Change to excise rules benefiting cigarette producers linked to future of Croatia's BAT factory

Change to excise rules benefiting cigarette producers linked to future of Croatia's BAT factory
By Clare Nuttall in Glasgow February 21, 2021

Croatia is preparing to hike its excise on heated tobacco products to 75%, the highest level in the EU, a move that government officials have openly linked to their efforts to persuade international tobacco giant British American Tobacco (BAT) to keep its factory in the Croatian town of Kanfanar open. 

The increase in the tax on heated tobacco would benefit BAT, which has the largest share of Croatia’s tobacco market overall, but lags behind rival Philip Morris International (PMI) in the market for heated tobacco. 

BAT acquired the Tvornica Duhana Rovinj (TDR) factory and other tobacco and retail assets from Croatian holding company Adris Grupa in a €550mn deal in 2015, pledging to keep the factory in Kanfanar, a major employer in the Istrian town, operational for at least five years.

That five-year period expired in September 2020, ahead of which BAT officials declined to confirm whether they planned to keep the factory open or not. With Croatia already one of the worst hit economies in emerging Europe by the coronavirus (COVID-19) pandemic in 2020 and local elections coming up in 2021, the loss of the country’s largest foreign direct investor in the last few years is clearly worrying for the government. 

Back in September, Prime Minister Andrej Plenkovic announced his government was in talks with BAT in an attempt to keep the company in Croatia. “We are having talks, I am sure we will make a quality agreement that will enable them to stay in Croatia, I hope for as long as possible, regardless of their global restructuring,” the prime minister said, according to a government statement. 

Five months later, it emerged at the beginning of February that Croatia was preparing to hike the excise on vaping products. If the changes, currently the subject of consultations, are adopted, from the beginning of March Croatia will have by far the highest tax on heated tobacco in the EU, at HRK800-1,400 (€105-185) per kilogram of tobacco. This would make such products around 60% more expensive per kilogram than cigarettes. 

The link between excise duties and the continued operation of the BAT factory has been extensively reported by Croatian media and the two have been openly linked by officials. Speaking to journalists in December, Plenkovic said that production at BAT's factory in Kanfanar must be maintained and that an excise policy should be set that will be an “acceptable solution for all parties”, reported Tportal. 

"We must find a solution. Our firm position is to continue production in Kanfanar, to keep jobs and to find a solution that will be acceptable to all actors,” the prime minister said. 

BAT did not respond to requests from bne IntelliNews for information on its future plans for the Kanfanar factory or its position on excise on heated tobacco products. 

No health benefits

The excise increase makes little sense from either a health or an economic perspective, as outlined by prominent Croatian blogger Marko Rakar. Excise sometimes dubbed a “sin tax”   is typically levied on specific products such as alcohol and tobacco that have harmful health impacts, those that have harmful social consequences (such as gambling), or that damage the environment. Yet heated tobacco is considered to be less harmful than burnt tobacco. Therefore, Rakar commented in a recent blog post, the excise increase “cannot be for health reasons, because raising the price of a more harmful product (cigarettes) by 8% and by 75% for a less harmful product (heated tobacco) is by no means logical.” It doesn’t make sense from a fiscal point of view either, as heated tobacco makes up such a small share of the market at present. 

Yet it could make economic sense for BAT, given its weak position relative to PMI in the market for heated tobacco and vaping devices. There is a steady transition from burnt towards heated tobacco in higher income countries; the global market for the latter growing strongly even as the overall number of smokers decreases. Hiking the excise on heated tobacco products would slow down this change in Croatia. 

With a population of 4mn, Croatia is a small but relatively attractive market for tobacco companies. Croatians are the fifth-heaviest smokers in the EU after fellow eastern and southern EU member states Bulgaria, Greece, Hungary and Cyprus. More than a third of Croatians smoke and almost a quarter are daily smokers. Not only that, but Croatia is surrounded by some of the most tobacco-dependent countries in the world. Adults from Bosnia, Montenegro, Serbia and Greece are all among the top 10 heaviest smokers worldwide. 

BAT’s 2015 deal was as much to take market share in Croatia as for the factory. When the deal was announced, BAT CEO Nicandro Durante commented that it would “provide immediate scale in three core markets of Croatia, Bosnia and Serbia”, as well as a platform to grow in Central Europe. BIRN reported at the time that TDR had a 57% market share in Croatia in 2014, as well as 30% in Bosnia and 11% in Serbia. It sold 8.7bn cigarettes in 2014, 67% of which were exported to countries in former Yugoslavia and EU countries. 

Since 2015, BAT has expanded further in the region, buying Bosnian manufacturer Fabrika Duhana Sarajevo (FDS), as well as increasing its stake in Croatian food and retail group Agrokor’s newspaper and tobacco distributing unit Tisak

“BAT wants to keep and increase its market share, and the government wants to keep a large investor and a factory, so it's no surprise that [there has been] a newly found "compromise" on excise duties, especially when it is likely that a number of factories will have to close this year, partly as a consequence of decades of mismanagement mainly of state-affiliated companies,” wrote Rakar. 

Still, rivalry with PMI on the Croatian market may not fully explain the planned excise increase, given the small population and the fact that 80% of the Kanfanar factory’s products are made for export and therefore not subject to Croatian excise. 

It may, however, become more relevant in a Europe-wide context. Given that heated tobacco products are relatively new, most European countries tend to tax them at the same rate as traditional tobacco products, but as a vaping cartridge contains less tobacco than a cigarette the tax burden is only around 30% of that of a cigarette. 

Now the European Commission is looking anew at the tobacco industry. On February 3, it released a €4bn plan to improve the fight against cancer. Pointing out that “tobacco consumption continues to be the leading cause of preventable cancer, with 27% of all cancers attributed to tobacco use”, it sets the goal of a tobacco-free Europe. “EU-level regulatory instruments will be strengthened to achieve these objectives. Tobacco taxation is one of the most effective instruments to fight tobacco consumption, particularly in deterring young people from taking up smoking,” says the document. 

Rakar speculates that the draft rule could be “part of a much bigger pan-European game in which we are just a sandbox of a lobbying experiment that emerges as a result of an interesting synchronisation of a company's interests and government political goals.” Hiking excise duties on heated tobacco products in Croatia would “create an interesting solitary precedent at EU level, ahead of the revision of Directive 2011/64 / EU dealing with these issues,” he added. 

An investor with clout

That the Croatian government wants to keep BAT happy is not surprising. On top of the initial deal, it invested a further HRK490mn (€64.7mn) in TDR. As well as the factories in Kanfanar and Virovitica, and the iNovine retail chain, BAT has an indirect impact on the economy as a purchaser of tobacco from local growers.

The factory in Istria employs 1,600 people, and the loss of their jobs would result in damage to the local economy, already battered by the coronacrisis. The departure of a major foreign investor would also send out a negative signal about the investment climate in Croatia, particularly because BAT already quit the country once in a blaze of bad publicity for Croatia back in 2005, when the privatisation of the Zadar Tobacco Factory, which it bought back in 1997, was annulled by the High Commercial Court. 

The question is: would this impact be worse than the signal sent out by the government’s willingness to make concessions to BAT? This sets a precedent for other companies to make similar threats, in turn creating an uncertain environment for investors without the clout to do so.

“For our government it is quite normal to adjust laws and regulations for some companies, which are usually government owned, but [BAT’s] level of influence is unusual even for the Croatian government,” Rakar tells bne IntelliNews

“Look at it from the point of view of tobacco sellers. They actually received a 30-day notice that the tariff would change … it’s simply a bad message,” he adds. “So much for the predictability of the business climate.”

As the media picked up the story in Croatia, further details came to light. Zeljko Aragovic from the Krupan List Tobacco Producers Association said in an interview with N1 on February 14 that BAT has an almost exclusive right to buy from local growers. “Manufacturers are forced to work with BAT because they cannot legally work with anyone else; BAT is practically imposed on us. Since 2015, when BAT entered Croatia, tobacco production has fallen by 32%,” Aragovic told the broadcaster. 

What’s going on in Croatia is no isolated incident. The Global Tobacco Industry Interference Index published by the Expose Tobacco NGO shows that "lack of transparency in interactions with the tobacco industry, government endorsement of tobacco-related charity, industry targeting of non-health sectors to derail tobacco control measures and conflict of interest issues persist as … across the globe.”

The index looks at 57 countries, not including Croatia, but it shows that tobacco industry interference is among the highest in the world in another Southeast European country, Romania, and there are also substantial levels of interference in Georgia, Ukraine, Turkey, Kazakhstan and Czechia. Both Romania and Kazakhstan are among the countries that “persist in viewing the tobacco industry as economically crucial”, which has “left their tobacco control policies vulnerable to being undermined and defeated”.