In the past few years, foreign cigarette-makers have poured investment into Ukraine's tobacco industry, seeking to capture a share of the sizable market. Production has been on the rise, with the quality of domestically-produced cigarettes improving dramatically. But cigarette smugglers are still a major player on the market, and the flood of cheap products they bring into Ukraine is endangering domestic producers' expansion plans.
Even by the most conservative estimates, smugglers brought about 15 billion cigarettes into Ukraine last year – about a fifth of the overall annual domestic demand for tobacco. And although illegal tobacco imports have halved since 1996, according to experts, they still continue to rob state coffers of more than a hundred million dollars annually in uncollected excise duties.
'That's a fantastic amount of money,' said Oleksandr Nechyporenko, a senior account executive at PBN. PBN is a consultant to the Ukrtobacco association, which represents more than 5,000 employees at 10 tobacco factories throughout the country.
According to the experts' math, Ukraine lost about Hr 500 million in uncollected excise duties from tobacco smuggling last year – more that it raised from privatization over the year. And the figure is expected to be even higher in 1999.
Since the economic crisis undermined Ukrainians' purchasing power last fall, cheap smuggled imports have flooded the country. The State Tax Administration has sold only 30 million excise stamps (which every legal tobacco product must bear) to tobacco importers during the first three months of this year, down from the 90 million it sold over the same period last year.
'The flow of contraband cigarettes from Russia has considerably increased since the crisis,' said Nechyporenko. 'If earlier the smugglers were bringing in mostly expensive cigarettes, now they are focusing on cheap brands.'
He said the production cost of a pack of cigarettes in Russia is generally about 30 percent lower than in Ukraine. Smuggled cigarettes are often cheaper and poorer in quality than legally traded brands, he said. Moldova is Ukraine's second largest supplier of smuggled tobacco products.
Not that all of the profits are going into the smugglers' pockets though. 'Charitable contributions' to customs officials have reportedly become a rule.
'There are already market rates established for getting smuggled goods past the border posts,' Nechyporenko alleged.
He said the smugglers use any of several hundred dirt roads to enter Ukraine unnoticed from Moldova. Most of the contraband from Moldova arrives via the separatist Transdniester region, which has a very porous border with Ukraine, he said.
The government isn't the only one hurt by the illegal tobacco trade – domestic tobacco manufacturers say that are also affected smuggling.
'Smuggled cigarettes reduce our sales and change our investment plans,' said Yuri Kishko, spokesman for Germany's Reemtsma, largest cigarette-maker in Ukraine. Reemtsma has so far invested DM 120 million in tobacco production in Ukraine and says it plans to invest another DM 45 million by the end of this year.
Other companies cite the flow of cheap Russian cigarettes into Ukraine as a major disincentive to investment. U.S. cigarette maker Philip Morris put plans to build a $200 million tobacco factory in Ukraine on indefinite hold because of worries over tobacco smuggling. Philip Morris' decision is a serious blow to Ukraine, which has attracted a meager $3 billion in foreign investment since gaining independence.
Pressure is mounting on the government to crack down on the problem.
Domestic tobacco-makers and consultants have long been pushing for severe punishments for the smugglers, and tighter controls over tobacco sales.
'All the smuggled tobacco has to be confiscated, even from the babushkas [old women] selling cigarettes in the streets,' said Nechyporenko. 'The argument that the babushkas are just trying to make some money by selling the smuggled cigarettes is a lame one. The half a billion hryvnas made on excise duties would be good compensation for all the negative effects [of a crackdown].'
Tobacco manufacturers are also calling on the government to significantly reduce excise duties on tobacco products made in Ukraine.
'It would be economically unprofitable to sell Russian cigarettes here, if Ukraine reduces excise duties [on domestically made cigarettes],' he said.
Kishko said that the excise duty on tobacco products in Russia is significantly lower than that of Ukraine.
He said that Ukraine charges ten times as much as Russia in excise duty on some brands, which makes it very profitable to sell Russian-made cigarettes in Ukraine.
The tobacco industry, one of the first industries to be privatized in Ukraine, has attracted over $200 million in foreign investment since independence. Domestic tobacco production has risen for the past three years, peaking at almost 60 billion cigarettes last year.
The country's tobacco market is dominated by four large foreign tobacco companies. Two of them – Reemtsma of Germany and Philip Morris of the United States – accounted for about 51 percent and 16 percent of tobacco production in Ukraine respectively, according to a Ukrainian News report.
