The rise of the middle class in Pakistan is offering a great opportunity for automakers from across the world to tap into the potential demand for small vehicles.
When Pakistan ended protectionist policies for the automotive sector, major players began setting up local assembly operations, starting with Suzuki and followed by Honda and Toyota. Local assembly numbers increased by sixfold from just 33,000 units in fiscal 1995-96 to 204,000 in 2006-07, the industry’s peak year.
However, production is still quite low in a country where per capita income has reached $1,380 and a teeming population of 180 million, including 2 million people who reach age 25 annually.
And while sales dropped by half in the two years following the 2006-07 peak, amid an economic slowdown and higher car financing rates, they are now stabilising, with about 137,000 locally assembled cars sold in 2013-14.
In any case, current production levels are not indicative of actual demand, as car imports rose significantly when the government relaxed its import policy. In fiscal 2012, the import duty on cars was relaxed from an age limit of three years to five years. Pakistan imported 54,000 units in that year.
However, mounting pressure from domestic assemblers caused the government to reverse the decision in December 2012 and imports diminished to 39,000 units in 2012-13. Clearly, there was a direct link between lower prices and higher demand.
This fact made a strong case for assembling lower-cost economical cars in order to tap into the enormous middle class of 30 million, which currently relies largely on old second-hand cars and motorcycles.
Cars with engines from 800cc to 1800cc that are assembled locally currently for between 30% and 50% more than what consumers pay for the same vehicles in India, Thailand and Vietnam.
Pakistan’s domestic auto sector was protected for 20 years in order to advance the industry to gain economies of scale. A “deletion policy” in place up to 2005 promoted a shift from importing auto parts to relying on local manufacturing.
However, the policy has not been successful as Pakistan still does not manufacture even a single electrical or mechanical component. Only tyres and some rubber parts are locally produced.
In 2005, when the deletion policy was phased out and the industry was supposed to be opened to the rest of the world, domestic players were still not ready to face the storm of free-market competition.
They successfully convinced policymakers to not remove the duties on completely built imported units, and to retain the duties on imported parts that were also available through local production. It was a “prisoner’s dilemma” (a term coined by Nobel laureate John Nash that shows why two purely “rational” individuals might not cooperate even if it is in their best interests).
Therefore, as a way out, the government decided to replace the deletion policy with a tariff-based system and introduced the Auto Industry Development Programme. However, the industry has yet to grow out of its state of infancy.
In essence, local assemblers engaged in rent-seeking behaviour and continued to pocket high margins without actually expanding or innovating to become competitive. In the entire process, the only loser was the consumer.
The All Pakistan Motor Dealers’ Association has responded with a three-point proposal to address the above-mentioned issues: a level playing field for all stakeholders; an environment of competition to discourage monopolies and encourage performance; and protection of consumer rights.
The Competition Commission of Pakistan (CCP), in a detailed report on the auto sector, has observed that the industry remains inward-looking and tries to protect its interests through mercenary regulatory instruments. The CCP recommended discouraging the current rent-seeking culture through the opening up of the domestic market to imports of new cars at reasonable tariffs, removal of entry barriers to imports, and other liberal measures.
The counter argument presented by the auto manufacturers is in the form of the question: “Do we want to be an auto manufacturing or an auto trading country? Employment and transfer of technology will only follow if we help create an economy based on manufacturing,” says Pervaiz Ghias, the CEO of Indus Motors.
He added that because Pakistan is a low per capita income country, there is not enough demand to justify expansion by manufacturers or to entice new players. “Pakistan has 12 passenger cars per 1,000 people at a per capita GDP of about $1,200. Look at the numbers for India: it has 17 passenger cars per 1,000 people with a per capita income of $1,500 to $1,600. That’s very little difference, and is explained by the low income levels in both countries.”
The main difference between the two countries is the size of the population and that is why India is able to manufacture cars at much lower prices. It remains unclear what policy Pakistan will adopt in the coming years.
Looking at demand for the more economical motorcycles, Mr Ghias said that increased income levels and rationalised prices of two-wheelers had led to a boost in production. He predicted a similar revolution in the four-wheeler industry based on a further rise foreseen in income levels.
Pakistan sells around 1.6 million motorcycles a year, compared with 10 million in India. Furthermore, the prices of two-wheelers in Pakistan are internationally competitive because the industry has reached a certain scale.
A key factor in the emergence of the motorcycle industry as a success story is the entry of new players, which lowered unit prices due to economies of scale and competition. The price of a standard Honda motorcycle has remained almost constant throughout the last decade.
This stability in the value of the product was due, in part, to the entry of a few Chinese companies, which forced the existing players not only to innovate technologically but also to lower their prices. Therefore, at least in the two-wheeler industry, the consumer is winning.
Similarly, the tractor industry in Pakistan is a successful market, as local manufacturers are producing basic but reliable models at affordable prices; consumers are satisfied and market demand is saturated.
However, the tractor industry was hurt when the goods and services tax (GST) was raised in fiscal 2012-13, and sales plunged to a seven-year low of only 34,000 units. The current budget returns GST to 10% from 16% a year earlier, and sales are moving back up.
The car industry would do well to learn the key lesson from the other manufacturers in the country: to be more open to competition through accepting the presence of importers. Furthermore, there is much potential for growth and expansion through creating a market in Afghanistan and other landlocked Central Asian states.