From Russia with Smoke

Source from:  Tobacco Asia  10/29/2014

It's an interesting time we live in. For the past year, Russia has been in the news nearly every day… but for all the wrong reasons.  It all started with an ill-conceived "anti-gay propaganda" law, gradually moved into the crisis in Ukraine and the annexation of Crimea, and what occupies the headlines today, are the western sanctions against Russia and the Putin's retaliatory sanctions against Western agricultural products.

Still, no matter where the political winds blow, millions of people across the world keep on puffing, and the Russian Federation is certainly no exception. After China, the country is the world's second-largest tobacco market by volume. It is also the third-largest cigarette producer globally, after China and the US, in spite of the fact that much of its high quality tobacco is imported. Until recently Russia had been a hugely attractive market, with the the "big four" – PMI, JT, British American Tobacco (BAT) and Imperial Tobacco Group – accounting for some 95% of tobacco production in Russia. As a result their brands also dominate the market, although distribution in the country remains a largely domestic business.

As was often the case in other countries, trouble started brewing when Russia ratified the WHO Framework Convention on Tobacco Control on June 3, 2008. Russia implemented regulations requiring health warnings on 30% of the front and 50% of the back of the pack in June 2010. As of May 2013, the health warnings on the back of the pack are also required to include graphic pictures. Regulations still allow descriptive words such as "light" and "low-tar", as long as the mandatory health warning on such products also mentions that these descriptors do not mean that they are less harmful to health.

The first stage of Russia's anti-tobacco law came into force on June 1, 2013. It instituted a bans on smoking in some public, including in government buildings, healthcare and educational facilities, cultural sites, sports stadiums and on public transport. Still, the first stage was relatively mild in comparison with what was to come.

But "the big one" hit exactly a year later, on June 1, 2014. The second stage of the law banned all forms of tobacco advertising and smoking in restaurants, cafés, public eateries, hostels, hotels, pubs, nightclubs, railway platforms, and airports, as well as on trains and vessels. The only exception to the otherwise comprehensive ban was long-distance passenger ships. It also demanded that cigarettes be hidden from customers at any points of sale in stores and supermarkets. It further strictly prohibited displaying people smoking onscreen and on stage.

Not surprisingly, the law has already sparked controversy. The Russian Association of Restaurateurs and Hoteliers, together with the movement "For the rights of smokers", has launched a petition demanding to postpone or reject the restrictions on smoking in restaurants, cafés, and bars, fearing losses of profit.

Such efforts might postpone the inevitable, but they are unlikely to succeed. Russia is not in the grips of one of toughest anti-smoking legislation in the world. Some deputies of the State Duma say that there are attempts to soften the anti-tobacco bill. But Nikolai Gerasimenko, deputy head of the Russian State Duma Committee for Public Health, is unmoved: "Under no circumstances are we going to support measures aimed at loosening the law."

Excise tax policy

The overall tax policy for the years 2015-2017 was approved by the Russian government this May. In particular, it states that in 2015 the excise tax on cigarettes is expected to increase by 20% to 960 (US$26.66) per 1000 sticks, plus 9% of the estimated value, calculated on the basis of the maximum retail price, but not less than 1,250 (US$34.70) per 1000 sticks. In 2016, this figure will go up 28% compared to the previous year, to 1,200 per thousand sticks, plus 9.5% of the estimated value, but not less than 1,600 rubles per thousand. In 2017, the excise tax already should amount to 1,320 per thousand, plus 10%, but not less than 1,760 per thousand. According to expert estimates, it would mean that in 2017, the average price of a pack of cigarettes will be nearly 90.

But then the Ministry of Finance proposed to adjust the excise duties, including the ones on tobacco. A new draft called "The main guidelines of budgetary policy for 2015 and for the planned period of 2016 and 2017" was published on July 10. It defines the growth of the ad valorem component of the rates as 14%, 16% and 18% in 2015, 2016, and 2017, respectively, with minor adjustments to the second component of the rates. The Ministry of Finance believes that the adjusted arrangement would not significantly increase the tax burden on the popular budget varieties of cigarettes, yet will still increase fiscal revenue from higher taxation of luxury brands. Such an adjustment, according to the ministry, could bring in an additional 16.6 billion in 2015, another 16.6 billion in 2016, and as much as 96.2 billion in 2017. This draft document has not yet been voted on by the government.

But the vast experience of tobacco multinationals in many other countries shows that a sharp increase in excise taxes and, consequently, cigarette prices, only leads to an increase in illegal cigarette sales.

"It is worrisome that the authors of these legislative initiatives deliberately use the countries of the European Union as a benchmark for Russian excise tax policy offers, when it is well-known that their excise policies led to a 30-40% growth of the illegal tobacco market," said the communications and public relations director for Philip Morris Sales and Marketing Irina Zhukova.

According to director of corporate relations at BAT Russia Alexander Lioutyi, Russia is not the only place where the tobacco supply and demand are sensitive to pricing regulation. It is not often mentioned in the West, but Russia is part of the Eurasian Economic Union that also comprises Belarus and Kazakhstan, with Armenia joining in October. It is an economic block that mainly models itself after the EU, but the tax systems in its member-countries are yet to be properly harmonized. Adjacent markets as well, with "high prices of cigarettes triggering the inflow of contraband and counterfeit products into the market."

"The sharp increase in excise duties in Russia will further increase the price gap with neighboring countries. Smuggling of cheaper products from neighboring countries will receive a new economic incentive. The first to suffer from this will be the budget, because the Russian treasury will lose income from each gray market pack," says Lioutyi. He adds that even now, illegal tobacco trade already robs the Russian government coffers of around 7 billion in unpaid taxes.

Incidentally, the naïve argument that huge increases in excise taxes and tobacco product prices would lead to many people quitting smoking does not stand up to any scrutiny. In Russia the excise tax has increased fivefold since 2008, the price of the cheapest cigarette pack has seen a tenfold increase, but hardly anybody has given up smoking. On the other hand, the drop in production is consistent with the rise in illegal products on the market, especially from the countries of the Eurasian Economic Union.

"With the increase of excise duties on cigarettes, the legal market in Russia has already contracted by 5.4% to 351 billion sticks in 2013, and in 2014, it is expected to decline even futher – by 7.4% (to 325 billion sticks)," says JTI director of communications Anatoly Vereshchagin.

A slim silver lining

Still, not everything is so univocal. After all, Russia is still an absolutely massive market, and millions of smokers will just kick the habit despite the best efforts of legislators.

One interesting phenomenon on the Russian market has been the meteoric rise of slim and superslim cigarettes that all the rage these days. The country's slim and superslim cigarettes market segment has been developing rapidly since 2003. By 2012, Russia accounted for 18.8% of the global consumption of slim and superslim cigarettes. The popularity of this category is evident in the fact that in Russia they can now be found in every price range. Most of the new versions of cigarettes in the country are produced in the slim and superslim category. Demand for thin cigarettes in recent years has skyrocketed: consumers enjoy the size of these cigarettes and the shorter time it takes to smoke them.

The true testament to their overwhelming popularity is a real nugget: in a country where men casually open their bottle of beer with their teeth, more and more male smokers in Russia switch to slim and superslim varieties, despite the fact that they were originally thought of as exclusively for women. This trend gives manufacturers in Russia an excellent opportunity to create added value. A cornucopia of unique designs also includes a wide range of innovative filters of various sizes and configurations: carbon filters, filter mouthpieces, two- and three-section filters, menthol, standard monoacetate, paper and high-tech filters, and even the combination filters, such as Essentra's latest BiTech.

The future is murky

Still, one must always keep an eye on the political situation. The international war of words has quickly escalated into an economic one, and so far, nobody is seeing any light at the end of the tunnel. With its ban on agricultural products from the US and the EU, the Russian government showed it was prepared to go to some drastic lengths in its game of tit-for-tat against the West.

Enter a new bill, introduced by Oleg Nilov, the deputy head of "Fair Russia" political party. The bill, should it ever pass into law, would establish state monopoly on tobacco and alcohol in Russia starting on January 1, 2015.

The bill was introduced back in March and was tabled at the time, but it is now being revisited and seriously considered in light of the Western sanctions. It is now scheduled to be discussed at the Public Chamber of the Russian Federation. According to the first deputy secretary of the Public Chamber Vladislav Grib, "this is not only a question of economic benefits, but also public health. As for the tobacco industry, in Russia it is completely monopolized by foreign companies."

And there you have it. If the world's second largest tobacco market is pushed into instituting a state monopoly on tobacco, it is likely to have very serious consequences on the tobacco industry as a whole. The way things stand now makes the future highly uncertain. All that remains for us to do is to hope that in the end, cooler heads will prevail. Enditem