Andrea Zanchi
Typical cigarette and kretek outlet/display in Indonesia.
Kretek dominates the tobacco industry in Indonesia, accounting for about 90% of the market, despite ongoing challenges both at home and abroad, including a new EU directive that includes a ban on flavored tobaccos; Indonesia’s ongoing dispute with the US at the World Trade Organization (WHO); lower consumption due to the country’s own economic downturn; more stringent anti-smoking laws; and the lurking threat of higher taxation.
By Nattira Medvedeva
On the Homefront… More Machine Made
The kretek market has gone through a shift, where traditional hand-rolled kretek cigarettes, known as the sigaret kretek tangan (SKT) have been gradually taken over by the sigaret kretek mesin (SKM), machine-made ones. While by no means a sudden shift – as machine-made cigarettes have consistently and continuously grown in popularity since they were first introduced in the 1970s, with smokers seeing them as the perfect combination that has the “class” of the white cigarettes and still having the much-loved taste of clove cigarettes – the upward trend for machine-made kretek is already posing a threat on unemployment rates and in effect, the country’s economy.
Over 800,000 people are employed directly by the hand-rolled industry, with millions more of employees working in industry-related areas. With hand-rolled sales going down and manufacturers shifting production to machine-rolled cigarettes, unemployment is going up. Last May, Indonesia’s largest cigarette producer, HM Sampoerna, closed two of its hand-rolled kretek facilities, shocking the industry and laying off around 5,000 workers in the process.
This July, Philip Morris International (PMI), which owns 98.18% of leading tobacco company Sampoerna, announced that it would be selling a part of its stake in Sampoerna to comply with pending stock-exchange rules requiring all Indonesia-listed companies to have at least 7.5% of its shares publicly held. Even this relatively small relinquishing of shares will raise upwards of US$1 billion, making the sale, if realized, one of the largest share sales in Southeast Asia in 2015. Sampoerna reportedly plans to sell as many as 269.7 million shares to raise the required amount of public holdings from 1.82% to 7.5% in order to comply with the new rule.
In the first quarter of 2014, Sampoerna posted 5% revenue growth to IDR18.3 trillion (almost US$945.7 million) from the same period in 2013. In Q1 2015, the company posted a 5.9% growth and 35.4% market share, largely due to strong performances by its SKM brands, Sampoerna A, Dji Sam Soe Magnum, and Magnum Blue. The company has also recently introduced U-Bold, a full-flavored, machine-made kretek. Sampoerna’s SKT production, however, showed a 16.1% drop in 2014.
Gudang Garam, another major producer of kretek cigarettes and whose products are 90% SKMs, enjoys a 23% share of the domestic market. Credit Suisse expects Gudang Garam to have 5% volume growth this year. However, in the first quarter of 2014 the company reported IDR1.4 trillion in net profit, while in Q1 2015 that figure has gone down by 7.1% to IDR1.3 trillion.
Economic Downturn and Higher Taxes
Since January 2015, Indonesian tobacco products faced an average tax rise of 8.7%. Machine-rolled cigarettes are now priced at IDR355 per stick while hand-rolled cigarettes are IDR290 per stick. This increase was in line with the government’s target to increase state revenue from IDR111 trillion in 2014 to IDR120.5 trillion in 2015, a 9.1% increase. The increased prices have already brought about declines in sales as consumption is down amid Indonesia’s worst economic slowdown since 2009.
Industry insiders have also expressed concern that the tax hike and sales drop will effect production and lead to heavy job losses.
From 2007 to 2013, cigarette production in Indonesia increased at an annual 7% average. Last year, it declined 0.5% and this year will see a 2% fall, says GAPPRI (the Association of Indonesian Cigarette Producers). Heru Pambudi, the Finance Ministry’s director general of customs and excise, said, ““If [production] is declining and we are not careful on imposing the tax, production will decline further.”
The number of cigarette factories dropped from more than 3,000 factories 5 years ago to 600 now.
Tobacco taxes have been raised, on average, 11% annually since 2010. The Indonesian government set ambitious tax collection targets for this year, including one of IDR139 trillion for cigarette taxes. Now, with the economic downturn, the government removed luxury taxes from most goods, raised the minimum taxable income threshold for individuals, and promised no new types of taxes this year in hopes to encourage public consumption.
Earlier this year the Indonesian government announced plans for an additional 10% value added tax (VAT) on cigarette sales, but it has yet to be imposed. Right now the government is undecided on what to do with the cigarette tax for 2016, leaving those in the local tobacco industry on the edge of their seats with trepidation.
International Challenges
While at home the current and future situations for SKMs looks bright, despite tax hikes, higher prices, and lower consumer spending power, in the international markets kretek face major challenges due to restrictions in the EU and the US.
In Europe, the new EU Tobacco Products Directive, which came into force in May, includes a ban on flavored cigarettes, which would include kretek. Member states have two years to introduce the legislation. Across the pond, the US banned clove cigarettes under US Food & Drug Administration’s (FDA) ruling in 2009, as part of the Family Smoking Prevention and Tobacco Control Act. Those who oppose this ban believe it is incorrect to include clove sticks under the US ban on flavored tobacco, the main argument being that kretek are not flavored cigarettes, as, unlike menthol cigarettes or fruit-flavored or chocolate-flavored cigarettes, kretek are basically tobacco and natural cloves, not clove flavoring.
An Indonesian appeal to WTO claimed that, “the burden of that measure fell almost entirely on Indonesia.” WTO agreed that FDA’s measure was unfair, based on the fact the US still allows the sale of menthol cigarettes. In a 2013 ruling WTO stated the ban was inconsistent with the “technical barriers” to trade agreement “because it accords clove cigarettes less favorable treatment than that accorded to menthol-flavored cigarettes” and decided that clove- and menthol-flavored cigarettes are “like products”.
However, despite the WTO ruling, clove cigarettes remain barred from sale in the US. WTO is now arbitrating on Indonesia’s request to suspend import licensing obligations and tariff concessions that it provides to the US under the General Agreement on Tariffs and Trade 1994. FDA has also been revisiting its position on menthol cigarettes. It looks like there is some hope for kretek cigarettes in these international markets still.