The Family Smoking Prevention and Tobacco Act, backed by cigarette giant Philip Morris USA, would give the Food and Drug Administration authority to prohibit the sale of cigarettes containing artificial or natural flavours other than tobacco and menthol, if the legislation is passed.
Indonesian-manufactured clove cigarettes (kretek) would be included in the list of banned cigarettes.
From the Indonesian perspective, the proposed exclusion of clove cigarettes is seen as a violation of World Trade Organisation (WTO) agreements. Business leaders point out that products permitted to enter a certain market cannot normally be banned.
“There are no grounds for exempting menthol from the ban,” said Halida Miljani, advisor on international cooperation at the ministry of trade. “Such discrimination violates the agreement on sanitary and phytosanitary agreements under the WTO.”
Sudjadnan Parnohadiningrat, Indonesia’s ambassador to the US, said the proposed ban is “discriminative” and “protective” because it bans cloves but not menthol.
Although exports of kretek to the US were a mere $20m in 2006, accounting for only 0.1% of overall cigarette consumption in the US, industry leaders worry that other countries could follow suit. Cigarette exports to the US accounted for 8% of the 220bn cigarettes produced in Indonesia in 2006.
Industry players and government regulators are actively trying to offset the potential damage of this ban.
“Although it is still only a plan, we must proactively lobby to prevent the plan from being implemented,” Imam Haryono, director of food and tobacco at the ministry of industry, said on September 17.
According to the ministry’s figures, total exports from Indonesia amounted to $285m in 2006, about 8% of the world’s overall clove-cigarette market. These exports represent a significant source of foreign currency revenue for the government. The ministry of finance forecasts $4.6bn in tax receipts from domestic sales and excise duties in 2007, a 9% increase on collections in 2006.
Rising tax revenues are paralleled by increases in the profits of the market leaders in Indonesia.
The Indonesian cigarette market is dominated by Sampoerna, Gudang Garum and Djarum. Combined, these companies represent 72% of the domestic market and all are positioned on the export market. The cigarette industry provides employment for over 10m people in Indonesia.
So far this year, all three cigarette makers have registered increases in profits over the same period last year. Drawing profits largely from the lightly regulated domestic market, Sampoerna, with 28% market share, recorded profits up 9.5% for the first half of 2007 compared to the same period in 2006 to $230m. 2006 sales were affected by the impact of fuel price hikes on general consumer spending. Meanwhile the second largest, Gudang Garam, registered profit increases of 31% over the first half of 2006, reaching $77.8m. Figures for privately held Djarum are not readily available.
The cigarette industry in Indonesia represents a strategically important sector, with the leading three companies amongst the ten largest companies in the country. The May 2005 takeover of Sampoerna, worth $5.2bn, by the Altria Group, which owns Philip Morris, was the largest foreign takeover to date in Indonesia.
US giant Altria is counting on its operations in emerging economies to contribute significantly to future profits, markets which tend to be less regulated than countries such as the US. Indeed Indonesia has the potential to be both a driving force in retail sales as well as an export platform.
“In the long term we see potential for kretek brands in many markets, but mostly as niche products,” Martin King, president director of Sampoerna, told OBG. “These brands could be a significant export product for Indonesia. However developing market shares for these products in markets beyond our regional neighbours is the challenge.”
As it now stands, clove cigarettes account for 92% of the market for cigarettes in Indonesia, while regular cigarettes account for the remaining 8%.
However, in addition to the threat of the US bill, rising profits on the domestic market may slow this year. Given the 7% increase in retail cigarette prices in March 2007, demand could drop within Indonesia. This could hit profit margins for the big three companies.
