Fitch Ratings, one of the big three credit rating agencies in the world, yesterday said higher alcoholic beverage prices due to the slapping value-added tax (VAT), will be absorbed by steady demand.
The government introduced VAT of 15 percent on alcoholic beverage manufacturers on November 1, 2016.
“We feel that the inelastic demand for refined alcohol and rising per capita income should allow companies – including Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Rating Watch Negative) and Lion Brewery (Ceylon) PLC (Lion, AA-(lka)/Stable) – to pass on taxes to consumers without worrying about them shifting to the more affordable illicit market,” Fitch said in a brief noted. Successive Sri Lankan governments have consistently used excise taxes as a tool to boost revenue to bridge budget deficits.
In line with the International Monetary Fund (IMF) three-year Extended Fund Facility, Sri Lanka has to bring down its budget deficit to 3.5 percent by 2020. Sri Lanka is expecting a budget deficit of 5.4 percent this year and 4.7 percent in 2017.
“Alcohol consumption appears to be inelastic to higher taxes, but if this reverts, we believe the government may hold back on further tax increases, especially with the importance of the sector’s contribution to government revenue,” Fitch noted.
Excise tax on alcohol constituted around 7 percent of government revenue in 2015. The sector is also heavily regulated, with restrictions on advertising and limited issuance of new retail licences creating high entry barriers that benefit entrenched players like Lion and DIST.
Fitch expects hard liquor’s share of the alcohol market to continue to rise in 2017.
Taxes on a unit of pure alcohol of strong beer surpassed that of hard liquor after back-to-back tax increases in October and November 2015.
As a result, revenues of DIST – the largest spirits maker – grew by 36 percent in 4Q16, while gross revenue of Lion – the largest beer maker – contracted by 12 percent. Spirit makers had previously been facing heightened competition from beer producers, given the competitive pricing on the basis of pure alcohol content, growing popularity of beer among the younger population and rapid urbanisation in post-war Sri Lanka. Fitch expects Lion’s financial leverage to improve in FY18 (year ending March 31, 2018), benefitting from lower capex and normalised returns, bringing its leverage ratios below Fitch’s negative triggers, having weakened in FY17 due to
DIST was placed on RWN in September 2016, reflecting a potential rise in financial risks due to the purchase of new shares of its subsidiary
Resolution of the RWN will depend on the details of DIST’s capital structure.
Meanwhile, Fitch noted that companies may find it difficult to revise prices on a regular basis if the government decides to raise taxes multiple times within the same year (as seen in 2015), which could affect profitability. “Similarly, consumers may shy away from the mainstream market if the price increases are significant and imposed at short intervals,” the rating agency cautioned.