Government seen getting less tobacco revenue despite hefty duty hikes

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This article first appeared in Corporate, The Edge Malaysia Weekly, on July 4 - 10, 2016.

THE government stands to derive less excise revenue from the cigarette industry this year despite having raised the excise duty for tobacco by a hefty 36% last November.

The hike, which led to a price increase of between 23% and 26% for cigarette packs, has hurt the sales volume of the legal cigarette players, but has driven up volumes in the illegal market to an unprecedented high.

According to the Confederation of Malaysian Tobacco Manufacturers (CMTM), legal volumes have fallen by a steep 30% as at end-March this year since the excise hike. Illegal volumes, meanwhile, have shot up to account for 45.6% of the entire Malaysian cigarette market as at December 2015, compared with 37.4% two months earlier, a Nielsen study on illicit cigarettes showed.

JT International Bhd (JTI), one of the country’s three key tobacco players — the other two being British American Tobacco Malaysia Bhd (BAT), the dominant player with about 60% market share, and Philip Morris Malaysia Sdn Bhd — flagged in May that the total sales volumes of the three players would likely decline by 28% this year to 7.35 billion sticks, from 10.5 billion sticks last year.

Assuming this is the case, the government’s collection of excise from the three players this year will come to just RM2.94 billion (7.35 billion sticks multiplied by the excise duty of 40 sen per stick).

Industry sources say, considering that the three key players command about 94% of the legal market, with the rest of the market taken up by smaller players, it would mean the government stands to derive an estimated RM3.127 billion from the industry.

This would be a substantial drop from the RM3.66 billion in excise duty collected from the industry last year, a figure cited by the Royal Malaysian Customs Department deputy director-general (enforcement and compliance), Datuk Matrang Suhaili, two months ago.  

This is unlikely to sit well with the government, considering that the cigarette industry is the second largest contributor to its total excise collection, after the automotive industry.

Last year, in the Finance Ministry’s federal government revenue estimates for 2016, it was estimated it would collect RM12.41 billion in excise duties in 2016, of which RM3.582 billion was expected to come from the cigarette industry.

The reason the government had raised the excise duty by an unprecedented level in the first place — a move that took the players by surprise as there had been no prior industry consultation, they say — was to improve its revenues, and reduce the nation’s cigarette consumption.

Industry players, however, point out that the drastic tax hike has not achieved the intended objectives due to the high level of illegal cigarettes in Malaysia, understood to be one of the highest in the world. They have asked the government to consider a moratorium on cigarette excise for three years, starting 2016, to allow legal volumes to stabilise.

“The hefty excise increase in November 2015 severely impacted legal volumes, therefore total excise collection for the government in 2016 will be less than last year. Additionally, instead of reducing consumption, what we are seeing is that consumers are going to illicit products, which are four times cheaper and readily available.

“As a result, according to Ministry of Health’s (MoH) numbers, there is actually an increase in overall smoking rates,” Guilherme Silva, JTI’s managing director, tells The Edge via email.

“If the objective of the excise hike was to collect more revenues or reduce consumption, it is simply not working,” he adds.

The MoH data he was referring to was based on the ministry’s National Health and Morbidity Survey in 2015, which revealed that there were 4.44 million smokers daily in Malaysia. The average daily consumption was 15 sticks, while the annual total consumption was 24.3 billion sticks.

This is higher than the numbers in a 2011 survey by the ministry, which revealed that there were 4.3 million smokers daily, with average daily consumption of 14 sticks and annual total consumption of 22 billion sticks.

“The 2015 numbers show that consumption was 24.3 billion stick a year, but given that the legal volumes are just 10.5 billion sticks, the MoH data means that there are 13.8 billion sticks that are unaccounted for, which suggests that 56.7% of the market is illegal,” an industry source remarks.

The players are worried that even a small hike in excise duty from now will drive illicit volumes up even further and impact their own volumes. They are required by law to pass on excise duty hikes to consumers. The retail price gap between legal and illegal cigarette packs is huge — a legal pack sells for RM17 compared with RM3 for an illegal one.

“Usually, it takes three to four months for industry volumes to adjust after an excise duty hike. But after the recent major hike, we’ve not seen the stabilisation yet. Our understanding of the market has been thrown out of whack and it’s hard to know where the bottom is,” says an industry source.

The request for a stay on excise duty hikes comes at a time the industry is already going through some of its most challenging times. Except for 2012, total legal industry volumes have declined year on year for the past 12 consecutive years mainly due to punitive excise tax hikes and regulatory changes. Illegal volumes, however, have gone up.

The MoH recently underlined its tough stance against smoking with the introduction of new initiatives under a National Strategic Plan for Tobacco Control. “Regulations being studied include the expansion of no-smoking zones, restrictions on point-of-sale advertising, a higher minimum pack price of RM10 a pack [from RM9 a pack, to be implemented in August 2016], introduction of plain packaging and further excise duty hikes,” says AmInvestment Bank in a research report on the tobacco sector last Tuesday.

AmInvestment also noted that under WHO’s Framework Convention on Tobacco Control (FCTC), excise duty should constitute at least 70% of the final retail price, which suggest that there may be room for additional excise hikes in Malaysia given that such taxes only make up roughly half of the retail price now.

However, an industry source says the guidelines to the implementation is non-binding and says nothing about any specific rate as an obligation. “It recognises the sovereign right of countries to determine and establish their own policies,” the source says.

Most analysts have a “hold” investment stance on BAT, the only listed player. BAT recently announced that it would ease its Malaysian manufacturing operations by the second half of 2017, citing the more difficult operating environment brought about by the continued growth in illicit trade.

“The industry is already at a tipping point and will not be able to withstand another excise increase this year. In the current operating environment where consumer sentiment is at a low, another round of excise increase will only produce a no-win situation for both the government and the legitimate industry as consumers will switch to cheap, unregulated illegal alternatives,” CMTM said in a statement in March.