Facilitating people ride in new cars and paying the cost in three to five years

SHABBIR H. KAZMI, Special Correspondent
Oct 01 - 07, 2007

At present automobile sales are mainly driven by easy access to auto finance. Around 70% of the total sales are through auto finance/lease. However, credit demand has slowed down in calendar year 2007 due to rising interest rates, an outcome of tight monetary policy being followed by the State Bank of Pakistan.

Auto finance rate offered by the financial institutions are from 15% to 20% per annum. As a result of the recent increase in the discount rate, there has been an increase in the mark-up on consumer financing which is expected to have a dampening effect on demand.

Reportedly, consumer loans have decelerated mainly due to higher interest rates. Due to increase in discount rate consumer financing during January-August 2007 grew at nearly half the rate compared to the corresponding period last year. Within the consumer loans portfolio, car loans showed the sharpest fall, declining to one fourth rate.

According to some analysts there has not been any visible shift in consumer financing patterns. However, they expect that consumer financing may respond negatively to the interest rate hike, dampening auto financing growth. Further, lower demand in auto financing may also result due to an increase in prices of automobiles.

The total production of cars and light commercial vehicles this year was 204,212 units compared to 187,436 units in the same period last year. This is a growth of 9% compared to a CAGR of 21% over the last six years. This decline is firstly due to an increase in the prices of some of the brands/models. Secondly, capacities of local assemblers, producing economical cars did not completely cater to local demand resulting in an increase in the supply-demand gap. This resulted in longer delivery periods which led to increases in "premium money" in the recent past.

The policies proposed in the budget will only invoke an unnecessary rise in the end-cost borne by customers, which is already under pressure from increased financial costs of consumer financing and will bear a negative repression on the domestic production. The Auto Industry Development Plan (AIDP) has proposed import duties on completely knock-down units (CKD), CBU and spare-parts to be reduced gradually. Moreover, the reduction will begin from 2008-09 instead of 2007-08. Likewise, on localized parts, CKD duty remains unchanged at 50% until 2008-09. Thereafter it would be reduced to 45%. However, no change has been made in the duty structure of CBU below 1500cc engine capacity.

The auto policy envisages significant investment in the next five years, to achieve a target production of 500,000 cars per annum. Most of this investment is being made by the vendors for capacity expansion to meet the target. This additional capacity will enable assemblers to meet ever increasing demand, driven on the back of improving purchasing power.

The local manufacturers of parts and accessories are adding on new production facilities as well as creating new employment opportunities and generating demand for a variety of services. Currently, about 200,000 people are employed in automotive parts manufacturing units and it is expected to touch 250,000 in couple of years. This number does not include people working in automobile assembly units, motorcycles assembly plants and tractors manufacturing plants.

Currently, car ownership in Pakistan is estimated at 8 per 1000 people, compared to 12 in India, 10 in China, 21 in Indonesia, 23 in Iran, 25 in Sri Lanka, and 31 in the Philippines. At an average; 28 out of 1000 Asians own a car. This indicates there is further room for expansion, not only in Pakistan but across the region that bodes well for the local manufacturers.

One of the beneficiaries of robust auto sales has been insurance sector. However, the growing consensus of the leading players is that underwriting auto insurance is becoming less attractive business. The reasons for this are declining trend in the premium rate and rising claim to net premium ratio. Though, the number of policies issued is on the rise but declining premium rate is eroding profit of the insurance companies. The leading players are also of the view that claims arising due to theft/snatching are also eroding profit of the insurance companies.

Though, the central bank continues to follow tight monetary policy, resulting in hike in interest rate, there seems to be little impact on auto financing. However, there is growing concern that probability of default is on the rise, it may not be due to higher interest rate but certainly due to fast eroding purchasing power.

However, financial sector experts are of the view that people interested in acquiring automobiles through lease/auto finance mostly belong to salaried class and payment of monthly rental has become pinching. It is mainly due to eroding purchasing power.

A disappointing factor is that public transport system has the largest potential but financial institutions are reluctant to finance the sector. The past experience has been very bitter, be it the yellow cab scheme or the urban transport scheme. However, financial institutions are partly responsible for this. In an attempt to attain "political mileage" various governments have been exploiting the nationalized commercial banks. The balance sheet footing of private banks is relatively much smaller as compared to "big five" and they cannot afford to take the hit.

It is also necessary to highlight the issue of tractor financing. In the past ZTBL used to be the biggest provider of loans for purchasing tractors. At present the financing by the ZTBL has shrunk to about 15% of the past lending. Commercial banks are also not providing much financing, though, the government claims that lending to the agriculture sector now touches Rs 160 billion.

Interestingly, financial institutions do not seem interested in extending credit for the purchase of tractors, though it also acts as collateral. Lending for the purchase of inputs is riskier because in case of any natural calamity recovery becomes very difficult.