Aurora Magazine

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A Smoother Ride Ahead?

Published in Jul-Aug 2021

In the wake of the new budget, Mazhar Mohsin Chinoy looks ahead to the new automobile policy.

The hype was writ large in the days before the budget announcement; it was made amply evident that it would be a ‘happy budget’ – in other words, pleasing to the public and not the select few, the much-awaited harbinger to the passive passing on of the benefits to the man on the street. Finally.

In the weeks prior to the budget hyperbole, the enduring automobile industry in Pakistan had rebounded, buoyed by the easing of the Covid-19 onslaught, releasing of pent-up demand, new entrants finally in the fray, lower interest rates triggering loans for purchase, higher economic activity, overall increased consumer spending and a rupee that had clawed back Rs 10 of its loss to the dollar.

Though not quite the proverbial phoenix rising from the ashes, the industry nevertheless registered consistent growth since the beginning of FY 2020-21 over FY 2019-20. Sales increased by 46% in January 2021 to 17,515 units compared to the same period last year. This was followed by a 35% increase in February (16,436 units sold) and a whopping 198% in March 2021, when 20,801 vehicles were sold against only 6,986 in March 2020, with the overall growth from July-March 2021 a decent 35% over the same period last year.

In this perspective, the budget unravelled a stream of tax relief and exemptions for most industries, a fair amount of which fell into the automobile industry’s lap. Winners here were small vehicles, the notion being to make these more affordable to the middle class, raise revenues for manufacturers (and taxes for the government) and jumpstart the industry. Specifically, locally manufactured cars with engine capacities under 850cc were exempt from Value Added Tax (VAT), with a further slice in sales tax on prices, down from 17% to 12.5%. This would positively impact Pak Suzuki, Regal Motors and United Motors – the three local assemblers that roll out cars in this category.

All other vehicles would also not go away empty handed. The 2.5% Federal Excise Duty (FED) on all such vehicles was phased out completely. Other big beneficiaries were electric vehicles (EVs). In an emphatic nod to climate-friendly vehicles, these were exempted from VAT and subject to a mere one percent sales tax on locally produced EVs. There was also some stick for impatient buyers with extra money ready to enable immediate deliveries for their ordered vehicles. Known as the “on” price, all such extra money would be taxed (although unclear as to the percentage) to keep a check on the out-line buying of cars.

Whither, the Auto Policy 2016-21?
The Automobile Policy 2016-21 officially ended on June 30, 2021 and most analysts believe it failed to achieve any rolling out of small, affordable 800cc and below cars by new international entrants, despite Greenfield policies and tax free regimes. Although at an estimate, some one billion dollars’ worth of investment was attracted, mainly from Korea and Japan, the scampering was mostly towards high-priced sports utility vehicles (SUVs) and high engine power models. There was also little movement on the ground from Western investors, despite initially indicative interest levels. Not much of an achievement when the core vision of the five-year policy was to attract foreign manufacturers, increase competition to enhance car features and lower prices and facilitate the middle class by improving their purchasing might.

Another pet peeve among consumers was that the strengthening of the rupee had not inspired local manufacturers to reduce prices; they dismissed the stronger rupee as a fractional adjustment, offset by increasing the prices of imported completely knocked down (CKD) kits.

The flip side of the argument took the stance that thanks to the policy, finally high-end SUVs were made available at competitive prices, only relatively higher than sedans. However, the naysayers prevail, arguing that since concessional import duty rates accorded by the last policy are mandated through to June 2026, high-end buyers of SUVs and sedan passenger cars will continue to take home the price benefit until then, something that analysts argue has resulted in the subsidisation of imports for the wrong vehicle segment, causing significant revenue loss to the government and generating employment in investing countries rather than in Pakistan, which in turn shaves off much-needed GDP contribution to the economy. An area of concern are local parts because the subsidy for imported cars will mean more completely built up (CBU) vehicles coming in, thereby depressing demand for local parts and eventually slowing down local development targets.

The Automobile Policy 2021-26
Any new five-year policy would want to correct these imperfections, and the budget announcement did appear to point in that direction. The Auto Policy 2021-26 is designed to target four broad areas: incentivise investments towards small cars (850 cc and below) and jumpstart the stalled “deletion programme” and to progressively manufacture locally assembled cars thereby building the parts industry, in turn enabling it to enter the export market. Finally, further advance the earlier greenfield policies and pave the way for more investment from foreign car makers. This was already a prior policy success with 11 car manufacturers in the market currently, from the three only five years ago, with no less than 15 models launched since January 2021. But the more, the merrier.

The policy has moved emphatically on the 850cc car initiative, termed as the efficient, economical, and environmentally friendly (EEE) segment. Customs duty on import of non-localised CKD kits up to 850cc has been reduced to 15% from 30% and for localised ones the duty is decreased to 30% from 46% for new models for a period of three years. Moreover, the seven percent additional customs duty (ACD) on CKD kits for cars up to 850cc has been abolished for two years. Adding to this, the seven percent ACD and 15% regulatory duty (RD) on CBU cars up to 850cc has also been exempted for two years. The possibility of EEE-segment specific, lower financing rates will also be probed via the State Bank of Pakistan to encourage consumers. Quite a handful.

Other plans are to beef up car production capacity to an ambitious 650,000 units a year from the existing 417,000 units in five years. And then leave it to simple economics, anticipating that this will trigger competition which will make vehicles affordable locally and open up the export market, employing draw-down on taxes and levies to compete globally.

The new Auto Policy has much to offer to expand the EV base in Pakistan and has racked up a slew of incentives. ACD and additional sales tax (AST) on imports of EV cars has been abolished, and only one percent tax on the import of EV parts will be charged for local manufacturers. There will be no FED on EVs, whereas the import of plants and machinery for manufacturing EVs will be free of any duty. And to incentivise the construction and set up of charging bays across the country, a mere one percent duty on the import of charging equipment will be imposed.

What happens now?
Analysts have given the thumbs up to the new policy but warn that the government will have to walk the talk. Vested interests will come in to milk choice areas of the policy – as in the last one when the focus of manufacturers fell instead on the more profitable SUV market, with little investment in the core EEE segment – with the regulators able to do little to arrest this.

So far, signs are that the policy has yielded immediate short-term dividends for the EEE segment. With 2.5% FED relaxed, prices for 1000cc car models have fallen from between Rs 91,000 and 134,000, with bigger price reductions for higher models. However, no policy will hit the mark unless longer term benefits are palpable to the targeted consumer segment and only when these are reflected in the growth economics of this high-potential industry, and of course, Pakistan.

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