Smartphone policy – say hello to localization

A much-needed mobile device (mainly smartphone) manufacturing policy draft has been prepared by Engineering Development Board (EDB). Mobile manufacturing is a labour intensive job and is well-suited for an economy like Pakistan with a burgeoning youth population looking for employment. Specifically, it could pave the way to provide skilled employment to women and help empower them.

Handset manufacturing is amongst the world’s top five industries in the world with over six billion units sold in 2019. China is the biggest player—half the world mobile phone exports are originating from China. But labour in China is fast becoming expensive which is opening opportunities for other countries to rise to the occasion. The manufacturing industry is moving towards countries like Vietnam, Indonesia, India and Bangladesh while Pakistan has lagged behind. But it’s not too late.

Pakistan is a big market for mobile phones, one that is growing. It is the seventh largest phone importer (in terms of units). The annual market size is estimated at 41 million phones (of which 28.2 mn are imported & 12.8mn are local). The subscriber base is at 164 million. The population of phones in use are estimated at 100-110 million as the remaining subscribers are using dual sim. The population with ages between 15-64 year old in Pakistan is 117 million and majority of this adult population is using phones. Meanwhile, the phone replacement ratio is close to 2.5-2.75 years. The market is evidently huge.

After the implementation of Device Identification, Registration and Blocking System (DIRBS), the illegal import of smartphone is not possible. This is an important development. In 2018, official import of phone sets was 17.2 million (less than previous two years average of 21.2). After implementation of registering every handset with PTA, the legal import increased to 28.2 million in 2019.

Thanks to the technology which let this happen. This pins hope on localization and increased penetration of domestically produced phones. But import of secondhand phones is still creating a disincentive. For example, in Jul-Dec 2019, 4.4 million handsets were imported under the price of $30. This is in addition to roughly 6 million sets manufactured at home. The under $30 category is supposed to be a basic handset (2G), how could its market size be 10.4 million in just six months?

In fact, experts fear that secondhand smartphones are imported and registered under the price of $30. Since imported taxes are low on this category, these are competing with potential smartphone manufacturing in Pakistan. The policy recommends restricting under $30 phones category for ‘other than smartphone category”.

The other problem under $30 category is that almost all of the parts imported are not under approved HS code 8517.1211. In FY19, only 1,000 SKD/CKD (Semi Knocked Down/ Completely Knocked Down) were imported against manufacturing of 12 million plus. Rest are imported as spare parts under HS code 8517.7000. This is due to sales tax exemption in AJK as most of the phone manufacturers are based in AJK.

Estimated annual imports in the price range of $30-$200 is 9-9.5 million units. This is in addition to the estimated 9 million units imported under $30 category. The idea is to substitute all these imports. Policy envisages to have 80 percent of the handset industry to be local in 2-3 years with creation of 40,000 high skill direct jobs in electronics & information technology industry. The potential of jobs in ancillary sectors is 300,000. A typical smart phone constitutes more than 60 parts and its assembly requires manpower, where Pakistan can benefit from its low labor cost.

The main element of smartphone policy is to incentivize SKD/CKD under HS code 8517.1211 over CBU (completely built units). That is why imports of kits through right channel is imperative after getting necessary authorization by Input Output Coefficient Organization (IOCO). This is now possible through the technology we have available. All it needs is will and a practical policy.

There are 19 manufacturers (29 are given licenses) providing 11,800 jobs in Pakistan. Smartphone is in nascent stage with around 300,000 units being assembled so far. The big transition is to move from feature to smartphones - 90 million plus subscribers are using basic phones (2G) while 3G/4G users are 74 million. Policy makers’ concentration is to increase the penetration of smartphones. The economic benefits are multifold. That is why a few months back government reduced the taxes on category ranging from $30-100 to Rs1,920 from 3,720. The duty structure is kept unchanged for higher price categories.

While that is the right policy to make smartphones affordable for marginal consumer, it has unintentionally dented the nascent smartphone manufacturing industry in the country. The taxes on CKD imports are at Rs1,920. The tax differential between CBU and CKD units is reduced from Rs2,000 to Rs200. The proposed smartphone policy has attempted to rectify this anomaly. The CKD import duties are completely abolished for this category and only GST is to be imposed at Rs200 per unit. The tax differential will now be at Rs1,720. Industry experts deem it enough for enticing new players in the business.

In comparison, Bangladesh manufacturers have slightly higher advantage. But that is possible by keeping prices high for consumers. Pakistan wants to keep prices low for the right reasons. In Bangladesh, 97 percent of the market share is captured by android phones. They do not need a price incentive for conversion from basic to smartphone. In Pakistan, 90-95 million consumers are using basic phones which eventually will shift to smart phones categories. That is why keeping prices low is the key.

The conversion to take place is in the $30-100 and $100-$200 categories. All taxes (but GST) are abolished in first category. In case of $100-$200, the taxes are proposed to reduce from Rs3,773 to Rs1,680. The tax differential of SKD/CKD over CBU is to be at Rs3,760. There is no change in duty structure for phones having price higher than $200. Approximately, 18 million phones are imported per annum under price tag of less than $200. The high-end phones (above $200 price) is mere 250,000.

The rationale for keeping SKD/CKD taxes lower is due to export subsidy given by China for exporting CBU. There are additional packaging cost and all for importing SKD/CKD as compared to CBU. That is why it is imperative to have advantage for local industry. Localization is envisaged in these for the next 2-3 years by having 80 percent of country phones demand to be catered by local manufacturers.

Other economies have done that. Around 95 percent of phones used in India are made in India. Over 60 mobile phone brands have generated 670,000 direct jobs in India. The country is targeting phones export at $110 billion by 2025. Bangladesh is manufacturing around 50 percent of its market at home. Vietnam is at next level. The country exported $38 billion in 2018 and is in business of Integrated circuit (IC) making. China’s cellphone industry is saturating with $142 billion exports (50% of world export). The focus of Pakistan should be to relocate part of Chinese share home.

The idea is to increasingly shift to local assembly with incremental localization at every stage. There are other fiscal advantages offered such as five-year tax holiday, duty free import of machinery and allowance of 100 percent depreciation of fixed assets in the first year. Apart from that, an array of non-fiscal benefits are proposed too.

The industry is labour intensive and will create additional jobs. One factory with an investment of Rs475 million having capacity of producing 250,000 phones per year is in operation. It is producing phones with an average price of $50-60. This company is now planning to double its capacity after this new policy. Many more are likely to join. The country needs players with big muscles in the segment to take the numbers to millions.

The beauty of this industry is that rent seeking possibilities are less. Technology has solutions to illegal imports and all. All smartphones are to be registered with PTA. Otherwise it will cease to operate in a stipulated period.  That is a big safeguard for investors. Same holds true for CKD imports. It is the area where joint ventures with Chinese under CPEC phase 2 can take place. The first step is to replace imports and the next step would be to export to markets like Africa.