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After much fanfare of its predecessor that expires this month, a new automobile development policy is in deliberation. (For overarching policy objectives, read “Auto Policy Pivots towards EEE” published on June 8.) There is not a huge difference of opinions among stakeholders on the overall policy objectives of enhancing competition and increasing the automobile market size. The current debate in Islamabad is on incentives—specifically, different automakers are demanding different incentives depending on their current product lines and those in the pipeline. Here is an attempt to gauge what the best strategy would be for the country—in line with domestic needs and best global practices—whilst keeping an eye on future of the automobile industry in general.

One of the major objectives is to make small cars more affordable. In the current budget, the government has lowered the duty and taxes for cars up to 850 cc assembled in Pakistan. The GST is reduced to 12.5 percent; FED is abolished, and overall duty structure is rationalized. This is good as this will make existing cars cheaper by around 10 percent and open avenues for new cars to be launched in the segment which will boost the engines for the burgeoning middle class.

But then, many automakers in Pakistan do not have engine options of 850 cc and below and are lobbying with the policymakers to extend the incentives to cars upto 1000 cc. That may not be entirely inviable as a favorable incentive structure may push automakers to bring more options in the compact and small engine category, though the real push is needed in the 800cc-1000cc category where options are almost non-existent for the quintessential middle-class buyer for whom Mehran was the most suited option.

The government should be careful about doling out incentives. And there should be a concerted effort to evaluate the demand as well as the supply dynamics of the market. If supply falls short of rising demand for the affordable segment, it might create the classic opportunity for investors to jump in and claim premiums from eager buyers. The government will end up losing tax revenue while buyers will not be paying an “affordable” price anyway.

There must be some fiscal consideration too. The incentives ought to be structured in a phased manner where by the incentives expire after a certain period of time—say 5 years and each year, a higher-engine is brought into the incentive frame. This way, the government can incorporate incentives to boost production of mid-sized engines as well and give the industry time to expand assembly lines. The growth in volumes can shore up revenues despite the concessions.

The other and more important point is to rationalize the duty structure on CKDs. The custom duty (CD) on non-localized parts is 30 percent and 45 percent for localized parts. In case of new entrants under 2016-21 policy, the CD is 10 percent and 25 percent for non-localized and localized, respectively. The delta is kept for incentivizing new entrants and it has yielded fruits. The incentive is for five years from the time of launch of a model or June 2026 which ever comes first. The government should continue this structure so that the new investors are protected.

However, there are additional duties which need to be rationalized. There is a 7 percent additional custom duty (ACD) and 2.5-7.5 percent Federal excise duty (FED) apart from the regular 17 percent GST. This duty structure needs to be revisited across the board. Interestingly, on 7 percent ACD, new entrants successful got a stay from the court and seeing that, the oldie OEMs also took the same stay order. Assemblers are charging the consumer based on the ACD but not actually paying that tax to the government.

The auto industry is proposing that the government should do away with ACD and FED altogether. Charging FED on a product that the government wants to boost makes little sense. But removing these duties in one go may be hard on the FBR and may disrupt prices dramatically –second-hand owner would be at disadvantage. The policy should ease into the process and have a clear road map on doing away with these duties in a staged manner for a soft landing. There is a severe semiconductor (chips) shortage in the market and existing car orders are being delayed. Lower prices could delay orders further as demand may pick up. Those players who have already imported CKD units may face a cost disadvantage. Hence, its better to phase out such anomalies.

Another major hot subject is incentives on electric vehicle (EV) and Hybrid Electric Vehicles (HEV). Some players are making EVs while others are making HEVs. Right now, on CBUs, the CD on EV is 10 percent till June 22 (and 25% thereafter till June 26) and GST is 17 percent. For HEV, CD is 25 percent to 50 percent (varies with engine capacity) and GST is 8.5 percent up to 1800 cc and 12.75 percent at higher engine sizes. Clearly, HEV imports have a better tax& tariff advantage.

In the EV policy, the CKD where CD on EV parts would be at 1 percent and GST is zero for battery size up to 50KWh (17% for batter above 50KWh). Here some players are lobbying for better incentives for CKD in HEVs in line with EVs. They want 1 percent GST on EV parts and GST at 8.5 percent up to 1800 cc and 12.75 percent for 1800 cc plus. It seems that the government would give the HEV folks what they want.

That may not be a rational policy. HEVs are considered “bridge” technology—introducing the electric feature while also giving the market enough time to make the EV and charging infrastructure accessible and available for the true shift to happen—from internal combustion engine to EVs. In order to truly achieve emissions, going completely electric is the only way to do it. The future is in hydrogen fuel cars – fuel cell electric vehicle (FECV). All these options are cleaner with a lower carbon footprint on the road. Within all, FECV is technologically the best. But it requires huge global investment in hydrogen fuel supply which may take decades to material. Till that time, battery operated EVs are the best alternative as electricity infrastructure is pretty much everywhere in the world.

Having said that, the government should be careful in its EV policy by focusing on moving up the technology ladder and not be bogged down by wanting to please everyone. In fact, the same incentive treatment granted to HEVs as EVs may do more harm than good. For one, why would any consumer purchase an EV, when an HEV is available—the latter is far cheaper and requires very small batteries and while it does lead to lower emissions, these cars will always need the internal combustion engine to power them and the hopes to replace ICE will never truly materialize.

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