India is the third largest producer of tobacco in the world. A total of 450 million kgs of tobacco was produced in 1995. Only 80 million kgs were used for domestic cigarette production and 55 million kgs exported as cigarette tobaccos.
Developments in the Indian tobacco industry have not been in line with international trends. The share of cigarettes in the total tobacco consumption in India is about 20%, compared with 85% globally. Internationally, there has been a shift from traditional forms of tobacco - chewing tobacco, snuff, pipe, cigar/cheroot - to cigarettes, which is recognised to be the modern and more acceptable form of tobacco usage. For example, the share of cigarettes in the US increased from 2% in 1880 to 84% currently. In the UK, cigarette share went up from 12% in 1890 to 79% in 1995. In Italy, cigarettes constitute 98% of consumption today compared to 5% in 1900. Even in neighboring Pakistan, the share of cigarettes has increased significantly - from 40% in 1971 to 58% today. Quite the opposite, however, has happened in India. The share of cigarettes has declined to 20% from 23% in 1971, while overall tobacco consumption has grown. In fact, industry volumes of cigarettes declined by 12.5% between 1984/85 and 1994/95 before staging a recovery in 1995/96.
Whilst the annual per capita consumption of all tobacco products in India stands at 0.83 kg, about 45% of the world average of 1.85 kg, the per capita consumption in cigarette form is barely one-tenth of world levels i.e. 101 cigarettes per annum compared to a global average of 1,030. Per capita consumption in Japan is 26 times higher, over 18 times higher in the United States, and in China almost 15 times higher.
There are approximately 200 million tobacco consumers in India, of which only 25 million smoke cigarettes, whereas 275 million in China smoke cigarettes out of 330 million tobacco consumers. Therefore, the Chinese tobacco industry contributes 7 times more revenue at US$ 7 billion, even though tax rates per 1,000 cigarettes in China are half those in India.
The United States tobacco industry is perhaps the best example of how this industry should be structured to contribute significantly to the economy. The United States is the second largest producer and consumer of tobacco products in the world. The country has one of the lowest rates of excise duty and still collects over $ 10 billion in revenue. It is estimated that on a purchasing power parity basis, cigarette excise intensity per capita in the US is less than 5% that of India. The relatively lower rates of tax have helped the industry invest in brands and quality upgradation, enabling the United States to be the largest exporter of cigarettes in the world with a growing share. The quality of tobacco grown there is the best in the world and even though the price of American tobacco is high, experts constitute over 30% of production. Exports of tobacco and cigarettes are reported to be the sixth largest contributor to the US balance of payments and rank second in the country's exports to Japan. In comparison, even though India is the third largest producer of tobacco in the world, its economic potential is largely untapped.
a) Adding Value to the Rural Economy
Tobacco is grown in India by small and marginal farmers, mainly in non-irrigated soils, on land holdings of less than 2.5 hectares. About 400,000 small and marginal farmers grow cigarette tobaccos and over 600,000 grow non-cigarette tobaccos. No crop other than cigarette tobacco gives the farmer as attractive a return consistently in similar agro-climatic conditions. Cigarette tobaccos offer returns more than two times those of non-cigarette tobaccos and comprise mostly the fluecured variety, which are sold through government-conducted auction platforms with a minimum guaranteed price (MGP) to the farmers. As a result, the better the quality of tobacco the farmer produces, the higher his return, with a minimum return guaranteed by the MGP system.
Farmers aim to produce tobaccos of such quality and in such quantities so as to ensure timely sale of the entire production at the highest possible margin. Fluctuations in supply due to unforeseeable factors can cause intense volatility in international tobacco prices.
Tobacco farmers in India therefore tend to use the more stable domestic market as the base and target commensurate production for exports. Even globally, exports average only 25% of the tobacco produced.
The Indian tobacco market is oriented heavily towards traditional forms of consumption. Our tobacco farmers produce larger quantities of non-cigarette tobaccos (which are not exportable), and cigarette tobaccos of low grades, since the bulk of Indian cigarette consumption is not in the upper and premium segments. Measures therefore need to be adopted to:
1) facilitate transition from non-cigarette forms of consumption to cigarettes in line with consumer aspirations and international trends, so that farmers increase their incomes by producing more cigarette tobaccos.
2) upgrade consumption to the higher end, to enable farmers to produce premium quality tobaccos, which can also be exported.
Severe taxation of cigarettes is an indirect tax on tobacco farmers. In 1951/52 farmers growing cigarette tobaccos contributed Rs. 4.03 per kg towards excise duty and farmer growing other tobaccos Rs. 1.42 per kg, while the burden on other tobacco farmers increased marginally to approximately Rs. 385 per kg During the same period the huge tax increase on cigarettes has inhibited cigarettes form of consumption, thereby artificially restricting potential earnings of tobacco farmers and thus sub-optimising tobacco's contribution to the rural economy.
b) Enhancing Foreign Exchange Earnings
Global demand is restricted to cigarette type tobaccos of specified quality. India's tobacco exports at Rs. 421 crores are miniscule, given the size of our tobacco market. Less than 20% of India's entire tobacco production is exported. In comparison, Brazil, with a tobacco market smaller than ours, exports 60% of its production, and is the world's No.1 tobacco exporter with annual exports averaging more than 3 times that of India's.
As stated earlier, the principal reason for our export potential remaining largely untapped is the low quality of tobacco produced. Firstly, cigarettes constitute about 20% of tobacco consumption, as a result of which the majority of leaf tobacco produced is unsuitable for cigarette production and hence not exportable. Secondly, cigarette tobaccos grown in line with domestic market requirements are of the "filler" type, which are exportable but not of premium quality. Price is thus a major factor influencing their export, impacting farm sand rural income.
India is capable of producing the premium grades of Burley, semi-flavourful and flavourful tobaccos. While current annual production of Burley, for instance, is in the region of 8 million kgs, a production level of 50 million kgs, is achievable by the turn of the century, with the right inputs.
The huge potential for India's tobacco exports can be fully realised by upgrading tobacco consumption in line with consumer aspirations and by adopting measures to increase cigarette consumption at the premium end.
c) Enhancing Government Revenue
Revenue collection from the tobacco industry, by global standards, is modest. The reason lies in the small taxable base of cigarettes. Almost 90% of Government revenues accrue from cigarettes, leaving 88% of tobacco consumers effectively outside the tax net. Any proposal to increase revenues from the tobacco industry must facilitate growth of the revenue-contributing sector. The non-cigarette segment of the tobacco industry, which accounts for over 80% of consumption, is unorganised and fragmented, thereby making revenue collection from this segment impractical to administer. An increase in the share of cigarettes within the tobacco basket must, therefore, be the key objective of any effort to raise revenue.
India's population has a very wide band of income distribution. High rates of taxation on cigarettes have artificially kept cigarettes beyond the reach of a large number of tobacco consumers aspiring for cigarette form of tobacco consumption. The route to optimising excise revenue collection is an excise duty structure that enables marketing of cigarettes for each income segment of tobacco consumers.
In 1987, the Government of India rationalised and modified the excise duty structure for cigarettes. Ad valorem duties were replaced by specific duties based on cigarette length, the objective was to introduce a more rational system of excise levy and to reduce litigation associated with ad valorem duties. The Government created five excise slabs based on length and type of cigarettes, with rates increasing from plain cigarettes at the low end, to international size filter cigarettes at the top end. The change has been highly successful on all counts and the Government must be congratulated on this innovative step of aggregating the advantages associated with both ad valorem and specific duties.
This structure still, however, left cigarettes beyond the reach of a large number of aspiring tobacco consumers. Recognising this, in 1989 the Government introduced a new excise slab for micros at the low end. The Government in 1994, therefore, boldly experimented with a sharp reduction in the excise duty on micro cigarettes reducing it from Rs. 120 per 1,000 to Rs. 60 per 1,000. The industry responded by passing on the entire reduction to consumers. As a result, a dormant segment of the cigarette industry was infused with growth. In 1995/96, this segment contributed Rs. 90 crores to the National Exchequer, up from just Rs. 7.4 crores in 1993/94.
The excise structure needs to be reviewed periodically to ensure that the excise slabs correspond to income distribution patterns of tobacco consumers. The structure should provide easy steps for upgradation of consumption to ensure built-in buoyancy as per capita incomes increase. Such a structure would eliminate the need to review excise rates frequently. The rates at the upper end need to be lowered to favour production of cigarettes within the shores of India and render uncompetitive the smuggling of cigarettes, which denies the National Exchequer an estimated Rs 200 crores in revenue annually.
In my view, the structure is largely in place. The general table of excise duty rates, however, are too high and should ideally be brought down in a phased manner. If imperatives in the short run do not permit this, they should at least be moderated and kept stable. Moreover, the introduction of one or two more slabs would facilitate upgradation of consumption in an orderly manner.
A less punitive and rational excise duty structure would enlarge the tax base and increase revenue manifold over the next 5 to 10 years.
ii) Local Taxes:
Excise revenue collected from cigarettes is divided between the Center and the States in a ratio determined by the Central Government. This is in accordance with an agreement reached between the Center and the States in 1956; whereby excise duty on cigarettes replaced local taxes. Over the years, this ratio has progressively increased in favour of the States. As a result, the States' share has grown considerably faster than overall excise collections.
State Government have for many years levied local taxes on cigarettes inspite of the 1956 agreement. The States argue that they are only restricted from levying Sales Tax on cigarettes by the agreement and are free to impose other state and local taxes. Such a stand defeats the entire purpose of the excise sharing system, which was created to ensure free flow of cigarettes throughout the country.
In other parts of the world, tax harmonisation is being actively purused. As economies globalise, tax equalisation is necessary to prevent tax migration. Countries within the European Unions are continuously rationalising structures and reducing variations in rates to make cross border movement less attractive. Canada recently had to reduce cigarette taxes when a significant increase in rates resulted in large-scale smuggling from the United States because of the large difference in excise duty rates between the two countries.
As our economy globalises, manufacturers in India should be able to leverage the synergistic benefits of our large common market. The proliferation of varying taxes at the local level would negate this. The issue is vital for the tobacco industry and suitable legislation needs to be enacted to make single point taxation fully effective.
d) Government Regulation
In the West, tobacco and cigarettes have become synonymous, unlike in India, where nearly 88% of consumers do no smoke cigarettes. Any effort to regulate the tobacco industry therefore must take into account the industry's ability to comply. To regulate just the 12% cigarette segment would defeat the very purpose of such regulation.
Statutory health warnings have been mandated by law on cigarette packets and all cigarette advertising material since 1975. The law was extended to chewing tobacco in 1986 and gutka in 1990. Other tobacco products are still not required to carry any statutory warning. Obviously, the statutory health warning requirements on tobacco consumption need to be uniformly applicable to all tobacco products.
Regulation of cigarette advertising is a hotly debated subject the world over. Contrary to general impression, advertising does not necessarily help to expand consumer demand for a product group, especially for mature product categories like cigarettes. Nor does a ban on advertising necessarily reduce consumption. The role of advertising is to inform consumers of product differentiation in features and value, intensify competition, thereby encouraging quality upgradation, thus providing better value to the consumer. Advertising is a legitimate commercial activity employed for products that are legally grown, processed and marketed. The absence of advertising for tobacco would be a form of unintended social engineering, almost implying that 200 million adults are unable to take decisions related to personal choice.
The US, Japan, Germany and the UK together contribute the bulk of the budget of the World Health Organization, but do not ban tobacco advertising. A proposal to ban advertising of tobacco products in the European Union was vetoed by the Governments of UK, Germany, Netherlands, Denmark and Greece. In as many as twenty-nine countries, Governments permit tobacco companies to advertise their products on the basis of a voluntary code.
Cigarette manufacturers in India have already agreed to evolve and adopt a voluntary code. In the interests of consumers, given the fact that many adults do make personal choices, in favour or otherwise of tobacco use, and only about 12% of tobacco users smoke cigarettes, there is a strong case to adopt a voluntary industry code towards advertising rather than resort to legislation.