Karachi, May 26, 2022 (PPI-OT): Autos: Weak demand ahead as historic patterns likely to repeat

With recent developments in the Auto sector we take a peek at historic macro patterns in the industry and compare it with the current scenario.

Steps such as stricter conditions on import of CBU of autos, discouraging auto consumption through stricter auto financing conditions and higher duties witnessed in FY19 are now being repeated as a part of consolidation in economic activity. This has been accompanied by sharp PKR depreciation as well, making vehicles more expensive to purchase.

Given similarities with the FY19 scenario, we expect auto sales to take a dip in FY23, as witnessed in FY19, with some respite from recently launched models such as City, Civic (HCAR) and Swift (PSMC).

Volumes to drop by 25% YoY in FY23

With a growing list of concerns such as the PKR depreciating to record lows amid economic and political concerns, inflation reaching alarming levels, multiple rounds of price hikes, freight rates 5-6x higher YoY, hike in interest rates and with the restrictions on auto financing by the SBP, auto sales volumes and margins are expected to remain under pressure going forward.

So far sales volumes have been able to maintain their growth momentum despite the above mentioned developments owing to higher delivery times, however, in April-2022, auto sales took a hit declining by 17% MoM showing first signs weakness in demand. We expect the trend seen in April-2022 to continue in the coming months with some respite from recently launched models such as City, Civic (HCAR) and Swift (PSMC).

We expect industry volumes to decline by 25% YoY where decline in the big three auto players is expected to be in a close range. Despite having more exposure to auto financing, sales decline for HCAR and PSMC is expected to be in the same range owing to the recent model launches.

Echoes from the past – especially FY19

With recent developments in the Auto sector we take a peek at the historic macro patterns in the industry and compare it with the current scenario. The industry’s macro conditions have significantly deteriorated over the past couple of quarters where prices have been on a consistent rise owing to rising costs, changes in taxes and measures taken by policy makers.

1. Ban on imports to contain BOP crisis

In an attempt to contain the balance of payments crisis, the current government has placed an import ban on luxury items which include automobile imports (CBUs). Looking back, in Jan 2019, the government imposed restrictions on auto imports through SRO 52(I)2019 which led to a drastic decline in imports dropping from 6305 units in Jan 2019 to just 135 units in 4 months. During the same period car sales saw an initial spike owing to import substitution where sales went from 11k units in Jan-2019 to 14k units in Mar-2019 before other factors such as PKR devaluation and implementation of FED in the Federal Budget FY20 started to outweigh the impact.

2. Devaluation of PKR

Similar to FY19, PKR over the past couple of quarters has witnessed steep devaluation owing to rising economic and political concerns devaluing by 22% during YTD FY22 and crossing the Rs200 mark last week. With heavy reliance on imports for auto parts (53% localization in the industry), the auto assemblers have announced multiple rounds of price hikes since Nov-2021 onwards and are expected to continue amid further devaluation.

During FY19, the PKR followed a similar trend where steep devaluation of 24% during the year which led to multiple rounds of price increases. As a result, industry volumes went spiralling down from Mar-2019 onwards up till Mar-2020 which marked the imposition of COVID 19 lockdown taking the already struggling auto sales down to zero in Apr-2020.

3. Inconsistent Budget measures

The previous government had reduced taxes (FED by 2.5% for all engine capacities and sales tax for less than 1000cc cars) on autos during the federal budget for FY22. This spurred sales volume in the industry through most of the year where sales posted a stellar growth of 50% YoY during 10MFY22.

In Jan-2022 however, the government through the mini budget had reversed most of the tax benefits announced earlier which was fully passed on by the auto assemblers. Looking back, during the Federal budget FY20, the government had announced the imposition of FED on autos ranging from 2.5%-7.5% (depending upon engine capacity) which contributed towards the decline in industry sales by 53% YoY FY20.

Although a similarly prompt and immediate impact has not been seen post Jan 2022, a delayed response amid higher delivery times showed first signs of weakness in demand during Apr-2022 where industry sales declined 17% on a MoM basis.

4. Changes in interest rates and auto financing rules by SBP

In Sep-2021, SBP announced a series of measures to control imports in the sector of both CBU and CKD kits. The central bank prohibited auto financing for imports while for local vehicles, maximum tenure of auto financing for 1000cc+ vehicles was reduced from 7 to 5 years. Furthermore, total financing was capped at Rs3mn while minimum down payment requirement was increased from 15% to 30%. Although the measures did slowdown the momentum of growth, auto financing since the implementation of these measures has increased from Rs338.2bn in Sep-2021 to Rs366.8bn in Apr-2022.

More recently, the SBP has announced a further reduction in the maximum time limit of auto loans by 2years for all vehicles which means for vehicles above 1000cc maximum tenure of auto financing is now capped at 3years (previously 5years) while for vehicles below 1000cc the cap is 5years (7 years earlier).

With auto financing accounting for 35-40% of industry sales, interest rates play a vital role in determining demand for auto financing. In an attempt to deal with the COVID-19 situation, SBP had sharply reduced the interest rates from 13.25% to 7% in a matter of few months. This led to robust growth in auto volumes throughout FY21 and for the most part of FY22. However, with growing economic concerns, the SBP has successively increased interest rates which have now jumped back to pre COVID-19 levels at 13.75%.