The government has decided that it wants to arrest the inflationary trend in the economy by applying some form of price controls on selected goods to prevent profiteering and hoarding. The premise of such a move defies basic economic principals. How can the government expect the private sector to slash prices of goods at a time when commodity prices are increasing? The subject will be discussed generally as a separate column in this space. Here, the discussion is confined to automobiles as cars, tractors, and bikes are all part of the so-called “price control list”.
The first question is whether passenger and/or commercial vehicles are a basic item of use in a country like Pakistan. Examining the other items in the price control list or even just looking at the current penetration of passenger cars, a vehicle is not an accessible or affordable good for a common man. It is certainly not basic. If the government’s intention is to avert profiteering in a sector where there is a possibility of an oligopolistic structure, the route to take is to open import competition by lowering duty structure on completely built units (CBUs) substantially enough that it would make them stand head and shoulders in terms of pricing with locally assembled vehicles.
A little bit of historical reference first. It is no secret that the automobile industry is a highly protected one where domestic assemblers are protected against imported CBUs through multiple duties and levies including custom duties, additional custom duties, regulatory duties etc. The entry of new assemblers in the local market was restricted because of prohibitive policies and restrictions in government licensing. For over three decades, the car industry was dominated by three Japanese players. These companies maintained an oligopolistic structure on the pretext of localization, while consumer protection remained weak.
In the recent automotive policy (2016-21), plenty of new players came in. This opened the possibility of competition emerging in the local market. But now, without any new policy that incentivizes greenfield or brownfield entrants, more new players cannot come in. As of today, at least three players (one European and two Chinese) are knocking on government’s door for a new policy to enter the market.
While localization amongst the players has been growing, the dependence on imports and thereby, vulnerability to the exchange rate continues to persist within the industry. Since 2018, Japanese vehicle assembler raised prices several times to pass on the effect of costlier imports onto consumers. To counter this, the government reduced duties and taxes on vehicles to make cars more “affordable”. The argument was, when cars become cheaper, volumes would grow which would make it more feasible for domestic assemblers to localize while also generating more revenue for the government. The government took the hit first (on its taxes) and players reduced their prices all around.
The surge in demand has been apparent, which has also been further enhanced by cheaper car financing rates. According to sources, there was a tacit agreement between the government and the assemblers that no one would increase the price before the new automotive policy 2021-26 was launched—which is under process.
However, last week one of the new players revised its prices. The government requested the company to take the price hike back. This was a clear message to other players contemplating the same- price increases at this time are not tolerable. In certain government circles, there is a strong prevailing belief that since demand is growing, players would want to profiteer, which ought to be curbed. On the other hand, the industry believes that higher costs due to depreciation, rising steel prices and freight costs, necessitate price revisions.
Both the arguments by government and by assemblers carry weight. It will not be easy for the government to investigate the cost structure of every company and within it, on different models and based on those to assess a fair price. That would border on overregulation and may even kill competition in many industries. The government shouldn’t be opening that Pandora’s Box.
The second option is to lower the duties on CBUs to boost competition. In the last budget, there was a proposal for reducing regulatory duties on imported cars – but that didn’t happen as car assemblers lobbied against it. If the government lowers duties, that may increase the import bill and may further reduce the capacity utilization in the industry. Already, 400 plus expensive CBUs were booked in the EV category within two months of the government lowering the taxes and duties on them. Now the government is thinking to reverse the step (or restrict the incentive to a certain price cap).
Apart from payment pressure due to higher CBU imports, the government has a dilemma on its hand. Consumer protection versus developing the manufacturing base in the automobile value chain. There are two arguments for promoting local assembly – one is the foreign exchange (FE) savings and the other is creation of jobs and developing the core engineering industry.
The FE savings are probably not a lot. As in many cases (for new players), the CKD imports are at a 5-20 percent discount from CBUs, and the discount is higher in older cars – one big player claims that they have 50-60 percent discount of CKD over CBU, as they have much higher localization. Then the localized parts here have some imported components as well. The cost of plant and machinery imports, and tooling development imports for any part should be added as imported component over the period of plant or certain model. In addition, there are royalty and technical assistance fees paid by assemblers to principals. There are also dividend payments, and energy imported cost component in running plants. Researchers should perhaps do a study on this to determine estimates for FE savings.
The other argument: of automobile industry creating jobs and developing engineering core carries weight. For that, localization must be supported in full. There are more jobs created in the parts making, logistics (parts supply to OEMs on Just-in-time principle) and after-market (including dealership) relative to those by assemblers. The after-market has nothing to do with CKD or CBU. It is directly proportional to the number of cars being sold. If imports are opened, there could be more jobs in the after-market.
Thus, the stronger argument here is in support of developing core engineering industry in auto parts which also have a potential to export. The policy makers need to be clear on the auto policy where a tax arbitrage is offered to develop and boost the auto parts industry, and also achieve FE savings. However, parts development has not been a focus over the past fifteen years. There is a list of localized auto parts in the country where, those parts which are on the list have a higher duty to those that are not. This penalizes assemblers—by way of higher duties—if they import parts that are already localized in the country. However, this list has been frozen since 2006. Once it begins to update, the incentive to localize parts will grow.
The government should focus on such incentive structures which work toward enhancing domestic assembly and localization of parts. If it deviates from that objective and begins to fix prices, the whole policy—that could work—would get derailed. Too much heavy-handedness may push automobile players in the corner who are motivated to make new investments in new cars and models. If investments dry out, and new models are not launched, the industry would be standing at the same place it did some time ago.