Cigarettes: FED cut on the cards?

As the budget season approaches, this year there seems to be more than the usual dose of pro-tobacco news reports and advertisements being fed into the public domain. After Pakistan Tobacco (PSX: PAKT), now Phillip Morris Pakistan (PSX: PMPK) also seems to have become a prominent industry advocate. The latter’s “media advocacy forum” called “Stop Illegal Trade” recently took out newspaper ads claiming that illegal cigarettes are causing a staggering loss of Rs44 billion to the exchequer every year.

The industry has long been arguing that locally-manufactured, duty-non-paid cigarette brands undercut the legitimate players by selling smokes on the cheap. Is the industry in for a respite this budget? It’s possible that the government’s main fiscal tool to reduce smoking incidence – federal excise duty (FED) rate – may be somewhat reduced/frozen on existing two slabs, or another tier is brought back for comfort. The argument goes that lower FED provides organized players a level-playing field against illicit smokes.

The industry’s trusted argument that “illicit” cigarette trade is causing tens of billions in tax losses now has an add-on: lack of enforcement against illicit trade is threatening the viability of formal sector firms. It was hard to do business here even in pre-corona times; now consumers also seem to be falling on hard times during pandemic. The government is generally sympathetic to industrial concerns in the coronavirus days. But any tobacco relief now will be a reversal from PTI’s nearly two years in power.

The falling cigarette production may force the government to pay heed to the duopoly. As per PBS data, the formal sector – dominated almost entirely by PAKT and then PMPK – had produced 33.5 billion sticks in the Jul-Mar FY20 period, down 31 percent or 15 billion fewer sticks year-on-year. (In terms of sales, manufacturers are also recording similar volume declines). The latest monthly tally of March was also down 33 year-on-year percent to 4 billion sticks. In short, in pre-corona times, production was down by around a third; the April data, to be released next month, will reveal the initial impact of coronavirus.

On the other hand, despite the production decline, the formal sector hadn’t done too bad financially until March 2019, as per company accounts. For instance, PAKT had a local gross turnover of Rs37.4 billion in 1QCY20, up 4 percent year-on-year. This helped the firm maintain its profitability level at Rs2.8 billion. While PMPK saw its first-quarter gross turnover decline by a yearly 8 percent to Rs10.2 billion, the second-ranked player became profitable by netting Rs361 million at the bottom, compared to a net loss of Rs1.3 billion in 1QCY19.

Expect the battle of narratives – between public health and revenue imperatives – to heat up in the run-up to budget. The industry has maintained in recent years that illicit cigarette trade commanded at least a third of total cigarette consumption in Pakistan. Excise-driven price increases are to blame for the stickiness of illicit trade, they argue. But health activists and investigative journalists disagree; they claim that the true scale of illicit tobacco trade is around 10 percent; besides, there are allegations attributed to FBR officials that formal players themselves indulge in illicit trade by under-reporting production.

While there is disagreement over the true scale of illicit trade, few will disagree that strict enforcement can help in alleviating the problem. In that regard, the FBR’s quest to roll out a track-and-trace system, now in its teenage years, still remains elusive. Forced by the IMF programme last year to adopt such a system to curb tobacco tax losses, the contracting process has been predictably marred by irregularities, amid allegations of major tobacco players influencing the process and apparent conflicts of interest at the top of the FBR.

With that nuanced context in mind, all eyes are on the fiscal and enforcement-related measures that may be announced in federal budget on June 12. It is no secret that big tobacco players don’t feel good about letting half of their gross sales vaporize as FED. Let’s see if the Khan government relents on a long-term public health issue (tobacco control) at a time when all attention is seemingly focused on fighting an immediate public health issue, the Covid-19.