Government loosing revenue due to under invoicing

Jan 31 - Feb 06, 2005

During the last three to four years, Pakistan's key macroeconomic indicators have shown some very positive developments. GDP growth rate has touched 6% and is projected to go to 8% this fiscal year, remittances have crossed $4 billion, per capita income is now above $652, foreign investments have touched nearly $1 billion while car leasing and financing rates have come down to 7% from 22%, four years ago.

These macroeconomic indicators have a direct bearing on automobile demand and accordingly, automobile market in Pakistan has experienced unprecedented and unexpected growth in the last three to four years. Sales of Passenger Cars and Light Commercial Vehicles have gone up from 45,000 units in 2000-01 to 115,000 in 2003-04 and are expected to go upto 150,000 in 2004-05. This phenomenal growth in demand was not anticipated by anyone; not even by the government nor the car manufactures or the vendors.

As a result of this tremendous growth, all the manufacturers are continuously increasing their production capacities and the gap between demand and supply is reducing. It has to be understood that increase in production capacity requires heavy investment, transfer of technology, hiring and training of additional manpower, product development and trials etc.

In order to reduce the demand-supply gap in the short-term, the GoP substantially reduced duties on imported cars in the 2004-05 budget, with a view to resolve the issue of late deliveries and premiums that were being charged by the investors and resellers plaguing the auto market. In the small car segment (up to 1000cc), import duties have come down to 50% only. The most affected is the medium car segment (1001-1300cc) where duties have been slashed from 100% to 50%. Duties have been reduced by 30% for the 1301-1600cc category and by 45% for the 1601-1800cc category. In the luxury car segment, duty has been reduced by 50% from 150% to 100%.

If we add upto 50% depreciation allowed by customs on used cars imported under the baggage scheme, the landed price of used cars has reduced substantially.

Thus it is not surprising that even though only 5 months have passed since the announcement of duty reduction in the budget and while it takes at least 3-4 months for imported cars to reach Karachi after opening of LC, the flood of imported cars has already started. Compared to only 306 units for the 2nd quarter, there has been a 300% increase in import of new cars to 1063 units in the 3rd quarter.

This does not include another 600 used cars that have reached Karachi port on October 19 and are under customs clearance. On condition of anonymity, it has been disclosed by a customs insider that 90 per cent of the used vehicles have been imported under the name of female owners, with obvious under invoicing for tax evasion. These vehicles have inundated the roadside dealers of Khaled Bin Waleed Road, Karachi and Jail Road, Lahore.

Encouraged by reduction in duties of imported cars in Pakistan as compared to other regional countries, Dewan Motors has recently launched its network of dealerships across the country for selling fully imported Mitsubishi cars with no local value addition or local assembly. This is an indication of a CKD manufacturer opting for CBU business over local manufacturing. If other manufacturers follow suit, then there will be a substantial loss of jobs, revenue to the government will be reduced and the local auto parts industry will be the worst affected.

What eventually forms the basis of such business decisions is the consistency in government policies. If policy changes render mammoth projects such as those of the auto manufacturing economically non-viable, the reason for sustaining investment, expansion, employment, technology transfer, human resource training and production is nullified.

Looking at markets that possess similarities with Pakistan, the Indian policy on import of used cars is one case in point. We find that Indian car manufacturers are protected through tariff as well as non- tariff barriers. Imported vehicles need to be evaluated by testing agencies set up in India to ensure that poor quality and fuel inefficient old vehicles do not enter the country. Moreover, registration charges for imported vehicles are higher compared to locally manufactured vehicles. Other non-tariff barriers include conditions such as rejection of cars that are more than three years old from the date of manufacture and submission of pre-shipment certificates by the importer, which conform to regulations specified in the Motor Vehicles Act 1988 of India and to the Original Homologation certificate issued at the time of registration.

On the other hand, NTN certificate is not required for purchasing imported cars in Pakistan, which paves the way for under invoicing and fake documentation. Thus importers and buyers of imported cars are still exempt from documentation and tax net while all sales of locally manufactured cars are fully documented with NTN certificate.

While there is no equity or investment of the government at stake in case of local auto manufacturing establishments, the revenue through duties and taxes paid by OEMs amounts to almost 30 percent of the vehicle price in Pakistan. Of this, 15 percent is just sales tax, which amounts to more than 100,000 rupees for a 1300cc vehicle. While taking straight benefits from the industry, at least the GoP should devise a policy framework in response that supports auto sector and safeguards their interests to foster expansion, growth and further investment.

Therefore, when we look at the recent policy change, it is necessary that there is an impartial assessment of the positive and negative affects on the market, the industry and the country's economy.

Apparently the recent policy decision of the government not only aims at slashing its own revenues, but also impedes future investment and expansion plans of the auto manufacturers who are already under lot of pressure due to government's strict regulations on localization and price control. On one hand auto manufacturers have been asked to increase production and maintain quality, while on the other hand, no incentives have been offered to facilitate expansion and quality assurance. It may be noted that a car may have 7,000-10,000 parts, and with government enforced localization targets of 50% to 75% for cars, there is a lot of pressure on local auto parts vendors to increase production and also maintain quality.

Contrary to the government's expectations of a positive impact through duty reduction on import of reconditioned cars, Pakistan has already begun to face the aftermath of the government's inconsistent policies. As one industry expert said, it is for the government to choose if they want Pakistan to develop a strong industrial base and make cars locally, or convert the Pakistani market into an international dumping ground for used and reconditioned vehicles. In the long-term, actually even in the short-term, the later is not in the interest of the consumer or the country.