After much deliberation and many rounds of negotiations and consultations, finally, the much-awaited Automotive Development Policy (ADP) 2016-20 has been approved by the Economic Coordination Committee. It was never an easy decision to form a balanced policy that takes care of all the stakeholders including existing players, rehabilitation of sick units, potential new entrants, importers as well as consumers. But the most important elements are the benefits to consumers and employment generation.
Had the imports of cars been relaxed, consumers would have benefited but at the cost of compromising existing production as was the case in 2011 when the import policy for age limit was relaxed to five years from three years which led to an influx of 50-60K imported cars within 12-18 months. That had lowered the production of existing three players and caused some job cuts. The higher imports also strained the country’s Balance of Payments. That policy was a classic example of ad-hocism and was rightly reversed due to the influence of existing three Japanese players.
However, consumers were at loss. The existing players have been operating since the 1980s. At the onset, they were offered protection to enable the spillover of technology and the localization of parts manufacturing. The initial plan was that the market would eventually be opened up for competition so that consumers would enjoy the benefits of choice, affordability and technological innovation. However, this never happened.
The first policy lapsed in 1995 and the protection was extended to 2005. Following successive such extensions, the existing players in the domestic industry have continued to reap the benefits of protectionism, to this day. Whenever policymakers have attempted to bring in competition, these companies have used their lobbying prowess to upend such plans. As a result, these companies have gotten into the lazy habits of rent-seeking without any fear of competition.
On one hand, such rent-seeking is rife across many other domestic industries, so the auto sector is no exception. On the other hand, the country has now borne significant sunk costs in the form of continued protection.
Hence, the protection continued and a monopolistic structure was created for the three Japanese players that hardly compete with each other given that their vehicles seldom land in similar categories. This continued connivance has prospective buyers and limited opportunities to create more jobs.
So, do these companies still need protection in the real sense? Let’s try to dig the answers from the financial statements of these public-listed companies. In the last financial year (all the three companies have different year-end), there was a benefit to auto assemblers due to the favorable Rupee-Yen parity as well as the depressed commodity prices. In a competitive industry, these benefits would have to be shared with consumers through lower prices. Yet this did not happen; in fact, all three companies have raised car prices at some point over the past 18 months.
Pakistan Suzuki Motor Company (PSE: PSMC) posted a profit after tax of Rs5.8 billion for period Jan-Dec 2015 while its operating assets and capital work in progress amounted to Rs4.6 billion by September 2015. This implies the net return of 126 percent on operating assets during that year. Similarly, return on operating assets for Indus Motor Company (PSE: INDU) was 175 percent for FY15 (July 2014- June 2015), and 110 percent for Honda Atlas Cars in FY15 (April 2014- March 2015).
In a competitive market, such abnormal profits cannot be sustained as usually, a decent return on operating assets ranges between 15 percent and 25 percent. The profits raked in by these companies were not too high in FY11-14 because external factors had not been favorable during that period, while lower import duties had also dented their bottom-line. However, as soon as they got a chance they pocketed virtually all of the incremental benefit without passing on any to consumers. Why? Simple, there was no threat of a new entrant in the market to normalize the returns.
Hence, existing players hue and cry against the new auto policy which is incentivizing new entrants is uncalled for. They are by no means worse off; as the duty structure for CKD has been reduced from 32.5 to 30 percent for non-localized items, and from 50 to 45 percent for localized parts. Many analysts think that the policy is neutral to positive for existing players as their margins will improve from lower duties and they most likely will not pass this benefit on to consumers either.
The policy is rightly incentivizing new players to enter the market. The new players will have no duty for one-off imports of plant and machinery. Greenfield projects shall enjoy concessionary import tariff of 25 percent for localized and 10 percent for non-localized parts for five years as compared to existing players new duty structure of 45 percent and 30 percent, respectively. For rehabilitation of sick units, the concessions are similar to those offered to new entrants, but for three years instead of five years as in the case of new players.
The apparent objection of existing players is that they have not gotten any new concessions for launching new variants. Well, similar benefits for existing players as those offered to new entrants would have defeated the whole purpose of the new policy. A new player will take 3-5 years to commence production from today, while an existing player can bring in a new variant within 6-12 months.
Let’s hope that competition in the four-wheeler market ramps up in a similar manner to that witnessed in the two- and three-wheeler market over the past decade. In FY01, 109,000 units of two- and three-wheelers were sold by local assemblers; of which Atlas Honda had a share of 68 percent. Since then the competition was allowed with Chinese entrants coming in the market and those were able to sell motorbikes at half the price of Hondas variants. This pushed Honda to innovate and lower its prices. In FY15, more than one million motorcycles were sold (10 times of that in FY01) while Honda’s share is still at 65 percent. Who benefited the most from competition apart from consumers? Of course, Honda whose sales increased ten-fold while it also maintained its market leadership. At the same time, consumers are now able to buy motorcycles at relatively affordable rates. There was a case of a shift in the demand pattern which was well captured by a liberal policy framework.
But in the case of passenger cars, the market never developed. Sales peaked in FY07 with 180,000 cars sold by local assemblers as demand was high. But due to lack of innovation and suppressed demand, cars sales in FY08-15 averaged at 131,000 units per year.
As Pakistans economy emerges from the woods and income per capita trots higher, the rising middle class is likely to bring about yet another shift in demand; this time towards car ownership especially in the 800cc and below category. The newly introduced policy is particularly aimed at building this market segment as it offers a flat 10 percent duty for all parts for new entrants irrespective of localization. It is time to welcome the new policy and see the wonders of competition!
First published: March 22, 2016.
