Diageo Distills Plan to Purchase United Spirits Ltd.

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DELHI – Diageo, the world’s largest producer of spirits, announced last Monday its intention to buy 26 percent of India-based United Spirits Ltd. (USL) for US$1.9billion. This will raise Diageo’s overall stake in USL from 28.8 percent to 54.8 percent, making Diageo the majority shareholder after the company offered to buy shares 18.5 percent higher than the previous closing price.

USL is the world’s second largest spirits company, and India is the world’s largest whiskey market by volume, consuming an estimated 150 million 9 liter cases of whiskey per year.

While the vast majority of whiskey sold in India is also produced domestically, many investors see room for the import of premium lines as the country’s whiskey market grows at a yearly rate of around 10 percent.

In 2013, India imported US$103.3 million in whisky from Scotland – an increase of 18 percent from 2011, and 46% from 2007. By volume, this makes India Scotland’s fifth biggest export market for whisky and the 18th biggest by market value.

This discrepancy comes about because most of the imported whisky is low grade grain spirit and used in the production of Indian whiskey (most Indian whiskies are blended with a small amount of imported whisky), and only one percent of Scotch whisky consumed in India is bottled in Scotland.

Whiskey produced in India differs from whiskey made elsewhere in that the alcohol is fermented using molasses, an abundant by-product of sugar production in India. Therefore, Indian-made whiskey does not currently meet EU standards for the “whiskey” label.

The rapid growth of India’s whiskey market can be attributed to several factors.

The first is India’s growing middle class, among whom whiskey is held in culturally high regard. Alongside this trend, more potential consumers are entering the market each year as the number of drinking-age Indians grows with the country’s demographic dividend.

Partly because of this, the spirits market as a whole in India could bear fruit for Diageo. With India’s spirits market is currently worth over US$16.5billion, whiskey accounts for around 50 percent of that figure.Diageo’s wide range of products could be used to brand, market and expand its Indian operations.

There are a number of notable obstacles that stand in the way of foreign spirit producers in India, however, such as a 150 percent import tariff on spirits.

In recent years, negotiations for an EU-India free trade agreement (FTA) have stalled and, while negotiations may restart after national elections, there remain a number of issues that must be resolved.

This does not, however, rule out a more targeted tariff reduction for spirits which, if the Diageo deal goes through, could become more realistic. This is partly because the principal opponent to a tariff reduction, Vijay Mallya, Chairman of USL’s holding company UB group, would no longer be an active opponent.

There are also individual state laws in place that restrict alcohol and other imports that traders must navigate.

The Indian whiskey industry may also benefit should import tariffs on spirits be reduced by lawmakers. A tariff reduction would likely cause production costs to fall as imported grain whisky, a key ingredient in the production of Indian whiskey, becomes cheaper.

The Diageo deal could signal a new beginning for foreign brands entering the Indian spirits market. If tariffs do fall in the future, it is likely that market conditions will be more accommodating to foreign firms that sell premium products to India’s ever-increasing base of consumers with growing disposable incomes.

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