A new auto policy is in the offing. Expected price reductions in local and imported cars are making rounds on the social media as government mulls various options to lower the duty and tax structure. The idea is to enhance car penetration in Pakistan and to move towards exporting auto parts by enhancing localization in the truest sense. The other aim is to have 'Made in Pakistan' cars in the country. For that to happen, a certain threshold of scale must be reached in any segment. The realistic option in Pakistan is to have that inflection point in smaller cars (1000cc or below). That is why the reduction in taxes envisaged in these are the highest, both for locally produced (CKD) and imported cars (CBUs).
There are some taxes which are to be decided by parliament such as General Sales Tax (GST), Federal Excise Duty (FED) and Custom Duty (CD). Reduction in these is already approved in the finance bill. Then there are additional duties such as Additional Custom Duty (ACD) and Regulatory Duty (RD). These are subject to cabinet approval. Proposals on these are to be tabled on Tuesday (6th July), and based on cabinet approval, the cumulative reduction in levies will be made final. Expect auto assemblers to announce new prices on Wednesday and a presser by the minister.
Pakistani automobile (four-wheeler) annual production capacity is approaching 500,000 units. This has increased significantly after a number of new entrants came under the 2016-21 policy. It was successful as the possibility of competition in the market became true for the first time. The number of players more than doubled. Consumers now have plenty of options. However, the market size is not growing. The peak production was a little shy of 260,000 units in 2017-18, including light commercial vehicles (LCVs). This year (2020-21), even after a sharp rebound, the production is less than what it was in 2017-18.
The current production capacity utilization is around 50 percent, and the aim is to take it 80-90 percent in a few years. The last policy was eying competition in the market by giving better incentives to new players. This time the motivation is to increase market size by rationalizing pricing and emphasizing on localization. Under the existing structure, the expansion is taking place in relatively expensive cars - mainly in compact SUVs. The numbers are not big and is cannibalizing the market share of the sedan segment.
The numbers game is in smaller cars (1000cc and below). The market is dominated by Suzuki with annual production capacity of 150,000 units. The star performer was Mehran in the last two decades. In 2017-18, 48,000 units were produced. Localization was higher and scale was reaching a good level. But the car did not have enough safety and tech features. In 2019, Suzuki discontinued the car, and replaced it with Alto. This year Alto is expected to produce around 42,000 units. This number must grow in the coming few years to have efficiencies of scale to reduce price and potentially export. Then there are other models by the company and couple of others in the 1000cc segment.
There are higher incentives for 1000 cc and below for both local and imports - GST is reduced to 12.5 percent and 2.5 percent FED is abolished. In the cabinet meeting on Tuesday, the proposal is to reduce ACD (local and imports) and RD (imports) for this segment. The prices are likely to be down by 7-9 percent for local and higher decline would be for CBUs. The delta between CBUs and CKDs will shrink.
Automobile assemblers want the delta to be maintained. The debate is similar for higher engine sizes. For government, there are two considerations. One is promoting local production for creating jobs and saving foreign exchange (FE). Other is to ensure that consumer gets better safety and other specs at a reasonable price. It is a delicate balance. When auto industry assembling in Pakistan was incentivized in 1980s, the idea was to have a spillover in production and technology. There were supposed to be a sunset clause to the protection. But in the 1990s and 2000s whenever the government tried to end protection, existing players lobbied, and protection continued.
Since the delta between imports and local was high enough for domestic producers to not localize or innovate enough to become competitive, the government is trying to change the status quo in the affordable segment. The idea is to take sales of small cars from 90,000 units to 150,000-200,000. Nothing but price reduction can do this in a year or two. But local production levels would take some time to develop. To bridge that gap, imports are to be encouraged in the segment. That will push the local producers to bring airbags and other features in their models.
The similar debate is on 1000cc -1800cc cars. The proposal to be presented in cabinet on Tuesday is to reduce RD from 15 percent to zero and ACD to 2 from 7 percent for CBUs. This will reduce the delta between imported and local cars. The government must be careful here as a number of new entrants have launched cars in this segment. They require time to localize and gain scale. Here competition from imports could be tricky. But at the same time, the government must ensure localization in the segment.
One of the landmarks (and less talked about) achievement is upgradation of famous SRO-693. For CKD, there are two duty slabs - localized and non-localized parts. CD is 46 percent and 30 percent, respectively. For new entrants, CD is 25 percent and 10 percent, respectively. In SRO 693, there is a list of localized parts that was frozen in 2006. There is no addition in localized parts list since then. There is no push for localization. Even if someone does it, others can import the same part at relaxed duty structure. That is hindering auto parts industry's growth.
Without localization, FE savings are minimal. Roughly, the price difference between CKD and CBU is 10-15 percent for new entrants and 25-35 percent for old OEMs - bigger the car engine size, lower the localization. There is not enough FE saving from promoting CKD without localization. The government could be better off by providing consumer options by opening floodgates of CBUs.
The other argument is of creating jobs. Automobile assemblers claim that they create 5 jobs on one car production - direct and indirect. But then, around 2 jobs can be created by imported cars (in trading, dealing and after-market) as well. With lower prices and more options, the number of cars to be sold will be higher. The higher volumes then would create more jobs in the trading market and compensate for the loss of jobs that the economy would experience due to lower assembling. Consumer surplus can be generated, and productive capital can be deployed in a sector with a competitive advantage.
There are pros and cons of promoting local auto industry. Some countries support them, and some do not. For example, Australia recently decided to support imported cars. The question is what should Pakistan do? The country needs core engineering industry to grow and auto parts could be big in it. That is why the automobile policy should focus on promoting localization.
The new policy says that SRO 693 list is to be upgraded every six months and if anyone part is localized by one player, it will be added to the list and others either must localize it or import at higher duty slab. With this clause in, those new (or old) assemblers who opt not to localize would be at a disadvantage. With this, it may be a better option to keep delta between CBU and CKD maintained for 1,000-1,800 cc. Thus, the cabinet should not approve its RD reduction to zero. There is a proposal of slashing RD to 30 percent from 90 percent on above 1,800cc. That should not happen. These are cars for the rich and are heavy on fuel consumption. They should pay higher taxes and their import should be discouraged.
The other interesting element is that the government is promoting newer and cleaner technologies - Electric vehicles (EVs), Hybrids and plug-in hybrid vehicles. Here local assembling is promoted with lower CD on EV parts and reduced GST. The incentives are a bit higher for EVs while significant cuts in taxes are for Hybrids. One may argue that EV is a better technology, and it is bridging to future technology of hydrogen fuel, then why should hybrids be incentivized?
Well, the challenge is EVs' adoption globally - at 2 to 4 percent. Low adoption is due to higher prices and evolving technology, lack of charging infrastructure and low range in charge. It may take time for EVs to penetrate the market. On the other hand, hybrid adoption is around 15 percent globally. With better incentives, it will be launched by a few players and people would like to buy it. Since it is better than internal combustion engine (ICE) and can help in saving on energy more effectively in the next few years - till the time EV adoption increases, there are pros to promote Hybrid.
Still the government wants to push EVs' penetration. That is why CD on CBUs is reduced to 10 percent from 25 percent and GST to 5 percent for one year. Once, the number of cars increase, the charging infrastructure will develop and OEMs may start assembling EVs in Pakistan. One thing is for sure that EV CBUs penetration will increase, and some players may assemble hybrid cars within 6-18 months.
The policy is comprehensive and incentivizing all types of cars - except Pick-up trucks. There might be some imports in smaller cars and ramped production by locals (mainly Suzuki) in the segment. The real game changer could be enhanced localization - especially in smaller cars with frequent upgradation of localization list in SRO 693. Then the government may want to have higher localization beyond nuts and bolts by having at least 30 percent value addition in any part. The objective is to have a car made in Pakistan and exports auto parts in coming years. Interesting times ahead.
Copyright Business Recorder, 2021