Aurora Magazine

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The high stakes of surviving

Published in Nov-Dec 2019

Mazhar M. Chinoy on the implications of the economic trials faced by Pakistan’s automotive industry.

Early in October 2019, I had the chance to visit one of the leading dealerships of a prominent local manufacturer and was taken aback to find the huge, once-teeming lobby virtually empty, save for two or three odd salesmen who appeared to leap with joy at the sight of a customer. As analysts will tell you, this scene is repeated in most dealerships dotting the country and indicates the turbulent times the industry is facing.

Bad economics

Automobile sales have dwindled in sync with a dimming economy, perpetuated by a range of factors, including a one-third shave off the rupee value, double digit interest rates impacting car financing, a jacking up of the federal excise duty and soaring input costs. In 12 months, the rupee has depreciated by nearly 32%. During this time, a cash-strapped government has imposed a seven percent additional customs duty, a three percent additional sales tax on all imports and a 7.5% federal excise duty on vehicles of 2,000cc and above. Moreover, there is a new federal excise duty ranging between 2.5% and five percent on locally manufactured vehicles. Conservatively speaking, about 40% of the total cost of a vehicle are the taxes and levies contribution, many of them imposed by the present government. Industry experts are amused at the government’s assertion that the additional tax imposition is not likely to affect car and vehicle sales, and therefore total tax collection; in fact, loss in sales will automatically result in a decline in tax collection from the automobile industry – a Catch 22 situation!

The slump in numbers

These factors have ensured that sales of cars and light commercial vehicles have plummeted by some 40% in the first quarter of the new fiscal year (2019-20) – only 31,107 units sold at the end of September 2019 compared to 51,221 units for the same period in 2018. The biggest dips were recorded by Honda (68%) and Toyota (57%) year-on-year. Pak Suzuki sales fared somewhat better, contracting by 18% year-on-year. Suzuki numbers have been buoyed by sales of the newly-launched Alto, which registered a whopping 4,924 units in September 2019 – the highest ever monthly sale for any Suzuki car model, beating the previous record of 4,648 units of the now-ceased Mehran (source: Pakistan Automotive Manufacturers Association [PAMA]). “Who knows what would have happened to our sales numbers without the Alto,” remarks Nadeem Ahmed, a sales manager at a Suzuki dealership. Despite the slump in sales, automobile plants have managed to remain open, albeit with breaks in between. One wonders how long companies can keep absorbing the financial pressure of this decision. The automobile industry currently employs more than 300,000 people as direct employees and 2.5 million people in indirect employment, and progressive unemployment is another spectre waiting in the shadows.

All segments of the auto sector have faced demand contraction during the first quarter of this fiscal year, with car sales plunging by 39.4% to 31,107 units compared to 51,221 units in the same period last year. Sales for each model sold by the big three (except the Alto), from the WagonR to the Honda Civic and everything in between, suffered massive drops ranging between 25% and 85% for the same time periods last year. Honda Atlas has been the most badly hit, impacted by a heavy 67% plunge in sales of their Civic and City models. Next is the Suzuki Swift, dropping 59% in the first quarter of FY 2019-20 compared to last year. Toyota is third, with a dip of some 58% in sales for their popular Corolla model. Depressed demand and burgeoning cost of raw materials has pressured local manufacturers to cut their imports, and these have slid nearly 20% in just the first quarter of this year compared to last year – from $225 million to $175 million. Unsold inventories have piled up in their thousands, and as such, both Toyota Indus and Honda Atlas have had to halt their production consistently since July 2019, with an average of 15 non-production days (NPDs) per month ever since.

Impact on vendors

Vendors supplying locally developed parts have been seriously affected. This segment directly employs some 300,000 people and with seriously compromised cash flows owing to slowed production may lead to a progressive closure of the heavily-invested vending industry, resulting in higher unemployment. With the local manufacturers closing down the second shift, an estimated

3,000-4,000 daily wage and contractual employees of these vendors have already lost their jobs. Faced with a rather precarious situation, all major players from the automobile industry, including PAMA and the Pakistan Association of Automotive Parts & Accessories Manufacturers (PAAPAM) met recently to map out a strategy to jumpstart this critical unit. However, little was achieved given the fact that over 30% of the car price increase was triggered by the rupee depreciation – an unassailable external factor, quite out of direct control.

New entrants

During last year, new entrants have launched some entry-level and mid-range models, mostly hatchbacks. KIA Motors launched their 1000cc hatchback Picanto to compete with Pak Suzuki’s Cultus. United’s 800cc Bravo, with a facelift, is also in the offing and the Prince Pearl is expected to launch shortly. Even so, the economic situation is giving new entrants second thoughts. They appear to be re-assessing their plant feasibility and delaying expansion plans. As a result, the total investment package (slated to be to the tune of $1.5 billion) is at stake.

Outlook 2020

The automobile industry has thus far staved off employee redundancy in the hope that things will bounce back. This will not be sustainable if the economy continues to slow down. Layoffs will compound the already fragile state of national employment.

While the rupee devaluation may not be under direct control, the focus needs to be on influences that can be managed. Unless the rate of interest is controlled to single digits, car financing is likely to continue struggling. At some point, the government may well have to reconsider reducing the federal excise duty and other taxes to make cars more affordable. Another important factor that impacts the industry is the investor. The new FED and customs duty regimes will not be able to sustain their interest in the longer run, impacting sales further, and they may be inspired to look for incentives where the investment environment is more predictable. An imminent aspect to be wary of is the FATF assessment scheduled for February 2020. If Pakistan is not able to maintain its grey rating at the very least, the ramifications will be terrible. Foreign direct investment will cease and the economy will be further thrown off course; hardly a good sign for an already tottering industry. This is the first real trial faced by the Pakistani automobile industry in its half a century of existence and the real challenge will be to look for and sustain the fine balance between what the industry wants and what the government ordains, and where Pakistan’s economy should be.

Mazhar M. Chinoy has led the marketing services function for a leading multinational automobile company and is currently a director at LUMS.