The tobacco value chain is the most enterprising SME sector in Pakistan, says a report recently released by the SBP. Although its cultivation may not be that widespread, tobacco not only earns forex but contributes the most to Pakistan's excise tax base. Unfortunately, there are two main problems that have capped the growth of this industry - illegal cigarettes and lack of agricultural credit.
The predominant use of tobacco is in the form of cigarettes, though some is used in Hookah and chewing as well. As most know, the only two names worth mentioning in cigarettes are PTC and Philip Morris International, who collectively formed around 99 percent of the legal cigarettes manufactured, according to the SBP report. Sales, income, and customs taxes aside, cigarettes and tobacco contributed over Rs75 billion in excise duty alone to the exchequer in FY15 (PTC's total taxes in FY14 were Rs74 billion!).
But the legal sector isn't all there is to the story; reports by Nielsen and Oxford Economics indicate that one in every four cigarettes consumed in Pakistan is illegal, with Euromonitor claiming the same number is almost one in three. As a result of this, the state loses out on some Rs20-29 billion in taxes, based on whose numbers you go with.
Domestically produced illegal cigarettes are the main problem - they account for 80-85 percent of the total illicit sector. Other than that, smuggled cigarettes (mostly from Afghanistan) account for the remainder. Since these cigarettes evade taxes, they sell at exorbitantly lower prices, eating away at the market share of the legal sector and creating a non-level playing field.
A source at one of the big two cigarette companies told BR Research that PTC had the leading market share in south Punjab, but has lost it due to the "Mardan walas" (the illegal manufacturers, who are mostly located in KPK). He said these illicit manufacturers have a minimal setup and hence are hard to crack down on, having greater agility.
The second major problem is credit to the tobacco growers. Tobacco cultivation is highly input intensive, involving not only fertilizers and machinery but fuel wood and kilns for the curing process. Moreover, the entire value chain is heavily regulated and taxed. As per the SBPs report, the cost of production of one hectare of tobacco is around Rs4 lac.
Contractual farming in the tobacco value chain presents itself as an advantage; the big tobacco companies provide seeds on loans to the growers which are adjusted in procurement, and the sale of their produce is guaranteed. Other than that, however, the growers seem to be on their own in terms of working capital requirements. In the absence of financial products to cater to the small farmers, credit is sought from the informal sector at far higher mark-ups. The SBP report mentions that the main cost in the curing process is the fuel wood which is available at Rs400 per 40kg, whereas for two-month credit the producer will have to pay Rs600 for the same.Three main steps need to be taken. Firstly, the crackdown on illegal cigarette manufacturing needs to be intensified so as to provide a level playing field and increase tax collection. Secondly, credit must be made available to the farmer so that he reduces his reliance on the informal sector (this holds true for commodities other than tobacco as well). Finally, some of the duty that is charged on the tobacco value chain should be reinvested into it to develop it further - our tobacco exports for the first quarter of FY16 have dropped 60 percent year-on-year in terms of volume!
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