The unprecedented 40-50% tax increase, driven by the shift from 28% to 40% GST and the introduction of a new excise duty structure on tobacco, has sparked fears of a surge in illicit cigarette trade, with several brokerage houses expressing concerns about the rising risks of illegal cigarettes in India following the tax hikes.

Kotak Institutional Equities termed the move as “two steps back”. The unprecedented increase in cigarette taxes “marks a clear departure from the gradual, calibrated tax approach followed in the past eight years, which had supported volume stability and helped the legal industry regain share from illicit trade,” it said.

The report also states that the steep increase in taxation “would drive volume shift to illicit trade and mix deterioration”. According to the report, “a steep 35%+ price increase would raise affordability barriers, triggering a shift to illicit trade/products, weighing on long-term growth prospects of the legal industry.”

The mechanics of consumer shift are straightforward: an extreme price differential directly exploits consumer price sensitivity. For price-conscious smokers, the stark contrast makes illicit products an increasingly appealing alternative.

Jefferies cited the Tobacco Institute of India (TII) amid growing concerns that “a wider legal price gap could help non-duty paid cigarettes, which will also result in tax leakage. Legal cigarettes account for 10% of tobacco consumption but contribute 80% of tobacco tax, so this outcome could have serious fiscal implications”.

Nomura echoed similar views, in its research report “high taxes on cigarettes while aimed at reducing consumption have unintended consequences of fuelling growth of illicit cigarettes and pushing consumers towards cheaper, non-tax paid smuggled cigarettes. During FY13-18, despite high tax hikes, the revenue to exchequer remained flattish due to declined legal volumes but illicit volumes saw an increase. Post FY18 we saw a stable tax regime, which thereby stabilized the pace of illicit trade penetration. We believe this sharp increase in tax will again give way to illicit volumes”.

International experience from Australia demonstrates how overly aggressive tobacco taxation can backfire by fuelling organized crime. Repeated tax hikes between 2012 and 2020 drove cigarette prices sharply higher, triggering a surge in illicit tobacco from under 2% to around 14% of the market. Recently Australia’s Health Minister has admitted that the illicit tobacco market has “exploded” with organised crime seizing control of illegal tobacco distribution. Australian parliamentarians have publicly appealed for tobacco taxes to be reduced, as enforcements have successively failed.

In India, illicit tobacco already accounts for about 26% of the total tobacco market, making it the fourth-largest market for smuggled tobacco globally. This trend is supported by global data. According to the WHO Global Health Observatory (2024), which tracks cigarette affordability worldwide, cigarettes in India are among the most expensive in the world when measured by the percentage of GDP per capita required to purchase the most-sold brand —much higher than in countries such as Japan, the US, Germany, China, the UK, Pakistan and Malaysia.

In their 2024 global study, covering 71 countries over 17 years (2005–2022), Alvarez & Marsal have observed that “when illicit trade gets embedded and established in a marketplace, it becomes difficult to reduce it.” The report further underscores that “governments cannot rely solely on enforcement to control illegal trade and disregard the more important influence of taxation and affordability.” This means excessive tobacco taxes run the risk of making illicit networks run by criminals an irreversible problem.

Speaking on the condition of anonymity, a brokerage firm expert said, “The new excise levies are unprecedented. Since they come into effect from February 1, 2026, there is still time to revisit and rectify them before they spawn a much larger problem of uncontrollable illicit networks. The expectation, based on assurances made on the floor of Parliament, was that the overall tax incidence would remain revenue-neutral.”

A JP Morgan report reinforces the concerns. “Higher increase for the KSFT (King Size Filter) segment implies increased risk of consumer downtrading to cheaper variants and may also induce an increase in the offtake of illicit cigarettes,”

Nuvama Institutional Equities too has warned about the rise of smuggled cigarettes. “A double-digit tax hike could push consumers towards smuggled cigarettes.”