Up in smoke

Health activists have something to cheer about. In the seven months ended January 2020, Pakistan’s cigarette production went down by 33 percent year-on-year, to settle at 25 billion sticks, as per data from the Pakistan Bureau of Statistics. That’s 12 billion less cigarettes produced in the formal industry in the fiscal with five months of data yet to come. At this pace, FY20 will end with a production shortfall of 20 billion cigarettes, which is significant for an industry that is capable of making over 60 billion sticks a year.

Throughout 2019, cigarette production averaged 4.2 billion sticks a month, sharply lower than 5.1 sticks a month seen the previous year. The January 2020 production of 3 billion sticks is even lower than the average last year. The formal industry, whose financials are coming under pressure, feels that the current government’s fiscal decisions have made the illicit players price-competitive, as duty-non-paid (DNP) segment evade taxes and duties.

Recall that government had increased the tobacco FED twice (September 2018 and June 2019); besides it also got rid of the erstwhile three-tier FED regime (June 2019). The tobacco majors maintain that the illicit sector gained a market share of 34 percent in 2019 due to the excise-driven price increases, which leading players Pakistan Tobacco and Philip Morris Pakistan had to undertake to pass on the impact to consumers.

If the formal industry is being truthful that the DNP brands are the sole cause behind declining cigarette sales, it would imply that the decline in formal cigarette production has been a direct gain for illicit sector. (This would further imply that Pakistanis are not smoking less, which should disappoint health activists). The industry’s claims need to be taken with a pinch of salt, though.

It’s not like the illicit sector suddenly woke up in 2019 to undercut the formal players due to higher FED per cigarette pack. The informal sector had been alleged by the industry to have similar high market share in 2016, 2017 and 2018 as well. Going by industry data, the illicit sector may have maintained its high market share (34%) in 2019 as well; and that could mean there are other forces at work behind lower production and sales at the two tobacco majors in 2019.

Note that in the past, there has been an incidence of sudden fall in formal cigarette production one year (purportedly due to higher FED) and a sharp recovery the following year (purportedly due to relaxed FED). The situation behind this sudden slump and abrupt jump in formal production is something that needs to be analyzed closely by the revenue authorities, for 2019 was a year of massive production decline and 2020 may well be the year of significant growth. Where is the track and trace system?

Be that as it may, down the road, there will be tax impacts of declining cigarette production in the formal sector. During CY19, Pakistan Tobacco’s tax contribution stood at over Rs102 billion, a 15 percent growth year-on-year. The tax tally for Philip Morris Pakistan is estimated to be above Rs25 billion for CY19, a strong double-digit growth over previous year. However, falling sales volumes will start hurting the tax revenues this year. All eyes are on the upcoming budget to see which way the FED will swing.