Calling a spade a shovel!

The PTI government is no stranger to controversy. Just days ago when a local English daily published a news item titled “Indus Motors shuts down plant”, twitter blew up. Critics of the current government (and trolls) were quick to point out the stark comparison between 2017 during the PML-N government when Indus Motors had announced that it will be expanding production and now during the PTI regime, when it is planning to apparently shut down its plant, making a case for government failure in the present. But to put a swift end to the rumor mill, Indus Motors has closed down its plant for 15 days in total—just like Honda did—citing the lack of demand. Are the critics right?

Granted, austerity policy has hit the economy like a pile of bricks. Not only did government expenditure quickly dissipate, the Central Bank tightened the monetary policy considerably to compress demand and curtail inflation. The rupee was depreciated, and all around taxes were raised subsequently leading to higher costs, reduced purchasing power and drying up demand. On the other side is the new government’s nascent effort to document the economy, and document it fast which has scared many folks into inaction, stripping the economy of consumption demand.

But for a company the size and veracity of Indus Motors—boasting nearly Rs160 billion in revenues during FY19—one would expect the shocks to be limited and potential risks to be mitigated. Since Dec-17, the company together with its peers Honda and Suzuki has excessively raised prices at least 9 times citing rupee depreciation. Toyota Corolla GLI’s price has gone up by 45 percent since then. Other models, including Corolla series as well as Fortuner and Hilux have seen similar price hikes.

In most developed economies where public transport is available and accessible, demand for cars tends to be more sensitive to price changes—consumers stop consuming when prices go up. In Pakistan, people don’t have the choice. Since cars like Toyota Corolla and Honda Civic/City are already beyond the purchasing power of most Pakistani households, the higher-income households tend to absorb the higher prices simply because they need the car.

However, there is a limit to how far the prices can be stretched (in economics, this is called elasticity). Demand was going to be affected at some point. Also consider higher interest rates that push out the car buyers expecting to finance the purchase through an auto loan. Furthermore, because these prices were raised in tandem with government taxes, disposable incomes have naturally been hit too which all propelled consumers to stop lining up the showrooms. The showrooms that were only a year ago brimming with anxious customers waiting 6 months for the delivery of their cars while these very same automobile companies now grappling to keep their plants open were working double-shifts to keep up.

In short, yes. This scenario has come to be because of the economy shifting reverse gears but consider the full picture. In FY19, despite the slowdown already starting to manifest, Indus Motors’ profitably remained fairly unscathed. It earned nearly Rs14 billion in after-tax profits (Rs16 billion during FY18). In an interview conducted in 2018, Indus Motors CEO Asghar Jamali told BR Research that the company uses 126 million parts from local vendors every day. That indeed seems impressive and maybe implies a significant level of localization, though the company has never shared the exact number. Overall, various estimates suggest local content from 50 percent up to 70 percent for some vehicles locally assembled in Pakistan. Why then do auto players remain vulnerable to exchange rate shocks to warrant such steep price hikes?

The answer is simple: the investment, the technology transfer and import substitution that has happened over the years in the automobile value chain has not been enough. The parts made locally are low value-added, cosmetic parts while the high-value sophisticated technical parts requiring an advanced level of engineering—including the CKD kits—are still imported. These are expensive. Consider on the other hand, the Indian economy which has cut down production costs and is relatively shielded from exchange rate shocks due to heavy indigenization. Partly, the fault lies with subsequent governments which did not create an environment for new auto investments to come in the sector while keeping highly protectionist policies in place on imported cars which staved off any whiff of competition for the three assemblers.

In the absence of any real competition or the motivation to modernize, innovate and invest, automobiles companies continued to build profits doing the bare minimum. It is also now clear that the Dar economy was running on an artificially overvalued currency which effectively subsidized imports for automobile companies, only adding that extra layer of cost advantage.

It is often argued that localization comes when volumes will come because auto parts makers need economies of scale. But volumes have been there (evidenced by high used car imports, consumers waiting for months for delivery and paying premium rates to investors and get cars on time), but localization into advanced parts did not grow. Also remember that volumes come when there is variety and affordability. Today’s cars (especially Honda and Toyota) are only accessible to a small section of the population hence small volumes.

Nevertheless, this historic lack of competition and consumers’ lack of sensitivity to price changes allowed Indus Motors—like its peers to raise prices as many times as they did. The demand ultimately succumbed to it. The problem is then clearly not just recent austerity measures, though they are a compelling factor, but long-running combined complacency of governments and firms. Automobile companies have not felt the push to be more competitive, or to be more prepared for jolts. The answer is to push them.