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The economic slowdown is highly visible in automotive industry; the big players are shutting down their plants for around half of a month, as sales are nose-diving. According to industry sources, around 3,000-4.000 layoffs are directly by OEMs, and around 15.000-20.000 workers have lost their jobs in the value chain – mainly auto parts manufacturers. The brunt is visible from the contraction in LSM and potential tax loss of the government; but the benefit ca be seen in falling imports of completely knockdown (CKD), and raw materials used to manufacture parts.

Scratching the surface narrates an intuitive tale. There is one factor of prices hike and increase in interest rates, which has made the cars dearer. The other reason is the fear of the taxman where the non-filers or even filers, but not fully complaint tax payers, are not buying cars as their apprehension is that FBR may ask questions. Thus, the spin of economic slowdown and shutting down of auto assembly plants due to it is not totally called for.

For instance, for tractor industry and two wheelers, sales dip is proportionately less – 29 percent and 16 percent respectively in 2MFY20 versus 41 percent fall in passenger cars and 52 percent in SUVs. But fear of taxman is one element and that cannot be quantified, and what government is doing on documentation is right, as the efforts are to change the culture, which will take time to implement.

However, that is not the only reason for the dip in sales. New taxes, impact of currency depreciation on imported parts and imported raw material to be used in manufacturing the localized parts are the other reasons along with the increase in interest rates. In good times around 25-30 percent vehicles were financed, and now with dip of around 50 percent, the financing ratio is similar.

The dip in sales in higher in segments where the price hike is more, and the price jump is in variants or segments where localization is low. For instance, in case of trucks there is no apparent issue of filer or non-filer, but the sales have dipped by 46 percent. The localization level of skin, body and cosmetics in trucks is less than 15 percent in volume while in case of engine, transmission and suspension, the localization is not even 5 percent.

On the flipside, the case of tractors is totally different where localization in all kind of parts is over 90 percent. The impact on prices of trucks is much higher than tractors. There is more to deviation in two products – trucking is leading indicator of economic slowdown in urban economy while tractors are used mostly in agriculture where the economic situation is better than urban centers.

The taxation problem, and economic slowdown issue is going to be resolved in a year or two. Similarly, interest rates will start tapering off in 6 months or so. The other problem of low localization is a deep down structural issue and that warrants some attention. In cars and LCVs localization of skin body and cosmetics is around 60 percent while for engine transmission and suspension it is less than 5 percent. The situation is much better in terms of localization for two/three wheelers and tractors.

When these automotive assemblers talk about localization, the numbers are thrown on volume but not on value, and the high value sophisticated parts localization is much low – such as engine, transmission and suspension. Even in case of low value added parts, the raw material for locally manufactured parts are imported – for instant resin and steel sheets are imported to manufacture many of the parts. Even these import numbers are not reflected in CKD as the raw material is recorded in its own sub categories. But due to less number of cars being assembled, less amount of raw material is being imported.

The lack of competition and higher influence of Japanese parent companies on local assemblers is explaining low value addition at home. A few years back, one of the leading assembler was looking to make an economical car in Pakistan with high level of localization. The company agreed to keep price economical under 1000cc car on a condition of government to forgo sales tax on it.

The idea was to have a car like Proton in Malaysia. The company did its homework and its local management was excited; but the parent company did not approve it. This company out of three main assemblers at that time had more local influence relative to the other two. If that company was not allowed, forget about the others.

And in the past whenever there were talks on opening up the sector, Japan embassy came to wield its influence - mind you, till few years back, Japan was the biggest bilateral lender to Pakistan, and there was some aid coming in too. There is no free lunch in economics. The countries use their political and economic influence to safeguard their own interests.

The actual numbers of localization are not known to anyone as these companies have kept these very close to themselves. The localization is dependent upon approval of parent companies as mostly imported parts come from directly or through subsidiary of parent companies. There might be elements of transfer pricing in it; and that partially explain why prices are high in Pakistan.

The other element for high prices is higher government indirect taxes or direct taxes in direct form on the value chain. Imported parts have duties; there is sales tax, FED, WHT and all – everything cascades into the final price – and today the taxes range from 38-46 percent in SUVs and passenger cars.