The government is going out of its way to ensure that not only does ITC face little additional competition in selling cigarettes, but also its Indian managers can keep out its foreign parent. Why this extraordinary treatment to one company?

ITC has very successfully in the past thwarted all attempts by UK-based BAT to raise its stake in ITC. It even lobbied with the health and finance ministries, which led the government to ban all Foreign Direct Investment (FDI) in cigarette industry on 8 April 2010, citing health reasons. 

If health is affected by cigarettes, then it is best to ban cigarette/bidi smoking totally and ban all forms of tobacco abuse just as narcotics abuse. The government, however, will never do that because the industry generates huge excise duties, sales taxes and income taxes. The second best option is to block fresh capacity creation in the industry. For a long time the government had banned fresh capacity creation in the industry and had stopped issuing industrial licenses. Therefore for the government it is immaterial now as to who owns the majority stake in the existing cigarette manufacturing capacity. So there is no apparent logic to block FDI into cigarettes as long as it blocks fresh capacity creation. 

In fact, in a letter to the Indian Ambassador to the US, five US trade bodies have written: “Some proponents of further restrictions have apparently cited public health as a justification, but since there is absolutely no difference in the health effects from consuming Indian or foreign tobacco products, that argument cannot be taken seriously…99.6% of the market is held by domestic Indian companies and one large Indian company controls 80% of the market…We fail to see the problem with companies investing in a manner that is consistent with Indian law…In short, the arguments of the proponents of additional restrictions do not contain a valid rationale, unless one considers valid the parochial political notion that India should be rid of even the minuscule foreign company competition that currently exists.”

The only reason to ban FDI in cigarettes is to block BAT from buying a majority stake in ITC for which ITC has been consistently lobbying very strongly over the years. ITC has its own reasons. It is diversifying into other areas aggressively, i.e. paper, hotels, FMCG, etc by cross-subsidising these areas from the profits of the cigarette division. It may be noted that in the September 2012 quarter, 80% of the profit came from cigarettes alone whereas only 26.5% of the total capital employed was in cigarettes. ITC will continue to block BAT's entry into ITC till these other businesses are developed properly and start generating adequate profits so that BAT can then probably take over and demerge ITC and retain the cigarette division which is BAT’s core area.

Commenting on the demerger of ITC, PTI quoted Mr Deveshwar on 24 November 2009, “We never exclude any options from our approach…No chief executive can ever put the options to a closure for the future generations of ITC. So all options are always open… Whatever we do, we would do it with the objective of ensuring that we do not lose on our synergies and that we create more wealth.”  If ITC does not cross-subsidise the capital guzzling divisions from the profits of cigarettes, it can never succeed in these businesses. So the bosses of ITC are serving their own expansionary objectives by this strategy of intense lobbying at the Centre.

Another ulterior motive of ITC’s lobbying is that it wants to prevent global tobacco majors like Philip Morris and Japan Tobacco from entering into India because they are players with deep pockets and can adversely impact ITC’s market share and profitability in the long run. By playing into the hands of ITC, the government is protecting and promoting the monopolistic 80% market share enjoyed by ITC. This goes against the basic principle of promoting competition for the best interests of the consumer. ITC has achieved all this by citing health reasons as if the cigarettes made by ITC protect the health of the smoker and those made only by the foreigners cause cancer.

But who is the big loser in this strategy of ITC? The government of India! How? For this, one has to understand SUUTI or Specified Undertaking of Unit Trust of India. Remember, the erstwhile Unit Trust of India (UTI) was split into UTI Mutual Fund and SUUTI. SUUTI came into effect from 1 February 2003 on the passing of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 (Repeal Act), which was gazetted on 18 December 2002.

Section 8(1) of this Act asks the Administrator to ensure “redemption of all the schemes of the specified undertaking and the payment of entire amount to investors”. SUUTI is yet to honour all the claims to investors probably because the government is postponing the sale of blue chips held by SUUTI on one pretext or the other.

SUUTI’s core holdings are in ITC, L&T and Axis Bank. As on 30 September 2012, SUUTI holds 11.41% stake in ITC, i.e. 89.67 crore shares which are valued at Rs25,336 crore as on 31 October 2012. Besides it also holds 5.05 crore shares of L&T valued at Rs8,215 crore and 9.72 crore shares of Axis Bank valued at Rs11,495 crores and some shares in other companies. The core holdings in these three companies are worth Rs45,046 crores. The government has to sell SUUTI shares in order to honour its old claims. It will also help substantially to meet the fiscal deficit targets. Incidentally the disinvestment target for FY 2012-13 is only Rs30,000 crore.

But what the government proposed about SUUTI in March 2012 is a very roundabout complex idea which defies logic. It says it would wind up SUUTI, transfer all its holdings to a new Asset Management Company (AMC). This AMC will then take loan from banks and buy the government’s stakes in the disinvestment programme. In short, the government does not want to sell the SUUTI holdings. The FM has indeed said so on 29 October 2012. 

The question is why does the government want to do this complex exercise and under whose pressure? It is quite clear that ITC does not want SUUTI to sell its shares because if SUUTI were to sell ITC, then the question will arise as to who can the pay the highest price for ITC. Naturally, BAT will pay the control premium. BAT holds 30.71% and LIC, GIC (government-owned insurance companies), etc hold 19.02%. But since the government has banned FDI, BAT will not be able to buy the shares of ITC. So SUUTI will have to sell these shares at a discount to market price as is the market practice (through offer for sale, etc). Naturally the government will then have to answer uncomfortable questions to the media, India gainst Corruption and probably the courts.

The simple arithmetic says that the 89.67 crore shares of ITC are worth Rs25,000 crore approximately at the current price. If BAT were to pay, say, a 10% control premium then the government will gain Rs2500 crore but if the shares are sold in the market then there will be a loss of Rs2,500 crore. So the government will in effect lose about Rs5,000 crore just by blocking BAT. (Except of course, blocking FDI means ITC has made higher profits, which has pushed the stock price higher). The point to note here is that BAT’s gaining majority is not going to change the cigarette industry since BAT cannot create new capacity, thereby taking care of the health ministry’s concerns. But blocking BAT will make the government poorer by Rs5,000 crore. If BAT could pay a control premium higher than 10% (as in the case of Maruti disinvestment), then the gain to the government would be that much more. Also, LIC and GIC could also negotiate with BAT along with SUUTI to sell a part of their 19.02% holding at that premium price. Another option could be to invite global bids from all tobacco majors worldwide for the stake in ITC belonging to SUUTI, LIC, GIC etc which could prove to be a windfall for the government and its 100% owned insurance companies.

So this is a straight forward case of government acting like the poet Kalidas, cutting the branch of the tree on which it itself is sitting. And all this is just to appease one company, the near-monopoly in cigarettes, ITC.