Interview with Iftikhar Ahmed, Chairman PAAPAM
‘Auto parts exports to cross $500 million by 2023’
Iftikhar Ahmad is the CEO of Risan Synthetic Technic and the current Chairman of Pakistan Association of Automotive Parts & Accessories Manufacturers (PAAPAM). PAAPAM represents over 400 registered tier-one auto parts vendors and manufacturers across the country and was set up in 1988. Manufacturers are typically SMEs that supply a variety of parts including glass working, machining, molding, textile, and plastics. BR Research recently sat down with him in Lahore to breakdown the industry dynamics, and discusses demand prospects, market expansion and the need for localization. Below are edited transcripts of the discussion.
BR Research: Give us a little background of the auto parts manufacturing industry—what are you currently making and what is the current level of localization?
Iftikhar Ahmed: The industry has more than 1100 manufacturers (400 are members of PAAPAM) that by most estimates provide direct employment to around 500,000 with an indirect employment of 2.4 million. There are different categories of work that we do including forging, machining, sheet metal work, plastics, chemicals, electronics and electrical work. Industry’s total revenue amounts to Rs370 billion; we contribute Rs110 billion per annum in taxes and we have an import substitution of $3.3 billion. Exports are about $210 million and are made to the US, Europe and a number of African countries.
There are three major components that go into a vehicle manufacturing: engine, suspension and chassis. Aside from engines which are mainly imported and some suspension parts, we provide all the other parts. Localization levels in the automotive industry is different for different sectors—in the motorcycle sector, it is about 96 percent; trucks 20-22 percent, LCVs I would say more than 30 percent while tractors are localized up to 95 percent. In the cars segment, Suzuki has more than 70 percent localization, Toyota more than 55 and Honda has 51 percent localization. On average, it should be around 60-61 percent. Engines for tractors and motorcycles are also made here locally.
BRR: Why can engine manufacturing not be localized for other segments?
IA: I believe automakers do not think we have the required capacity or expertise in Pakistan. But right now, the volumes are not there either. We would require at least 500,000 cars in the country as a baseline. As soon as we reach this level, you will see investment in the sector grow. However, there is another problem. Across the world by 2030, combustion engines are predicted to be replaced with battery run cars—China is already doing that in the next two years. This is a threat but an opportunity as well. Threat for us is that investment may dry out in engine manufacturing, but there is potential in the electric vehicle segment where we can secure investments. We can invest in battery and battery inputs. We can also see whether lithium ores can be explored in Pakistan as that is the major raw material.
BRR: What is the geographic distribution of the industry?
IA: Our concentration is mostly in Lahore, then in Karachi. In Lahore, most auto parts makers are for tractors and motorcycles because market expansion has been here. Vendorization began back in 1976 which was started by Millat Tractors. Before that, parts used to be imported and there weren’t any car makers. Cars came a decade later and car vendors are mostly based in Karachi. Lahore was also at the center of industrialization before the 70s, if you consider small manufacturers. Karachi is the hub for large manufacturers.
BRR: Why hasn’t the auto parts industry been able to build its capacity to cater to higher exports and become part of the global value chains?
IA: In the motorcycle industry, Atlas Honda has created an entire global chain for procurement of parts. It has parts makers from 14-15 countries including Vietnam, Thailand, Pakistan, India among others and it purchases parts from whichever supplier provides at the cheapest rate and provides parts on time. My company is part of that chain. But generally, the local auto parts makers are not as competitive and struggle with the quality.
But let me share my company’s example. The local motorcycle industry is growing at a very high pace. Over the past 3-4 years, we have invested a lot in the business and the demand is still more than the capacity. Local demand is absorbing the additional capacity. I have added 20-25 percent capacity in my own business every year for the past few years.
Exports have grown but not by as much. A few years ago, exports were less than $100 million, but now they have crossed $200 million. Attaining greater productivity and good quality cannot be done on the back of old, obsolete technology. Plus energy efficiency is not possible either, so a lot of our vendors are expanding and investing in the new machinery. Auto parts makers such as Metaline and Infinity Engineering are already doing that and have started exporting. By 2023, we predict exports to increase up to $500million.
BRR: You said by 2030, combustion engines will be substituted by electric vehicles. So for those, you will also have to do some up gradation. Why don’t auto parts manufacturers enter into joint ventures (JV) — is that not the best way to innovate?
IA: JVs are happening. Recently, Loads Limited has entered one, but more auto parts manufacturers will follow suit. OEMs are saying the same thing—that we need to improve our capacity and capability. Until or unless we go into joint ventures, we cannot survive.
BRR: What challenges you are facing in doing business? For instance in attaining bank financing.
IA: For commercial financing, even at current rates, we get 16-18 percent interest. That is far too expensive. For the first time in many years, as a business I have found the need to secure finance since I am reinvesting in my business and profit margin is also shrinking because our inputs are expensive. Moreover the currency is depreciating as well. Currently my margins are about 1-2 percent; but only 2 years ago, they were more than 10 percent.
Secondly, our human resource is not as productive. Our engineers and skills based workers lag behind others. We don’t have vocational training institutes in this country. If I want an electrician, I make my own electrician after training him for two years on my cost. I have to invest one year into an engineer for him to be ready since the curriculum of those engineers is not according to industry specifications. PAAPAM is currently working on setting up such an institute.
BRR: Do you receive any government support in the form of export promotion that other sectors such as textile enjoy?
IA: Not on that level, to be honest. Our grievance has been that the government has only focused on the textile industry. However, for us and the engineering sector, it had set up Engineering Development Board (EDB) in 1994 which played a very supporting and facilitating role for auto parts makers. Their engineers had the technical expertise. They had greater understanding of the technicalities and over the years, we built a strong working relationship with their members that allowed work to be done swiftly and smoothly.
However, the outgoing government dissolved this organization. PAAPAM has already challenged this decision in the Islamabad High Court and it is our request to revive the EDB. There are areas where improvements could be brought. For instance, installing a professional CEO to run the organization. In the past, EDB flourished under strong leadership. But it should not be disbanded.
Another area where we can get support is through special economic zones. Just like the Chinese are getting tax incentives and subsidies, Pakistani auto parts could also benefit from such industrial zones.
BRR: What is your view about the current auto development policy?
IA: The policy provides incentives for brownfield and greenfield plans for new entrants but I don’t believe the policy will benefit everyone. Our raw material—for instance sheet metal—used to be Rs70per kg but today it is at Rs113 per kg. We currently import the steel that is not manufactured in Pakistan but while imported steel has zero rated duty input-output ratio (IOR), the government has imposed 10-30 percent regulatory duties. How is this level playing field when our costs are going up?
Within the policy, there is a cascading duty rate where raw material is 0 percent, sub-assemblies 10 percent and then full assemblies have 20-25 percent. On the other hand, our raw material is being imported at 30 percent RD.
BRR: But you don’t face much competition, because the finished product has a duty of 35 percent and above. So while you will face competition with suppliers from China and India in the export market, in the local market, you still have an edge. Is that not the case?
IA: Yes, but our end product is becoming more expensive with these RDs.
BRR: What is your level of preparation for the new players that are coming under this policy?
IA: They will find the parts they require locally. We have the machinery as well as the expertise and we are also building capacity. The only new investment will be in moulds and dies for new cars.
The government has mandated that over a period of five years, new entrants should localize their production up to 70 percent. But there is fear in the industry that the new manufacturers will enjoy the tax free benefits for 4-5 years and then exit. We want the government to set up a watchdog to ensure localization is happening. In fact, new OEMs should be mandated to localize in a staged manner starting from year one or two.
BRR: Since they receive duty benefits on imports, do you think local auto parts manufacturers have the capability to compete with those imports and come out stronger so that new players turn to you from the start?
IA: I would say it would be preferable for them to come to us first. But for us to compete with those tax breaks will be difficult. The reason is of course, for our own parts, our input raw materials have up to 30 percent RDs. If the government removes those, we might be able to stay competitive.
