S.L. RAO

I have been a proponent of competition and open markets except twice : when ICI with around 12 per cent market share tried a hostile takeover of Asian Paints with a 40 per cent market share; and earlier, when BAT tried to impose itself on the well-managed Indian company – ITC. However, I took it for granted that companies, and especially large multinational ones, would always follow the laws of the country in which they were manufacturing or trading. Documents made available by websites dent this belief, at least as far as cigarettes are concerned.

Even more interesting is how the attempt to maximise profits irrespective of the legality or otherwise of the sales, can circumstantially be linked to the corporate battles over almost all of the Nineties between ITC, its largest single shareholder – BAT, and a smaller Indian cigarette company, VST, in which also BAT is the largest single shareholder. BAT owns 31 per cent of ITC shares and has two out of 14 directors while public financial institutions with 34 per cent have five directors. With 32 per cent of VST shares BAT has five (one so-called independent) out of seven directors, public financial institutions with 23 per cent have two. ITC’s cigarette business is far more profitable than that of VST. Until a few years ago, VST top management was largely seconded from ITC, and most returned to ITC. This changed during the Nineties when, I am told by ITC sources, the loyalties of at least some of the seconded managers switched to BAT.

After the government relaxed the rules for foreign direct investment, they clarified in 1998 that foreign financial/technical collaborators with previous joint venture or technology transfer or trademark agreement in the same or allied field in India, would have to give detailed justification to the government for a new venture. They would have to prove that the new proposal would not jeopardise the interests of the existing partners. However, the manufacture of cigarettes was still subject to industrial licensing, as was any expansion of capacity. The government also clarified that 100 per cent FDI would be considered, subject to the other conditions.

If BAT wanted independent production facilities, they needed ITC’s agreement because of the other existing trademark agreements with ITC for the manufacture of top premium brands. At present it has the excellent distribution and manufacturing capacity of ITC for the purpose. However, Indian excise duties, sales and entry taxes on such premium cigarettes, which are "king-size", vary on average between 60 and 70 per cent. This makes such cigarettes very expensive and so limits their sales, erodes profit margins of manufacturers who must try to keep prices down in order to achieve volumes, and denies the retailer the extra margins he would make if there were no taxes. This was a situation that most multinational companies in markets like India faced when there were quantitative restrictions and high duties on imports.

Some companies may have tried to beat the import ban by encouraging their distributions in neighbouring markets like Dubai and Singapore, to use "unofficial" or illegal routes to send their products to India. They also went all out to encourage duty-free sales, in duty-free shops, to returning Indian workers from west Asia and to naval personnel who are entitled to duty-free cigarettes. These would be resold at low prices in India. In the Seventies and during much of the Eighties, some companies and distributors were so well-organised that one saw their salesmen in major wholesale markets, booking orders from dealers for such imported goods, which were delivered within a given time schedule. Many such products were also advertised in programmes beamed into India from outside, like Radio Ceylon. There was advertising, supply and a distribution chain for such products.

Internal company documents filed by cigarette companies in the United Kingdom and the United States were deposited in courts in the US and UK. Some have been published on websites. They suggest that the largest cigarette companies in the world were actively involved in promoting such "duty-not-paid" sales. A UK parliament inquiry in 1999-2000 quotes a witness that "a majority of the present management board of the company (BAT) can be shown to have been complicit in the commission of criminal offences overseas." In one company document, there is concern about reconciling the image of the company as "clean and ethical" while engaging in such operations. This "ethical correctness" was sought to be achieved via "letters to government, presentations to them, papers prepared for excise departments", and so on. The main issue for the company was to achieve the highest market share in the "duty-not-paid" business.

Cigarettes are a dying business in developed countries, especially in the West. But markets like India have enormous potential for growth, given that over 80 per cent of smoking is of bidis, and these smokers will, with prosperity, graduate to cigarettes. The premium market is at present small, but could be much larger if the prices were not so high because of taxes. Hence the strategy to stimulate DNP cigarettes. The packets may not meet the requirements of the Indian laws, but this is a small problem that can be tackled in the notoriously lax Indian system.

The lowering of import duties in Bangladesh and Nepal, and the import duty concessions by India to these countries, now make DNP sales much easier. The long and porous borders enable the DNP (smuggled) entry not only of premium cigarettes, but also of lower priced ones, since the price in many cases is lower even than the taxes charged per cigarette in India. A recent survey by the Indian Market Research Bureau estimates that around 50 per cent of king-size cigarettes now sold are DNP, valued at consumer prices at around Rs. 70 crore a month.

A DNP business with a legitimate manufacturing front in India ensures that any sales can be said to be part of the same production. This may be the case today with many other consumer products flooding in from other countries where they are cheaper and which are also made in India. Some duty-paid import, some local manufacture, and a large quantity of no-duty imports can maximise the profit for the multinational corporation. The Indian manufacturing might be hurt but money is made in countries whose exchange rates are favourable for the MNC.

As far as BAT is concerned, BAT’s shareholdings in both ITC and VST do not give it a majority. ITC has a management that does not depend on BAT, while VST is almost a one-product company without any great strengths of its own, in which also BAT is not the majority shareholder. To be able to make premium cigarettes for BAT it needs money. BAT can finance it if it had majority control. This may explain the suspicion that the recent attempts to buy almost 20 per cent of VST shares could be because it is BAT that is the buyer.

Any shareholder including the institutional shareholders should be free to sell and get maximum value. But the government should stop any "fronting", or back-door acquisition. All imports of cigarettes as of other consumer products should be duty paid and there must be strong penalties for violations including of packaging laws.

The penalties must be on the stocking retailer, but the local manufacturer of the same brand whose company overseas has allowed the product to enter India without following our laws, must show cause why he should also not be penalized.

Our indirect tax rates must have parity with neighbouring countries to prevent smuggling. The laxity in implementation of our laws, and the ease with which people can buy their way to violating them are also to blame for such violations. Cigarettes may be the foremost instance of collaboration between respected MNCs and the mafia, but there may be others.