Car financing

The latest decision of the State Bank of Pakistan to ban car premium financing is a step in the right direction. According to a circular issued on 28th January, 2005, from now on, banks and development finance institutions (DFIs) will give auto loans only to the extent of the ex-factory tax-paid prices of cars and would no more finance premiums or on-money on purchase of cars. In other words, the premium charged by dealers/investors over and above the prices fixed by the manufacturers would have to be paid by the buyers themselves.
A press release issued by the State Bank stressed that this measure, besides curbing speculative activities, would also facilitate genuine buyers of cars. It may be mentioned that SBP had earlier restricted banks/DFIs from extending loans solely for the purchase of land in order to discourage speculation in the real estate and had also prescribed limits on banks/DFIs' investments in shares listed on the stock exchanges for the same purpose.
The latest restriction obviously has a certain background. The aggregate demand for cars, financed largely by bank loans, was far in excess of the supply in the market and the speculators found a good opportunity to make money at the cost of genuine buyers by exploiting this imbalance between supply and demand. Of late, according to market sources, the premium for quick/on-the-spot delivery had increased from Rs 50,000 to Rs 150,000 per unit depending on the model and value of car, and genuine buyers were being fleeced without any inhibition. The present circular of the State Bank is a positive signal to the market to curb this unhealthy tendency, but how far it would be able to reduce the rate of premium is difficult to tell, because most of the banks/DFIs were already reported to be financing only the ex-factory price of cars and insisting upon the buyers to pay the premium from their own pockets. Anyhow, in the absence of reliable data in this connection, no authentic conclusion can be made.
In order to get the desired results and for certain other reasons, we would suggest that the State Bank be a little bolder and prescribe a selective credit control measure, advising the banks/DFIs to finance only a part (say 50 percent or so) of the car price fixed by the manufacturers. Looking at the practice in other countries, such a proposal may look odd but in Pakistan, the situation is quite different.
The savings rate in the country is not only inadequate to sustain a high growth rate but also very low compared to other economies with equivalent per capita incomes. The demonstration effect is so strong that almost every ordinary household has a strong desire to own status symbols like cars without caring much whether it is an affordable proposition.
It is true that the banks have found a good outlet for unloading their excess liquidity, but the financing of cars on a large scale would not only hurt the savings rate in the economy but also put ordinary households under great stress at the time of repayment of these loans with interest.
Already, the share of consumer loans in total lending is increasing rapidly. During July 25-December 2004, consumer financing amounted to Rs 39 billion and this was higher than even commerce, services or transport, storage and communication.
Almost 57 percent of total consumer financing was utilised for the acquisition of automobiles. It would be better to redirect a part of the consumer loans to basic industries which are better positioned to promote employment etc. Also, as increasing traffic jams suggest, the present infrastructure and the quality of roads cannot cope with the burden of rapidly rising number of cars. Instead, it would be better to facilitate the commuters by providing loans to the transport companies for large vehicles in order to enable them to bring more buses on the roads.