FMCG: Give impetus to rural income generation

FMCG sector analysts say that due to excise free zones, impact of the excise duty hike will be limited, except for Hindustan Lever. The sector wants impetus for rural income generation and no hike in service tax.

India is on the threshold of a structural uplift in consumer demand. The rising income level, favorable demographics, changing lifestyle and growing rural prosperity is helping the FMCG sector to show a good double digit growth.

The FMCG industry performed well during the economic down turn based on their prudent management and focusing on rural India and their needs by going for innovation product launches and attractive price point with local advertisement. FMCG companies are witnessing a 40% growth in rural sales as against 25% in urban areas. Rural India accounts for more than 40% consumption for major FMCG categories.

In the quarter ended December 2009, the FMCG sector has shown a growth albeit at lower pace. With food inflation is growing at high double digits  of 17% for the week ended January 16, the pace of growth in spending on FMCG products has decelerated with rural population going for down trading.

The aggregate net sales of 11 BSE FMCG Index companies (Nestle is yet to declare its result) for the quarter ended December 2009 grew by 16% mostly on back of volume growth. The FMCG industry performed well based on their prudent management and focusing on rural India and their needs by going for innovation product launches and attractive price point with local advertisement.

The companies have increased their advertisement and sales promotional (ASP) actives for gaining the market-share and increasing volume for the last 2 quarters. As most of the company has also continued with launches and re-launches of products, it has also resulted in the higher ASP spends for the quarter, which has really benefited the companies in increasing their volume.

Industry Expectations

Cigarettes

• Maintain tax stability on cigarettes.
• Continue with the specific excise duty structure for cigarettes even after introduction of GST.
• Introduce a new slab of excise duty for filter cigarettes not exceeding 65 mm in length with excise duty of Rs. 550 per 1000 cigarettes.
• Increase surveillance and stricter implementation of anti-smuggling measures.
• Licensing under I(D&R) Act, 1951 be made compulsory for all Cigarette manufacture in the country, irrespective of the size and nature of the Units in which such manufacture is undertaken.
• Cigarettes be kept in the "Negative List" in all bilateral / multilateral trade treaties, economic cooperation agreements, etc. Preferential treatment to cigarettes must be not be entertained.

Current Status:

Non-edible industrial grade oils (FFA > 20%) are being imported into India.  The oils that are being imported are used largely for soap manufacturing.

The duty structure is inverted and does not promote local capacity creation of soap noodles manufacturing, the process of which is labour intensive. Newer capacities are coming up in South East Asia and they will be used to export noodles into India, further impacting capacities in India.  Some of the recent entrants in the toilet soap business have resorted to import of soap noodles. 

Inputs like caustic soda used in soap manufacturing and other inputs used in related industries like detergents etc attract duty at an average rate of 5% - 7.5%.

Industry has requested that the duty suggested on non edible industrial grade oils be reduced to 5% to encourage manufacturing activity and correct the inverted duty structure

Food & Food Processing

The foods processing industry in India is in nascent stage and needs fiscal support to grow. This apart, the food processing industry is supporting the agricultural sector by providing better remunerative prices to a large section of large and medium farmers for the agricultural produce. The sector also provides support in the area of reservation and value addition resulting in avoidance of wastage and ensuring sustainable food and processed food supply.

The sector requests that the processing food industry should suffer lower rate of tax if no exemption is possible under the new system.

FMCG

• Tax on stock transfers

Stock transfers under the Central Sales Tax Act are exempted from levy of tax. It is learned that stock transfer would be subject to tax under GST system at full rate.  Stock transfers for any FMCG company account for a minimum of 2.5 times the sale turnover. 

In the background of this factual scenario levy of tax at full rate would result in serious cash flow issue and financial burden in the form of interest, which would seriously impact the viability of business. The implications are serious enough to invite a thoughtful consideration and arrive at a via media

The industry suggests that a reasonable rate of IGST of 1% to 2% with credit would reasonable and fair to the industry.

• Trade discounts and sales incentives

Under the present VAT law there is a lot of ambiguity regarding treatment to discounts, sales commission, incentives given post sale through issue of credit notes. Unambiguous provisions should be enshrined in the GST for treatment of discounts, commission and incentives in the taxable value to avoid valuation disputes and disallowance of credits.

• Damages and obsolescence

An integral part of the FMCG industry is the damages to the goods in the course of transfer before sale. This apart, lot of goods becomes obsolete and unsaleable due to obsolescence and expiry of use period.  Such losses are integral part of the business costs.

The industry suggests that such loses should be treated as business losses and allowed without reduction in the entitlement of credit.

• Refunds of excess credit

FMCG sector, like other sectors such as engineering, iron and steel, has dedicated manufacturing facilities at a centralized location from where the goods are cleared for sale across the country. 

A natural consequence of this is that under GST the input credit is expected to be more than the output tax resulting in refunds to be obtained from the dept. It has been the experience of the industry that both centre and state Governments are reluctant to grant refunds without long drawn legal process. This will delay refunds and cause severe financial hardships to the assessees. 

• VAT/CST processed food

Fruit juice and Fruit based drinks are taxed at different rates. Few states are charging VAT rate of 12.5% and others are charging it at 4%. This anomaly of different tax rates should be brought on the same level to bring parity among states

• The government fully exempt Tea fortified with micronutrients and carbohydrates like chicory, jaggery, tapioca, rice flour, whether classified under Chapter 09.02 or 2101.

• The excise duty on Printed Laminates (falling under Chapter Heading 3920 / 3921 / 3922 / 3923 ), Pet Jars ( falling under Chapter Heading 3923 ), Corrugated Cartons ( falling under Chapter Heading 4819 ) , which are used in Food Processing Industry, may be reduced to 4% from present level of 8%.

• Rate of excise duty be scrapped on Packaged Drinking Water. Alternatively, it should be kept at 4% from present level of at 8%.

Analysts/market expectations

There is expectation of roll back of stimulus, which is hike in excise duty from 8% to 10% and service tax from 10% to 12%. Excise duty on filter cigarette is also expected to go up by 5% to 8%. Also there is industry expects that there may be rise in MAT rate also.  GST, which was supposed to be implement from next fiscal year, may get delayed. There is expectation of higher allocation to National Rural Employment Guarantee Scheme.

Stock to watch

Hindustan Unilever (HUL), ITC, Godrej Consumer Product (GCPL), Dabur India, Marico and Nestle.

Outlook

The government is keen on withdrawing economic stimulus in a few tranches.  Fortunately, if the excise duty is hiked by 200 basis points, its impact will be very marginal on margins of the FMCG companies.  However, Hindustan Unilever can be negatively affected, as its share of sales coming from non excise free zone is higher.

But any increase in service tax will be negative for the FMCG companies due to increasing advertising cost, which is in the range of 13% to 14% of the revenue. Also, If MAT is increased, it will be negative to MAT paying companies like GCPL and Dabur.

Though we donot expect GST to be implemented any sooner, as and when it is introduced, it will be negative for the companies, which have greater share of revenues coming from products manufactured in excise free zone as their indirect tax incidence will go up under GST regime.

Amidst all these, the main concern at this moment for the FMCG companies is high and rising agri inflation.  This has the potential to FMCG volume growth in coming quarters. With spike in sugar prices and rise in edible oil prices, companies in biscuit sector have started raising their product prices to protect their margin and bottom line.

The management of most FMCG companies expects that inflation will remain for the next 2 to 3 months till Rabi crop, which is expected to be good. If the Government roll back stimulus, it will affects the FMCG sector, as companies have to pass on the excise / service tax hike and rising input costs effectively to consumer whose wallet size is already shrinking due to agri inflation.