdered milk, and flavoured dairy drinks. Tax burden on one company which has the largest share in powdered milk will increase by Rs 3 billion!

BRR: As processor of locally produced milk and milk powder, does PDA support increase of tariffs on import of whey powder, milk powder, and fat filled milk powder that is mainly used in the snacking and dessert segment?

AAK: PDA advocates import of powdered milk in the country, as imported milk represents only 1 percent of total domestic milk consumption. Thus, dairy farmers will not face any serious challenge from imported milk (in powdered form). Previously, duties on import stood at 50 – 60 percent, which after imposition of proposed GST will rise further.

Even though Pakistan is one of the top five global milk producers, the quality of milk produced domestically is very poor. Moreover, because cold chain infrastructure is virtually absent, most of the excess milk during the flush season cannot be stored for later use during the lean season, when there is shortfall.

Thus, milk powder is imported to make up for seasonal shortfall. Another reason driving import of milk in various forms is to fortify low quality, raw milk used in several dairy based products to achieve optimal nutritional composition.