Entrenching a monopoly will not solve Ukraine’s tobacco problem

Finding a balance between encouraging tobacco consumers to quit, and the revenue tobacco taxes bring to state budgets have long been a problem for governments across the world. It’s a conundrum Ukraine is currently trying to solve.

Smoking is of course enormously harmful to human health, and as such any responsible state policy is aimed at reducing its prevalence. On the other hand, however, the tobacco industry significantly contributes to the financial health of states themselves, via taxation.

In Ukraine, for example, tax revenues from the tobacco industry account for around eight per cent of the total state budget. It is therefore difficult to condemn smoking while still making use of the infrastructure that taxes on the industry – both consumers and producers – help to pay for.

The government therefore needs to maintain a certain balance of influences in the industry, on the one hand encouraging its citizens to give up the habit of smoking, while on the other being careful not to lose a not insignificant source of tax revenue.

Recently, however, the state’s policy towards the tobacco market has done the opposite, and as a result Ukraine risks not only losing out on tax revenues from the tobacco industry due to the growth of the illegal market, but also losing control over the process of encouraging its citizens to quit smoking.

The issue was recently discussed at Tobacco Market Vision 2021, a forum that brought together industry leaders to try and forge a path ahead. Participants included foreign companies who manufacture tobacco products, Ukrainian companies who distribute them, and representatives of tobacco industry associations. All agreed that they want constructive dialogue with the government to ensure that all stakeholders can work towards a positive outcome.

The illegal market

According to Gintautas Dirgella of Japan Tobacco International Ukraine, the problem of the illegal tobacco market depends directly on the fiscal policy of the state, since most of the cost of a pack of cigarettes (about 70 per cent) represents taxes.

“A sharp increase in excise tax immediately leads to the growth of contraband and counterfeit cigarettes,” he says.

Yulia Zavalishina, the head of corporate and legal issues at Imperial Tobacco in Ukraine, agrees:

“Due to a sharp increase in excise taxes in recent years, there has been a fairly rapid increase in the final cost of cigarettes. As a result, the legal market for tobacco products has decreased, while there has been an increase in smuggling in Ukraine and other European countries.”

At the same time, fiscal policy is not the only reason for the growth of the illegal market.

“The regulatory activities of the state, the monopolisation of the wholesale market and, as a result, extremely low retail trade margins also have a significant impact on the illegal market,” says Anton Sukhomlyn, vice president of Ukraine’s Specialised Trade Association.

Anton Sukhomlyn, vicepresident of Ukraine’s Specialised Trade Association

Strengthening a monopoly

The meeting also addressed the long-term monopoly of the cigarette distribution market in Ukraine. Over the past four years, the anti-monopoly committee in Ukraine has repeatedly imposed record fines on one of the main cigarette distributors, Tedis, which was fined as much as 130 million euros last year alone.

At the end of 2019 however, the Ukrainian government signed a memorandum of understanding with tobacco players, which identified the need to demonopolise the distribution of cigarettes, and the anti-monopoly committee issued official recommendations obliging tobacco manufacturers to submit their commercial policies for approval.

Manufacturers obliged, but the anti-monopoly commission has now delayed issuing its approval for almost a year. Instead, the government has tried to legalise the tobacco monopoly by establishing a national operator. This has caused a backlash from the tobacco industry and a wave of legal challenges. In particular, the National Anti-Corruption Agency has officially identified a high risk of corruption.

But it’s the consequences for market players that are not Tedis that will likely be the most severe. Some companies have already warned that should a national operator be established they would have to shutter their business. This, of course, means the loss of thousands of jobs.

And that could translate into increased migration from Ukraine to EU countries, a country that like so many other emerging Europe nations is struggling with the problem of brain drain.

The opposite result

As for cigarette smuggling, a problem that establishing a national operator is supposed to solve, many experts say the result could actually be the opposite. With only one wholesaler, questions are raised as to whether it can really serve all retailers promptly, which could turn some shops toward the black market.

Representatives of the tobacco industry have also taken exception with the claims that this move toward a monopoly has anything to do with implementing the legal standards of the European Union, as has been claimed. They point out that EU law has no such provision that would require a national operator to be established.

Agia Zagrebelskaya, a co-founder of the Antitrust League platform, and state commissioner of the anti-monopoly committee of Ukraine from 2015-19, sums up the confused messages being sent to the industry:

“We face a rather ambiguous state policy in the tobacco market,” she says. “On the one hand, the anti-monopoly committee is doing good work to break up the monopoly, while on the other, the government’s position is headed practically in the opposite direction. I believe that Ukraine should move towards the best world standards of regulatory policy in the tobacco market, where the anti-monopoly authorities play a key role.”

The legality of the decision to create a national operator is itself open to question, according to industry experts. When making the decision, the government did not coordinate with the anti-monopoly commission and there were no discussions about the law with the public, industry representatives (domestic and foreign), or any civil society organisations.

The anti-monopoly committee of Ukraine, which guards against violations of competition law, should regulate such processes. However, the delay of the committee in approving the commercial policies of manufacturers indicates the opposite, namely the lack of interest in the real demonopolisation of the tobacco industry. Prosecuting violators through fines does not always lead to demonopolisation. Resolving the issue of distributors’ commercial terms will be a real test for the anti-monopoly committee to fulfill its responsibilities.

Finding a balance

It’s clear that for the effective functioning of the tobacco market there must be a balance of state and market regulation. “The market for tobacco products is very specific – these are goods that circulate quickly, but are not cheap. And, like any specific market, it has problems, the solution to which is to combine government regulation with market methods. There must be a balance of these influences,” says Anton Sukhomlyn.

To the question of what is the best method by which the market should function, he says that “one should at first find out the purpose of such actions: is the goal to regulate and control the market or reincarnate a monopoly.”

If the first goal is to regulate and control, then the methods should be different from what the Ukrainian government is trying to do, which, contrary to Ukrainian and ultimately European legislation, is attempting to legalise a monopoly, even if it is called a “national operator”. In fact, the recipe and the method for solving the issue are obvious. Moreover, the principle of this method is to benefit all the participants of the process.

Ukraine’s tobacco market players have taken a huge step towards establishing a dialogue with the authorities: it’s now up to the government to respond.

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