Nikhil Mookerji

ON November 1, ITC stocks zoomed on the Bombay Stock Exchange and Bombay Stock Exchange based on persistent rumours that Unit Trust of India (UTI) was selling its 14 per cent ITC holdings to BAT, the British tobacco multinational which already has a 31 per cent holding in ITC. On November 2, UTI announced that it was not selling its ITC holdings and the cigarette company's stocks plunged. If the rumour was a speculative ploy by a group of operators, they obviously made a killing by floating the false rumour, but a lot of small investors who latched on to the manipulators were left high and dry.

Apart from the ethics of the operation, this incident raises some important questions. If the rumour was baseless why didn't the UTI officials inform mediapersons, who were persistently seeking a confirmation, whether UTI was selling its ITC shares to BAT? Why did the UTI officials wait till the next day before announcing their denial? Because of this delay, the speculators had time to sell out after making a killing.

Of course, it is possible that this sale was discussed but subsequently turned down. The matter is reportedly being investigated by the Securities and Exchange Board of India (SEBI) who will undoubtedly want answers to the UTI officials role.

It can be legitimately argued that the cash-strapped UTI's main responsibility is to look after the interests of its unit holders and this overrides supporting the management of well-run Indian companies. But this argument should not apply to the three foreign cigarette multinationals - Philip Morris, BAT and R J Reynolds - which should not be allowed to acquire shares in any Indian company, even non-tobacco companies, say analysts. Each of these MNCs is facing criminal investigation for active involvement of its top management in cigarette smuggling across the world.

Also they are desperate to plant their roots in developing countries, particularly India and China. It is therefore, essential that the Government makes a definite policy statement firmly closing the door of foreign direct investment (FDI) in the country's cigarette industry. Although the current Industry Minister Murasoli Maran is against FDI in the tobacco industry, his predecessor , Sikandar Bhakt in 1997 supported Rothman's application to set up a 100 per cent owned subsidiary. Rothman's entry was prevented by the Foreign Investment Promotion Board (FIPB), which did not clear the application What is now required is an unambiguous policy statement debarring FDIs from investing in the tobacco industry.

Foreign watchdogs on the global tobacco industry have pointed out that every third cigarette sold is a smuggled. In India, contraband cigarettes have already chewed up 10 per cent of the domestic cigarette market. The sale of smuggled cigarettes is growing by 20 per cent each year, while legal cigarette sales are declining steadily.

It is interesting to note that although on April 1, 2001 the Government allowed legal import of cigarettes, levying an import duty of 35 per cent against a permissible duty limit of 150 per cent by the World Trade Organisation (WTO), not a stick of cigarette has been imported.

The three cigarette MNCs are facing a number of investigations and if their guilt is proved, they will be slapped with mind boggling penalties. The Department of Trade Industry, UK is investigating the suspected direct complicity of the BAT directors in international cigarette smuggling operations. The European Union (EU) has filed cases against Philip Morris and R J Reynolds in the US under the draconian Racketeer Influenced Corrupt Organisation (RICO) Act for willfully and criminally depriving the EU of its legitimate excise revenue by smuggling their brands into Europe. The EU has sought punitive action against these companies. Therefore, if the Indian Government bans investment of these companies in India, there will be no protest in WTO forum.

The three cigarette majors are facing a crisis due to the rapidly declining cigarette demand in the developed western countries, due to the growing clout of the anti-tobacco movement of the World Health Organisation (WHO). As a result, the three MNCs are saddled with huge overcapacity in the US, UK, Germany and the Netherlands. This is driving them to increasingly smuggle their cigarettes throughout the world, according to investigators.

The investigators allege the three companies manufacture cigarettes specifically for exports, which are exempt from excise duty. They then export their cigarettes to countries in different regions which levy the lowest import duty and countervailing excise duty. The MNCs using these low duty countries as hubs smuggle their cigarettes to the entire region.

With the cost advantage gained through this illegal operation, these MNCs are able to pay retailers three to four times their normal trade margins for selling their smuggled cigarettes. The investigators have listed a number of instances of key customs officials being bribed by the smuggling syndicate.

Analysts, therefore, say that it will be a short-sighted policy if the Government allows UTI to sell its ITC shares to BAT as the short-term gain would result in a much bigger long-term loss. The analysts feel that by disallowing FDI in tobacco the Indian Government has learnt important lessons from the miserable experience of several other countries which had relaxed their norms and allowed FDI in tobacco.

In each of these countries, namely Argentina, Brazil, Uruguay, Paraguay, Bolivia, Russia and China, the share of contraband cigarettes in the domestic market sky-rocketed after relaxing the norms of direct foreign investment in tobacco.

When major restrictions on FDI in tobacco were in force in these countries, the quantum of smuggled cigarettes remained in check at under 5 per cent of the total cigarette sales. But when the FDI norms were relaxed, each of these countries witnessed a dramatic surge in sale of smuggled cigarettes. The sale of contraband cigarette in these countries leapt between 37 to 50 per cent of the total cigarette sales.

Extrapolating the experience of these countries, the Indian Government will surely lose nearly Rs.10,000 crore of revenue from cigarettes every year if BAT is allowed a controlling interest in the Indian cigarette industry. It already has a foothold in the Indian cigarette industry by virtue of its management control of VST, but if it can control ITC with its huge marketing, retail and wholesale network it will be poised to flood the Indian market with smuggled cigarettes.

According to media reports, UTI may be able to raise Rs.2,500 to Rs.3,000 crore by selling ITC shares to BAT to lighten some of its financial burden. But if this sale is allowed, the Indian exchequer can lose up to Rs.10,000 crore annually. Analysts suggest, to raise funds UTI can sell some of its blue-chip stocks to LIC or GIC which generate huge investible surpluses. They also point out that there is a compelling need for the Government to amend the guidelines of the Finance Ministry and SEBI to compel foreign financial institutions (FIs) to declare whose interests they are representing when they hold strategic and sensitive blue-chip stocks.

Currently an FII can hold up to 5 per cent shares of an Indian company without disclosing in whose interest it is acting.

FIIs can also hold up to 49 per cent of a company's stake. In sensitive industries like tobacco, already being rocked by the growing menace of smuggled cigarettes, it is advisable to restrict the elbow room given to FIIs.