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Increase in tax to impact cigarette volume: ITC
Money Control - 16 Nov 2009

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In an exclusive interview with CNBC-TV18, Kurush Grant, Divisional Chief Executive of ITC, spoke on how soon the goods and Services Tax (GST) would be implemented and what impact it would have especially for sectors like tobacco.

Below is a verbatim transcript of the exclusive interview with Kurush Grant on CNBC-TV18.

Q: What have you made of the white paper on GST? Is it giving you any kind of relief that overall tax burden on ITC will go down, or do you think it might be the other way round?

A: Regarding the timing of the release of the first discussion paper, all one can say is better late than never; it is finally out. It is extremely interesting, very well crafted, well-written document. There are certain issues, obliviously, that have not been covered in this particular document which we hope will be recovered in the future. The big one obviously is what rates are they are proposing. Until we know what the rates are, the industry will not be able to comment. However, apart from the issue like rates, there are two–three other issues also which need to be clarified. The first is what kind of legislative provision would there be in a final Goods and Services Tax (GST) set of regulations and laws.

In order to ensure that classification of goods and services across every single State are the same unlike the way it is currently happening in value-added tax (VAT). The second obviously is what kind of regulations or legislation there will be to ensure that the rate of GST across states for a particular product remain the same and third, the big is how do we ensure legislatively that individual states or collectively and not able to change rates arbitrarily without a total concurrence of all the parties involved, all the states and the centre.

Q: You don’t think that problem will be obviated once the state and centre agree on a uniform or dual GST rates?

A: We certainly hope so. Unfortunately, the current discussion paper has not got any provisions for a legislative limit on it. This will obviously be discussed in the future. For example, we do know that there is a fair amount of constitutional changes which will have to take place to enable GST to come in, perhaps they are looking at that particular point of time to introduce these other legislative requirements also.

Q: You are a unique category, tobacco, but aside of the GST the centre reserves the right to levy excise and even without input tax credit, does that worry you?

A: As long as there is input tax credit on GST and throughout the world and in a lot of states of the countries there is GST or its equivalent by whatever name it is called on products like tobacco, petroleum, alcohol. In which there is input tax credit and there is a separate excise duty in variably specific in nature on which there may not be an input tax credit.

Q: There have been some people who have been whispering the ad valorem word, is it a possibility in your eyes that you have GST plus an ad valorem tax instead of an excise?

A: I would certainly hope that that would not happen for the simple reason that every single economist both in the government and in the private sector realized that a specific tax for products like tobacco which have a very high rate of taxation is always the best way of taxing the product. A specific tax is now in existence since 1987 and the advantages it has had is known to everyone, both the central and the state government as well as the industry.

Q: So from the little that you have seen in the discussion paper, assuming that the central GST rate hovers between 16-20% do you think the overall tax burden on ITC or other tobacco companies would be similar to what you have burdened with today or do you think it could be more?

A: We will have to work out details exactly, between 16–20% there is also a difference because today the tax burden, if you add up the excise duty and which on some products its on maximum retail price (MRP) and on some products its on ex-factory price, so if you add up that plus VAT and the differing VAT rates across the states, some amount of calculation will still have to be done. So until they are very sure of the actual final rates of taxation, it will be difficult to say, however, one thing is certainly there, because of the new method proposed for interstate transfer and sale of goods, the IGST as it is being called, quite clearly some amount of input tax credit which today is not going to the industry in the current VAT system hopefully will go to the industry also and that will certainly be a relief for everyone in the industry.

Q: Now we come to the big point as to whether higher taxes do indeed worry you because on the evidence of the last couple of quarters it’s not because you have taken price and it’s not affected your volume growth at all. In fact, you have seen some of the best volume growth in recent times with 8% tobacco volumes.

A: We haven’t published any volume growth numbers. Two years back when VAT was first introduced on cigarettes, the average rate then of 12.5%, the industry volume came down considerably. Last year when the excise duty on non-filter cigarettes was increased dramatically, once again the industry volume came down. At this point of time even over the last two years, if one were to go back at 1987 when the current specific duty rate system came into being, roughly the total industry has remained fairly constant over the last 30 odd years. The cigarette industry has not grown, what is interesting is that in the same period the overall tobacco industry has grown pretty dramatically and an in increase in taxation may not have an impact on overall tobacco. However, it clearly has an impact on the cigarettes form of tobacco which most people are aware nowadays is very small which is less than 15% of the total tobacco consumed in the country.

So what happens is that an increase in the taxation has in immediate impact on the volume of cigarettes because of movement from other forms of tobacco to cigarettes and those people who consume both.

Q: What do you attribute the high single digit volume growth that you have witnessed after quite few quarters?

A: I think it’s a combination of a few factors; the first is that we have got a strong brand. Brands that are doing relatively well and the second issue is that Indian economy has grown pretty considerably over the last few years and this momentum of growth of the Indian economy has seen an upgrading into cigarettes as happens every single time the economy grows. Ultimately, the rate of growth of cigarettes within the overall tobacco basket will clearly depend upon the rate of taxation on cigarettes relative to rate of taxation on other tobacco products and on how well the Indian economy is growing.

Q: But in your case it appears that king-size volume have grown even faster. Again you don’t publish numbers but it appears that we may actually see double-digit percentages in king size volumes, is it because of upgrading or something else?

A: There has been upgrading constantly over the last 15–20 years. There is no question about it and people have been upgrading which is one of the reasons why excise collection has been so rigorous and good as far as the government is concerned because the process of upgrading also increases revenue collection of the government and upgrading has certainly taken place.

Q: Do you see this kind of volume growth being sustainable because it has come after a long time––2008––which wasn’t a great year for tobacco volumes. Is it just a one-off or is it sustainable?

A: For that I will have to ask the Finance Minister because 2007–2008 the industry actually shrank in terms of overall cigarette volumes, 2009 thus far has been pretty good. Keep in mind that there was no change in excise duty this year as far as cigarettes are concerned and that has helped the industry get some amount of recovery for the loss it had made for the last two years.

Q: At the higher end product level, the launch and aggression of Marlboro has not made any dent at all in your volume growth?

A: In all fairness one must understand that Philip Morris has been marketing their products in India for several years. Recently, they have changed their source of manufacture to a domestic manufacturer. Moreover, they have changed their distributors from a series of smaller distributors to a known company JPI Industries; consequently, their distribution mechanism in India has changed.

But Philip Morris has been in India for the last four–five years and to that extent their volume at this point of time doesn’t appear to have grown to the extent one would have thought for the simple reason that they have already been here for four years, and it is not a new launch by any chance at all.

Q: There is some talk of creation of a new entry level filter cigarette segment by the government––encourage conversion from bidis to cigarettes––is that a reasonable expectation?

A: The objective of any entry level excise slab for filter cigarettes is very clearly not aimed at conversion of bidis to cigarettes but it is aimed at the huge illegal Rs 1 filter segment which came into existence into India around two–three years back whilst little bit was always there.

After VAT came into India on cigarettes in 2007 and after high rates of excise increases on non-filter cigarettes last year, this illegal Rs 1 filter segment absolutely exploded. Today, it is estimated that this segment accounts for something like 12–13% of total cigarette industry in the country. They don’t pay any taxes, they don’t pay any excise, they don’t pay any VAT at all, and they don’t pay any taxes at all. So if there was an entry level filter segment which enabled manufacturers to produce a fairly good cigarette which could compete at an attractive price point against these illegal players, it will certainly help the industry.

Q: Are you expecting it though, this is a statement of principle?

A: It’s a statement of principle. The tobacco institute has certainly made representations to the government on this and we hope that the government brings this into being.

Q: Talking about fast moving consumer goods (FMCG), there is a lot of talk in the market and I think the ITC management has conveyed that as well that they are about to launch another personal care or enter another personal product category. By when do you think that decision will be taken?

A: In all fairness whenever the decision is taken, I rather don’t think I will be able to talk about it publicly.

Q: But is it going to happen in the next calendar year, the next four quarters?

A: I am afraid I really cannot comment upon that. It would be inappropriate.

Q: You cannot share what that category would be?

A: I am afraid not. That would be competitive information.

Q: Why your investors and analysts would be worried about that is that they are probably trying to map a timeframe by which your FMCG business starts getting out of the red and into the black. But if you launch or enter new category maybe losses will just get staggered for a longer length of time. Is that a legitimate concern because of start-up cost or launch costs?

A: Any start-up into a new venture, there will always be a period of time before the business starts recovering. In the case of FMCG, the main inputs on product development innovation and communication, if it was, let’s say paper mill, the main inputs would be in physical assets and capital assets. But ITC has got a robust portfolio both across businesses as well as within the FMCG businesses. So you have got certain categories and brands which were launched seven-eight years ago and some newer ones which were launched just few years ago. Thus, with a combination of these you got certain categories which have crossed the humps, certain categories which are still growing and require investments.

Hence, to that extent I really would not be too worried or concerned about introduction of a new category especially now in a space where we have enough category knowledge. We have enough understanding of the industry space and we are making progress in the market place.

Q: By when do you think the FMCG business will start generating profits, at a composite level?

A: I would not care to make a forecast on that.

Q: What about biscuits as a category? Have margins improved there?

A: Yes certainly, in fact, over the last few years we have taken a great deal of efforts to ensure that with innovative product development margins have improved at the same time to ensure that what the consumer gets in terms of value has also improved. So combination of these has enabled our FMCG business to surge. In fact, if you have been noticing over the last few quarters the losses in the FMCG category have actually been coming down whilst simultaneously turnovers have been increasing pretty dramatically.

Q: Your agriculture business margins have also gone up quite a bit. Is it because of that leaf tobacco shortage internationally?

A: It would be a combination of tobacco as well as other commodities but quite clearly leaf tobacco prices on exports from India have, the prices have been increased dramatically over the last few years and that is certainly one of the reasons for that.

Q: You are sitting on a large kitty of cash at ITC, any thoughts on how to utilise it? Is there any thought at the management level of giving out a large dividend or giving some of the cash back to shareholders?

A: It will be totally inappropriate for me to even talk about that. But as the Chairman has mentioned in the past in his annual general meeting (AGM) speeches, ITC will continue to invest in existing businesses whether it is investment in paper, investment in tobacco, investment in FMCG. So, we clearly have plans to continue growing and continue investing to increase our capacities, increase our quality, variety, etc. which are available. So investments will continue, very clearly so.

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