IMPACT OF DISMAL AUTO SALES ON FINANCIAL SECTOR
IMPROVING SALES IS NOT POSSIBLE WITHOUT AUTO FINANCING
SHABBIR H. KAZMI
June 27 - July 3, 2011
Financial year 201-11 (FY11) was full of challenges for Pakistan because of 1) unprecedented floods causing US$10 billion losses to the economy, 2) precarious law and order situation and 3) acute energy crisis affecting performance of the manufacturing sector. Real GDP growth is likely to be around 2.5 per cent, which is not bad keeping in view the above stated factors. Pakistan has benefited from hike in commodity prices enabling rural economy to recover, improving earnings of farmers and increasing exports. Together with an improved trade account, higher remittance is likely to touch record high of US$11 billion for the full year to keep exchange rate stable.
The federal budget 2011-12 (FY12) aims at achieving a difficult balance between growth and stability. Real GDP growth target has been set at 4.2 per cent, expected to be driven equally by agriculture and manufacturing sectors with added support from services. The cumulative impact of FY12 budget measures is likely to lead to reduction in automobile prices, which may spur demand. The measures include 1) reduction in GST from 17 per cent to 16 per cent, 2) removal of SED and 3) removal of 5 per cent FED. That said CNG kits will continue to be subject to 16 per cent GST. There is no change on depreciation rates on import of used cars.
LOSS TO NATIONAL EXCHEQUER
Auto sector experts say that tax collection will improve with the increase in import of used cars. However, they completely ignore the fact that it will also erode foreign exchange reserves of the country. With the increase in import of completely built units (CBUs), worst hit will be the manufacturers of parts and accessories. Import of those models which are not assembled locally will also increase the import of parts and accessories of these models, further eroding the foreign exchange reserves.
A visit to replacement markets (selling parts and accessories) indicates that the shops are flooded with smuggled items, which also suggest that no duty/taxes have been paid. For years the vendor industry has been demanding curbing smuggling but the groups having vested interest seem much stronger than the customs authorities. According to the sector experts, the smuggling has been going on for decades under 'Afghan Transit Trade'. The worst sufferer of this practice has been the local manufactures of tyres and tubes. In fact, bulk of the quantity imported for Afghanistan never crosses the border. It causes billion of rupees losses to the national exchequer and also results in poor capacity utilization of local installed facilities.
DECLINE IN CONSUMER FINANCE
Till 2008 auto finance used to contribute a substantial share in consumer finance. Reportedly up to 75 per cent of total sale of automobiles was financed by the financial institutions, either through auto lease or auto finance. As against this, now bulk of the sale is on cash, especially of the 1300cc and above cars. One of the reasons is stringent credit approval system, mainly aimed at discouraging the borrowers. This is often attributed to rising delinquencies due to rather reckless lending by some of the financial institutions.
With the persistent hike in interest rates and yields on treasury bills, banks seem least interested in consumer finance. Though, it is said that banks conveniently earn 7.5 per cent spread, the real earnings are more than that especially for the 'big five' as they still hold huge cost free deposits. The banks have been instructed by the central bank to pay minimum 5 per cent return on deposits whereas the average lending rate charged is Kibor plus 2.5 per cent. The rate charged on consumer finance hovers around 18 per cent.
In an environment where the average person, especially those belonging to salaried class, suffer from eroding purchasing power often find themselves in difficult position when it comes to paying the monthly installments. Their best efforts are to avoid delinquency for fear of foreclosure. At times, the financial institutions try to negotiate a deal because selling such vehicles is very cumbersome.
Insurance companies were said to be the biggest beneficiary of the booming auto finance business of yesteryear. Since these companies were able to negotiate 'bulk deal' with the financial institutions they often ended up in 'price war' and underwriting the business at very nominal rate. New business was handsome and renewals were also guaranteed, insurance companies were not 'too stringent' when it came to paying claims. However, many of the insurance sector experts term auto insurance 'loss making business'. Not only car snatching is on the rise the chances of recovery are also diminishing because of the involvement of 'very influential people' in this business. At times, the stolen cars could be found moving in certain cities but just can't be recovered and brought back to Karachi. Added to this has been increase in claims due to bomb blasts and/or burning by the mobs.
As against conventional banks and insurance companies, the business of Islamic banks (car Ijarah) and Takaful operators is on the rise. According to some banking sector, Islamic banks have emerged the biggest provider of car leasing (Ijarah) business and Takaful operators are also the beneficiary of this kind of business. One of the reasons for this has been the 'over flowing liquidity' of a few Islamic banks. However, with the government of Pakistan offering Ijarah Sukuk in billions of rupees, Islamic banks may also not remain keen in auto financing.
Most of the commercial banks have 'captive' insurance companies and have also invested huge amounts in the shares of assemblers listed at the local stock exchanges. They will have to come up with revised strategy for auto financing. Prices of locally assembled automobiles can only be reduced by increasing output and not by importing used cars. As such maintaining a car is becoming punitive for the middle income groups.