Chapter 10 CONCLUSIONS AND RECOMMENDATIONS

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exists in this sub-sector even on a single-shift basis and potential economies of scale do not appear to have been exploited sufficiently. Over the last five years the production of trucks and buses has declined to under half the output in 2005-06. While part of this maybe the consequence of economic stagnation, this also reflects the competition provided through the import of secondhand CBU trucks and buses, and the import of old chassis (declared and assessed as scrap) of concrete mixers, dump trucks and other construction related ORVs and their subsequent conversion to rigid 2- and axle rigid trucks. These sell in the market for Rs.
800,000 to Rs. 1.5 million. Some of these are then converted to buses. The total value of output by the sector has been estimated to be Rs. 233 billion (US 2.8 billion) for the OEMs and Rs. 168 billion (US 2.0 billion) for the Vendors (formal and informal. Total imports by the sector in 2010-11 are reported at US 905 million of which CBU/CKD import of vehicles was US 757 million. Exports by the sector in the same year were a total of US 126 million and US 108 million worth of transport equipment. Other key parameters of the sector’s size and performance in 2009-10 are summarised as follows Turnover
Rs. 402 billion Employment

209,324 Value Added
Rs. 108 billion (4.8% of Manufacturing, 0.7% of GDP) Exports
US 89 million Imports
US 835 million Value of Cumulative Investment US 2.8 – 3.0 billion Foreign Exchange Savings US 704 million Contribution to Revenues Rs. 61.8 million The results of the demand analysis indicate the following i) The short-term income elasticities are generally high, ranging from 2.75 to almost 4. This implies that fluctuations in the growth of real per capita income in the economy have a magnified effect on demand for vehicles. ii) The elasticities with respect to relative price of vehicles are low. This could explain the aggressive pricing policy, especially in the case of cars. iii) The elasticities with respect to interest rate are significant and moderately high. The explosive growth of sales in the middle of the last decade can be partly attributed to the steep fall in interest rates on advances from over 14 percent to just over 7 percent and the increased availability of consumer financing by banks

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The sector is governed by a number of international conventions and treaties which it has ratified, but has implemented only one, the WTO’s TRIMS as a consequence of which it abandoned the deletion programme by mid. The domestic regulatory framework consists several policies and regulations the Industrial Policy the Privatisation Policy, 2000; the Trade Policies, 2009; the Finance Acts which modify the fiscal and tariff regime backed by the Statutory Rules and Orders (SROs) and the Customs General Orders (CGOs) which are modified from time to time the Auto Industry Development Programme (AIDP); the Tariff Based Scheme TBS) which ensures compliance to the WTO-TRIMs; the Pakistan Standards governing the sector and implemented through the Pakistan Standard Quality Control Authority (PSQCA); and the National Environmental Quality Standards (NEQS) which governs vehicular exhaust emissions. The Import Policy Order 2009 includes a negative list forbidding imports of automotive products from India and allows for the import of secondhand motor vehicles which is misused for commercial quantities) and scrap (used for importing old chassis of
ORVs). Cumulatively they impede competition, technology acquisition and dispersal, and lead to monopolistic behaviour. The absence of skills and equipment with the MVEs results in plying unfit and unsafe vehicles on roads. The conclusions emerging from the ERP estimates are v) If domestic prices fully reflect tariffs, then the ERPs are generally high. They range from
98 percent for small cars (cc) to as high as 374 percent for large cars (above cc. This is a reflection of the very high customs duty of 75 percent on large cars. The ERPs comedown sharply to between 35 percent and 113 percent for cars with the second set of assumptions. vi) The ERP on parts ranges from 32 percent to 78 percent depending upon the particular set of assumptions. vii) The ERP on motorcycles is extremely high at 196 percent under the first set of assumptions and falls to 76 percent if in the presence of intensive competition in this market the domestic price remains somewhat below the world price plus tariff. viii) In the case of trucks there appears to be a large differential between the ERPs for small and large vehicles respectively. The measure most commonly used by regulatory agencies to assess degree of competition is the Herfindahl–Hirshman Index, HHI, which in essence is a measure of the shares of all competing organisations in any particular segment or product. The lower the value of the index, the greater is the competition. For most market regulators, including the CCP, the threshold is considered to bean index value of 1800. There are three producers in the large car

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category, namely, Honda, Toyota and Suzuki, with Toyota having the largest market share of 67 percent. The HHI value is high at 4728, well above the threshold level of 1800. In cc cars, Suzuki dominates the market, leading to a HHI of as high as 9090. In the cc category, there are two car manufacturers and the HHI is also high at Further, market shares of individual manufacturers have not changed substantially overtime. Also, there has been very limited entry into the car market. Nissan and Kia did enter in the cc – cc group earlier but have since ceased production. There is evidence of lack of innovation in terms of changes in models, quick availability, fuel efficiency, increase in user efficiency and cost cutting. A key indicator of the lack of competition is late deliveries and high premium payments even in the presence of substantial excess capacity. The high prices of cars is demonstrated by the high ratio of prices to average household income, which places Pakistan in the lowest decile of countries in terms of affordability of cars. Some competition has been introduced through the removal of the requirement for obtaining licenses for investing in the automobile sector, the import of CKD cars at the same rate, 35 percent, as auto parts, 50 percent initial depreciation allowance, 100 percent foreign equity and full remittance of profits and low customs duty of 5 percent on imported plant and machinery. Further, import of used and reconditioned cars has been liberalized, but only under gift, personal baggage schemes and transfer of residence (which is grossly abused, but this policy has been revised year-to-year, especially with regard to provisions for depreciation. The survey of 34 vendor units (formal and informal) reveals that employment informal units is on the average almost thrice that of informal units and, given the technological nature of the industry, the major part of the employment is of managerial and supervisory personnel and skilled workers. Labour productivity is about 72 percent higher informal vendor units. Further from the sample of vendors we conclude that the bulk of the units, both formal and informal, are private limited companies there is wide variation in size of units fairly high level of capital- intensity as demonstrated by relatively labour productivity high share of material and electricity costs and reasonably high gross profit margins. Also, formal units perform significantly better than informal units both in terms of size and profitability. While many of the licensed vendors supply only to OEMs, some sell their products in the replacement market clandestinely. These vendors manufacture (88 percent, or some assemble
(17 percent) sophisticated parts. Of the sample 41 percent of manufacture subparts, while 64 percent manufacture the assemblies and components. The production processes for different parts area mixture of different processes. The main processes involved in the manufacturing of

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auto parts (Table 7.2) and span the spectrum from metalworking to precision machine tooling. The most commonly reported production process is sheet metal fabrication which is in use by
20 firms, followed by 12 firms using die-stamping and 10 engaging in production of moulds. Quality is monitored through OEM supervision, technical assistance and self-induced mechanisms including skill development and acquisition of production technology and equipment. Government help in upgrading quality is marginal (only 4.5 percent responded positively. 59.1 percent had ISO certification in one form or another. An OEM may have more than one supplier fora specific part/component/assembly thus ensuring quasi competition. One instance of a sole supplier to the industry at large is Rastgar Engineering’s steering knuckles which are also exported. Some vendors also sell to more than one OEM.The major constraints to improving quality are the availability of appropriate machines and skills of labour in both the formal and the informal sectors. Shortage of finances also impedes, but not to as great an extent. The overall conclusion is that while the formal sector, which has stronger links with OEMs, has achieved a fairly high level of technology deepening, the informal sector is still using low or intermediate technologies and producing simple parts mostly for the large replacement market. Growth in the sector is attributed to a number of factors. The two main ones being the increase in demand placed by the OEMs/market and an expansion in the number of parts produced by individual vendors. Government regulations have an ambiguous impact on growth. Only 12.0 percentof the responses reported positive impacts - ability to import on concessionary rates and tax rebates on exports. The adversely impacting factors were not necessarily only in the realm of regulations but extended to policy and modus operandi. These included energy crisis, corruption, law and order situation, and a spectrum of Government policies, such as, payment of bribes to customs officials (at the import stage, the police and officials of various government agencies. The majority stated that exemption from sales taxon new technology products, duty free imports of supporting machine tools and access to new technology through RD and SMEDA’s technology development fund would contribute to growth substantially. Over 90 percent of the formal sector generated their own electricity to overcome power outages which reduce output by about a third and increases costs by 22 percent and 33 percent in the formal and informal units. The major automotive imports consist of CBU/CKD cars, trucks and tractors. Parts and accessories and motorcycles also account fora significant share of imports. As opposed to this, the base of exports is small and narrow. Given its dominance in the fleet of vehicles on road, Japan is traditionally the largest supplier of the range of auto-parts products. Emerging sources

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are Turkey in tractors, Singapore and Thailand for cars and parts, South Korea in trucks and China in the case of motorcycles. Pakistan has established a small market niche for motorcycles in two SAARC countries, Afghanistan and Bangladesh for tractors in African countries like Nigeria and Kenya for and for auto-parts in USA and Italy. The imports are controlled by the framework of the Import Policy Order 2009 which requires that the EDB certify the level of imports by any manufacturer. This certification allows the importer-manufacturer to avail the preferential rates of customs duty. In effect this is a method of licensing which is against the very essence of the Tariff Based Scheme. In the presence existing documentation of the authorised level of installed production capacity, there is no justification for such certification. Therefore, this requirement for certification, either directly or indirectly, by the EDB should be removed immediately to encourage greater capacity utilisation, thereby lowering prices and increasing competition. Pakistan has a very small share in the world trade in the automobile sector. The factors constraining the growth of export were cited during the survey as inability to enter the export market, lack of awareness of export possibilities, lack of motivation to export owing to un- competitiveness as a consequence of low levels of production and high level of profits from the domestic market. Parallel discussions with a sample of CEOs identified other factors also. The major ones were firstly, the absence of assistance by the Commercial Counsellor’s attached to
Pakistan’s diplomatic missions abroad and the Export Development Fund in identifying opportunities, such as bulk public procurement opportunities in the developing countries, hosting roadshows using their own available resources and lack of skills in performing the task assigned to them secondly, the lost opportunity in accessing technical assistance available from international sources for improving the quality of output and transiting from reverse- engineering processes to more sophisticated processes thirdly, high cost of production as a consequence of low productivity and low rates of capacity utilisation exacerbated by the rapid decline in the Rupee’s exchange convertibility rates was also identified as a major inhibiting factor and fourthly, perhaps the most irritating factor, the delays in refund of domestic and import input taxes paid on exported goods, which impacts working capital and thus on output through the inability to finance inventory replenishment. Ina recent report (2009)
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the
Pakistan-Japan Business Forum states “If the competitiveness (cost and quality) of cars and

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