In India, 'bidis' and chewing tobacco account for 86% of tobacco consumed. Cigarettes account for the remaining. With such a skew, growth prospects are promising.

But globally, the industry under scrutiny for health reasons. It is believed that the Indian tobacco sector is the least taxed on a relative basis. Given this backdrop, can the growth momentum continue?

Key Positives It's a habit industry and hence, continues to thrive despite odds like punitive taxation, ban on smoking in public places and restrictive advertising. Being a habit industry, it finds it comparatively easy to pass on excise duty hikes, though lately there have been signs of a resistance to price hikes.		Key Negatives Heavily penalized through punitive taxation policies. Cigarette companies pay roughly 50% of their revenues as excise. As a result, the share of cigarettes in total tobacco consumption has declined from 21% in 1981-82 to a mere 14% in 2004. Domestic cigarette companies suffer a double whammy. On the one hand, they are barred from sponsoring sports and cultural events and on the other contraband cigarette volumes continue to thrive. Net result, volume growth is sluggish. In the last 20 years, tobacco consumption in non-cigarette varieties has increased especially in the chewing format by 68 m Kgs, and reduced in the cigarette format by 21 m Kgs. With the government going against even a Supreme Court verdict relating to cigarette related excise, its policy has become even more abundantly clear towards the sector.

Before 1987, cigarettes were subject to ad valorem rates of duty resulting in administrative problems as well as reduced revenue to the exchequer. The specific excise duty rate on the basis of length of cigarettes introduced in 1987. As per the CII, it has resulted in increased excise revenue to the exchequer from Rs 13 bn in FY87 to over Rs 53 bn in FY02. This reduced litigations considerably and helped fill government coffers.

Over the years, the government has become pretty predictable in its policy towards the tobacco sector. Every year, the industry faces hike in excise duties, which then are passed on to consumers. However, in the last three budgets (2002-03 to 2004-05), the finance minister kept the excise duty structure more or less unchanged for tobacco sector. However, on cigars and other value added products sales (value added tax) VAT was increased 16%. These years were a positive for the cigarette companies.

This is part of Equitymaster's Budget 2005-06 series. Equitymaster.com is one of India's premier finance portals. The Web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.