PAKISTAN'S AUTO INDUSTRY

AROOJ ASGHAR (arooj.asghar@crosby.com)
Oct 01 - 07, 2007

The automobile sector of Pakistan has shown significant growth in the last couple of years. Since 2001-02 the automobile market has grown immensely whereas it is expected that market will cross the milestone of 500,000 units by year 2010 if it maintains growth rate of around 8% per annum. Long term investment-friendly policies of the Government of Pakistan (GOP) and up-gradation of production facilities by the manufacturers are considered as prerequisite for achieving the automobile vision 2010. As of now, Rs. 17 billion has been invested in the cars and commercial vehicles segment, Rs5.50 billion in motorcycles, and Rs3.5 billion in tractors. According to the government sources, cars and commercial vehicles, motorcycles and tractors contributed Rs84.0 billion, Rs30 billion and Rs15.08 billion respectively in Pakistan's GDP. GOP's auto policy envisages an investment of Rs. 250 billion mainly as capacity expansion in the next five years in auto sector. In order to contribute effectively in the national economy by this sector, it is important to have high quality standards, enhance skill training institutes which government is planning to establish by the end of fiscal year 2007-08. Local manufacturers of auto parts and assemblers are expanding their facilities as well as creating new employment opportunities and generating demand for several types of services.

In the industrialized world the automotive industry generates about 10% of the revenue and annual size of the automotive exports has grown over US$600 billion. According to Fortune magazine the automotive and allied industry is the largest employer and second largest investor after chemical industry. It is also called the "mother industry", because it has given birth to many other business opportunities. That is why many countries, especially those with high population have chosen the automotive industry to be the engine of economic and strategic growth. In today's fast globalizing world, changing models, improving fuel efficiency, cutting costs and enhancing user comfort without compromising on quality are the most important challenges of the industry.

Though car production in Pakistan has increased manifolds during the last few years but Pakistan's share in global car production is negligible. It is estimated that cars per 1000 persons ratio in Pakistan is around 8 whereas it is 765, 641, 543, 25, 23, 12, 10 in USA, Malaysia, Japan, Sri Lanka, Iran, India and China respectively. This means there is enough room available for expansion of this sector. Due to sound macro economic policies, auto industry in Pakistan is fast growing and may soon begin to achieve economies of scale. There are various factors which have contributed in the development of this sector, including various incentive schemes for electronic goods, auto policy, liberal adjustment of tax regime to lower duties on raw materials and intermediate products etc...The tremendous demand of automobile has resulted in increased production thus providing over 150,000 direct employment opportunities besides contributing tax revenues in the national exchequer as commercial vehicles, motorcycles and tractors paid Rs28 billion, Rs11 billion and Rs4.50 billion respectively last year.

Major automobile companies in Pakistan have joint venture agreements with foreign multinational companies which is a source of inflows of foreign direct investment in the country. The automobile industry operates under franchise and technical cooperation agreements with leading world manufacturers and can be broadly categorized into various segments, i.e. cars and light commercial vehicles (LCVs), two and three wheelers, tractors, trucks and buses and vendor industry. The importance of auto industry in the Pakistan's economy can hardly be over emphasized. The vehicle manufacturers alone employ around 150,000 workers with more than 300,000 people working in the vendor industry. Presently, the automobile industry mainly comprises of more than a dozen manufacturers of passenger cars, commercial vehicles, motorbikes and tractors, and over 800 down stream vendors supplying various indigenous component to these Manufacturers.

From the late 80s to the early 90s the demand for automobiles in Pakistan was on the rise, setting the stage for a decade of robust growth. The demand has risen substantially after September 11, 2001, partly in the wake of the increase in home remittances which resulted in greater liquidity in the market. Auto sector in Pakistan has seen exceptional growth in the last three years mainly due to State Bank's easy monetary policy and historically low interest rates. Due to availability of bank credit facilities, people heavily inclined to get cars, motorcycles, auto rickshaws, buses on lease which in turn helped the manufacturers to expand their capacities. Consumer financing, particularly by the larger commercial banks, has played an important role in supporting the demand for automobiles. In order to meet the rising demand, the automobile industry has increased its production considerably. It wouldn't be wrong to say that automobile sector is heavily benefited from the growing credit disbursement schemes of various banks. According to the State Bank of Pakistan, auto loans disbursement stood at Rs. 18.7 billion in 2003, Rs. 27.8 billion in 2004 and Rs. 65.9 billion in 2005 and Rs. 70 billion in 2006.

Compared with Pakistan, India has a strong engineering base and has successfully created a sizable capacity for production of vehicles. It enjoys a clear edge over Pakistan in the automobile sector. Indian auto companies are highly cost competitive due to appropriate levels of automation and low cost automation and have achieved a high level of productivity by embracing Japanese concepts and best practices. India is already the second largest two wheeler manufacturer in the world, second largest tractor manufacturer in the world, and fifth largest commercial vehicle manufacturer in the world and fourth largest car market in Asia. The automobile industry in India is now gradually evolving to replicate those of developed countries.

As regards auto trade with India, there is a fear in Pakistan that free trade with India will adversely affect Pakistan's automobile sector particularly its two wheelers, as Indians are presently marketing these items at much cheaper rates. Many assemblers feel that the local industry will suffer due to opening of trade with India in case the cost of doing business in Pakistan is not brought down in due course of time. Pakistani auto parts industry is only interested in the procurement of raw materials from India instead of seeking any technical collaboration or the transfer of technology. However, Pakistan can import automotive components and spare parts from India at a lower price as presently these items are being imported from Far East at higher prices. On the other hand, India is expected to benefit from free trade due to its low raw material, electric and labor costs.

The prices of locally manufactured automotive vehicles are generally less than the landed cost of imported vehicles. But these are higher than the CIF values of imported vehicles. That is one of the major reasons why the automotive industry in Pakistan has not been able to make a breakthrough in the foreign markets. In the domestic market however, the profit margins are estimated at 10% to 20% of return on equity (ROE) depending on the brands, manufacturing companies and consumer preference, etc. Government of Pakistan has imposed 2.5% withholding tax on locally manufactured vehicles and 1% excise duty/surcharge on imported and locally manufactured goods in the finance bill 2007-08. In addition to this, GOP has also imposed restriction on the age of imported cars to three years instead of previously of five years. Industry experts expect that these measures will discourage the import of used vehicles as country has already paid above Rs. 13 billion on the import of used vehicles in fiscal year 2006-07. On the other hand, above mentioned withholding tax and excise duty on imported and locally manufactured goods allow local manufacturers to raise the price of their products for the customers who are already under pressure of banks due to continuous increase in financial costs. Going forward it is expected that it will leave negative impact on the domestic production.

In short, automobile industry of Pakistan has great potential and can achieve new heights provided a balance be maintained between production levels of vendors and assemblers, stable policies, continuity of governmental policies and assistance in financing investment and taxation, as there is a growing demand from local consumers along with the potential to export in foreign markets. Value-addition should be a national priority to improve Pakistan's position on the value chain as well. Moreover, a long-term well defined auto policy is required that would provide investors a predictable and transparent environment and would facilitate long-term investment, encourage growth and competition, and enhance competitiveness. Pakistan is among few countries where cost of manufacturing is lower than several other countries and has the potential to become an export hub for auto parts and sub assemblies.