Mar 02 - 08, 2009

In an attempt to control inflation in the country State Bank of Pakistan has been raising interest rates to the tune that discount rate now touches 15% per annum, which has also kept Kibor rate also high. Since interest rate charged is based on Kibor plus formula, the raising interest rate has not only adversely affected auto finance but also delinquent loans are also on the rise. This has caused twin problems for the financial institutions 1) shrinking size of market and 2) rising cost of provisioning. In an attempt to repossess the vehicles, often unethical practices are being followed, which is scaring potential customers.

The declining auto sales are the biggest evidence of the prevailing market conditions. According to reports, auto sales in 2008 were significantly low as compared to 2007. Lately, auto sale boom was mainly due to leasing/financing but with the rise in prices, hike in interest rates and some of the financial institutions following unethical practices, number of customers seeking auto financing has also reduced substantially.

Therefore, it is necessary to pinpoint that financial institutions have always been charging relatively higher interest rate on auto financing, which at times have exceeded 24% per annum, mainly because of various hidden costs. The demand driven policies of the previous government kept consumer financing a booming business for the financial institutions, especially big financial institutions because their average cost of funds was often less than 5%. However, as the central bank put a minimum ceiling of 5% payout on deposits, the inefficient ones are facing problems.

On top of this, persistent increase in yield on Treasury Bills by the central bank has encouraged financial institutions to lock their funds in risk free and high yielding securities rather than lending to the private sector. According to analysts, one of the reasons for boom in consumer finance was low yield on Treasury Bills, which forced the financial institutions to focus more on private sector and particularly on consumer finance. At time, the internal rate of return (IRR) on some of the products was more than 40% per annum. Since the economy was booming borrowers were not bothered about the interest rates being charged by the financial institutions. However, with double-digit inflation rate being experienced for more than 18 months, mainly because of hike in commodities prices especially crude oil purchasing power of people in general has reduced considerably.

Another factor responsible for thriving auto sale was booming equities market. Since capital gains made in equities market are tax exempt people making a fortune in equities market were spending a lot on buying new cars, cell phones and even the real estate. As market went bearish, disposable income shrank and many faced virtual bankruptcy the reverse cycle started. It is said that now people find it hard to earn a monthly figure, which some of them were making on weekly basis. Worst hit are the research analysts and traders, many of them find it extremely hard to keep on paying the monthly rental and some of them forced to sell their cars, laptops, expensive cell phones at whatever price they could get. The situation has deteriorated since August 2008 and there seems little hope of recovery.

Some of the readers may not consider the above stated narration close to reality but these are facts. Nearly half of the vehicles sold in the country belonged to Karachi. It is mainly due to the life style of the people living in Karachi and because of the handsome earnings. According to some cynics per capital income of people living in Karachi range from 10,000 to 25,000 dollars. Taking Karachi's population of around 17 million, retention of half of the cars sold in Karachi gains credibility.

It may also be said that over the last five to seven years' earnings of banks were substantial and ratio of non-performing loans was on the decline. Not only that fresh lending faces virtual halt but also other options are also drying fast. Actively participation, directly as well indirectly of the financial institutions in the equities market also encouraged them to sponsor asset management companies and Insurance companies. As the equities market plunged deeper into bearish spell redemption pressure mounted on asset management companies and insurance business reduced.

Lately, motor insurance emerged as one of the major segments for non-life insurance companies. There were substantial claims, but inflow of premium was huge. With the slowdown in underwriting fresh business and mounting claims, this milking cow is becoming dry. The associate insurance companies of banks, face double edged sword because not only motor insurance business has started yielding loss but other segments i.e. marine, property and miscellaneous are bearing brunt of economic slowdown.

The auto assemblers, which had not fully recovered from the adverse impact of import of secondhand vehicles, are now finding it difficult to rollout more cars due to rising inventory. On top of this more than 25% erosion in Rupee value has made CKD/SKD kits expensive and forced the assemblers to increase prices of CBUs.

A strange phenomenon notices lately is that while the sale of up to 1200cc cars is on the decline, sale of higher engine capacity and expensive cars is on the rise. This reminds an old clichÈ 'rich are getting richer and poor are getting poorer'. However, the biggest class of yesteryear 'middle class' is vanishing fast. Some of them may have become rich but most going broke with the passage of time.