Oxford Economics report details wider impacts of tobacco smuggling in SL

The implications of the illicit tobacco market in Sri Lanka go beyond revenue and impinge on policy and disrupt sensitive socio-economic value chains. The legitimate sector is not a standalone entity and there are extensive supply chains embedded all across the economy supporting over 71,600 jobs in whole. Further growth of the illicit tobacco sector will impact these jobs and the development potential of the country

Global forecasting and quantitative analysis expert, Oxford Economics, states that uncollected tobacco tax revenues are not the limit of potential consequences to Sri Lanka due to illicit trade. 

Pete Collings, Director of Economic Impact Consulting, Europe and Middle East at Oxford Economics says when prices increase rapidly beyond incomes, consumers naturally shift towards cheaper alternatives. Over the past five years, the share of legitimate products in Sri Lanka have shrunk dramatically, though smoking incidence has hardly seen any change, he adds. 

Collings was speaking exclusively to the Daily FT, following the release of a report titled ‘The economics of illicit tobacco in Sri Lanka’. The study highlights the opportunities presented by the industry to reduce the country’s national debt, drawing attention to the growth in the illicit activity. 

The report finds the Government lost as much as Rs. 35.3 b in revenue last year due to smuggled cigarettes, as taxes on legal products increased as much as 101% from 2015 through 2019. More than 46,700 jobs are directly reliant on the legitimate tobacco sector in Sri Lanka, while the industry also provides wider support to retailers numbering over 41,600.

In addition, the legal industry also generates Rs. 33 billion in GDP infusing over Rs. 120 billion in Government revenues. This legal value chain has been put at risk due to the shift in consumption towards illicit tobacco products, the Oxford Economics report adds. 

“It’s not just the high prices, it is the speed at which prices change. If it becomes less affordable to buy a legitimate product the shift is quite dramatic. However, if price increases take place on par with incomes – which has not been the case with Sri Lanka in the past few years – then the affordability issue does not arise, as it is the same amount on relative terms. There is also the demand and supply factor. If consumers cannot buy at this price they go to alternatives, because they cannot satisfy their demand. Then comes the supply angle, as there must be means for smugglers to bring illicit products into market,” Collings says. 

Elaborating further, the Oxford Economics Director remarks the illicit activity is affecting Sri Lanka in four distinct dimensions. In the first place is the obvious economic impact, as there is significant tax evasion due to high prevalence of smuggled products. He adds the range is dependent on how consumers respond if they were to shift back into the legitimate market, and therefore estimates the annual loss to be around Rs. 35 billion at present. “However, despite illicit cigarettes being priced far lower than legitimate products, the revenue loss is quite sizeable, he says; a third of what is currently being collected from legitimate products. 

The second aspect is the impact on Government policy. Regulations are drafted and enacted by Government to control many aspects of the market. These include public health, access and visibility to minors, messaging and more. The Government is able to engage with the legitimate market to drive its policy. This engagement is disrupted where there is high prevalence of illicit, which leads to undermining of Government policy. The cheaper unregulated illicit products make it easier for younger smokers to be involved with the market, Collings says. 

Also, significant consideration is the reason why smugglers engage in the trade. Besides profits, it is also important to factor what they do with those profits. In addition to reinvesting on more tobacco products, they often diversify into more product lines and these profits are also used to fund various criminal and terrorist activities for criminal groups, it has been revealed. 

“Number four, you have to think of the impact on legitimate markets. Because if you have a growing illicit sector, what you are doing is you are undermining legitimate businesses, and that is not just manufacturers for there are farmers, retailers and the supply chain which has many jobs and activities that are linked together. If you have increase in illicit activity that threatens and impacts the whole value chain. You can look at countries like Malaysia which has very high illicit trade, and a number of international manufacturers have shut down factories. The legitimate industry there has reduced in size considerably. That is not a marginal change when we consider actual factories shutting down and stopping of those supply chains which have wide economic impacts,” Collings avers.  

Commenting on their Sri Lankan experience, the Oxford Economics Director notes the legitimate tobacco market in Sri Lanka has shrunk considerably over the past five years with significant growth in illicit consumption and the beedi segment. He noted that his research team noted with surprise that half of smuggled cigarettes in Sri Lanka are sold by legitimate retailers. Collings avers that whilst registered outlets are found retailing smuggled products elsewhere, the share of such traders in Sri Lanka was relatively higher. 

What is important is that Government is missing out on revenue for development, and it also needs to think about what the beedi market in Sri Lanka is doing, he adds. With beedis counting almost 60% of tobacco consumption in Sri Lanka, the question must be asked, does it still qualify as a cottage industry, he states.

“Where you have sudden increase in price of cigarettes it has led to large increases in the illicit sector and that’s had knock on effects. I mentioned Malaysia, there is also Brazil where the illicit sector increased dramatically to about 54% of the market. In 2018, Brazil’s estimated tax loss was equivalent to all taxes collected from cigarettes. Pakistan presents another similar story. But there has been a nuance to it. Tax increases led to a growing gap between the cheapest legal pack and the average illicit pack. In Pakistan there were policy changes in 2017 that reduced the gap; they halved it and the illicit trade dropped. In 2017 the illicit trade was about 38% and in 2018 it was about 33%. But policies have changed again, and the gap has grown and in March 2020 its 37% again. This shows how the illicit sector and consumers respond to price changes,” Collings notes. 

In addition to pricing, Collings also points out it is important to handle the supply element. Once people are engaged with the illicit sector they may continue to purchase from the illicit sector, he asserts, describing their experience in Malaysia where consumers sought illicit brands unaware of their origins. “Some of the illicit brands build up a degree of brand value and loyalty so you need to stop the supply side as well, not just the demand side. Each market is going to have their own dynamics at play,” he explained. 

With the illicit sector growing in complexity across many states worldwide, governments need to do more and consider new measures to curb the growth of smuggling. This may also entail considerable amounts of spending on enforcement, Collings said. 

Commenting on what advice he could offer governments to tackle the burgeoning problem of illicits, Collings avers it comes down to addressing supply and demand factors through pricing and enhanced enforcement to reduce access. “On the demand side it is really thinking about tax changes and the impacts on affordability and consumer decisions. The changes have been substantial in terms of tax, given the trends that I have seen over the last five years. Any price that is doubling in a short span of five years is significant,” he notes. It’s not that consumption is dropping, but legitimate consumption is dropping and moving into other markets which are completely untaxed. 

The Oxford Economics report on the illicit tobacco market in Sri Lanka highlights the wider implications posed by the smuggling of cigarettes into the country. The issues go beyond revenue and impinge on policy and disrupt sensitive socio-economic value chains. The legitimate sector is not a standalone entity and there are extensive supply chains embedded all across the economy supporting over 71,600 jobs in whole. Further growth of the illicit tobacco sector will impact these jobs and the development potential of the country.