Auto financing: the SBP surgical strike! – BR research
The country’s economic officials are colluding to try to curb growing imports. The first line of attack is consumer credit. In Pakistan, consumer credit is dominated by automobiles (outstanding on August 21) at Rs326 billion and personal loans (Rs: 240 billion) while the financing of housing construction (Rs112 billion) remains negligible. The government believes that if auto loans and personal financing are cut, it could remove the barriers needed to control the current account deficit.
One way to do this would be to increase the key rate. Although an increase in the policy rate has an impact on private credit in the broad sense, on the asset price bubble, on limiting budgetary expenditure and on controlling currency depreciation, the discussion here is limited to the impact on auto and personal loans – particularly auto financing.
Auto loans and overall car sales are correlated with interest rates as well as overall economic growth and confidence. When rates are low, car sales are up and the trend is constant in the opposite direction. When rates are low, economic growth is also on the rise.
When rates fell, volume car sales certainly increased in FY21. However, they have yet to reach their FY18 highs, even after incorporating sales of Kia and imported cars like the MG-HS. The real difference is in the type of vehicles sold in FY21 versus FY18 and, therefore, the value of the imports associated with them.
For example, official PAMA figures suggest that SUV sales in FY21 were 11,306 while they rose to 12,870 in FY18. But, if we include New players in total, Kia Sportage as well as MG-HS and other imported vehicles, are said to have sold around 25,000 to 27,000 vehicles during the year. It is much higher than FY18. Now let’s compare this to smaller cars. During fiscal year 2018, Suzuki sold 122,564 vehicles (excluding Ravi). The small- and medium-engine car assembler sold around 78,000 vehicles in FY21. Smaller car values decline more in real terms. Sales of sedans have also increased compared to smaller engines.
This is reflected in the import figures: FY21 CKD imports in dollar value were 39% higher than FY18 and overall CBU + CKD imports were 9% higher at those in FY18. This implies that although car sales are lower in FY21 compared to FY18, the value of the cars (in dollars) is higher because more expensive cars and less localized are imported.
True, the value of total cars sold is higher in PKR. This is evident from the growth in auto finance numbers. The net increase in auto finance was Rs 43 billion in FY18 compared to Rs 97 billion in FY21, an increase of 2.25 times. Car prices have gone up, but certainly not doubled. This indicates that the real value of auto finance is increasing. The number of cars financed may be less.
The assertion can be reinforced by seeing the numbers in terms of GDP. The outstanding auto financing currently stands at Rs 326 billion (0.65% of GDP), which is higher in terms of GDP compared to FY18 levels – Rs 195 billion (0. 56% of GDP). However, the number is still at half of the record highs of FY07, when auto financing was 1.17% of GDP.
This implies that the pass-through of car finance on GDP growth and in turn the impact on imports in terms of GDP is less in FY21 compared to FY07 or FY08. However, funding is higher in FY21 compared to what was happening in FY18. The transmission of monetary policy on reducing auto finance growth could be better in FY18. the FY21 compared to the FY18. Therefore, the increase in interest rates could have a slightly greater impact. However, the impact would have been much less than what might have been the case in 2006-08.
The other way to look at it is to think of auto financing as a percentage of the total credit in the system. It represents 1.2 percent of total system credit, including public borrowing, and 4.5 percent of private credit. In fiscal 2018, auto finance to total system credit was 1.1% and the auto finance to private credit ratio was 3.5%. Auto finance as a percentage of private credit was 4.0 percent in FY08 and 4.7 percent in FY07.
This implies that today the share of automobile financing in the private sector is close to its peak in FY07 and is higher than that of FY08. This brings us to the present day and SBP’s latest restrictions on automobile financing. By setting targeted limits, the SBP can reduce the import bill, as around 80-85% of a car’s value (excluding taxes) depends on imported parts and raw materials. Although the contribution of auto finance is still less than 5 percent of total private credit and just 1.2 percent of overall system credit.
As part of prudential regulatory reviews, the maximum limit for financing a car is limited to 3 million rupees, and the minimum prepayment is increased from 15% to 30%, while the maximum financing period is reduced. at 5 years (instead of 7%). The financing of imported cars, whether new or used, is no longer allowed. To reduce consumer credit, the overall debt ratio has been reduced from 50% to 40% and the maximum limit for personal loans is reduced to 4 years.
This would reduce consumer credit without impacting the entire credit system by raising interest rates with an emphasis on restricting financing for larger and more expensive cars. The impact on small cars which are still struggling to reach the peak levels of fiscal 2018 would be limited.
However, for obvious reasons, auto players are not happy because their sales are going to be negatively affected. According to one of the top three sellers (in terms of car value), 40% of their vehicles are financed. Another player claims that the funding is higher for expensive and luxurious cars; while the CEO of Indus Motors said that only 10-15% of Fortuners are funded while the number is around 30-35% for Corolla and Yaris.
Overall there would be an impact; but industry players have different numbers to cite to gauge the exact impact. SBP and the government, in their quest to reduce imports by reducing auto sales, forget that auto production faces major constraints due to the global shortage of chips and the limited availability of containers. It also has an impact on sales. Some car reservations are closed. For example, Kia does not reserve FWD Sportage and Picanto automatic because the reservation deadline has exceeded six months. Hyundai has not reserved its flagship Tucson for a few months. Even for Fortuner, the reservation deadline is six months.
Thus, restricting auto financing would have a limited impact on auto sales. The story is similar for imported cars – the delivery of the MG HS is late while the Audi e-tron is booked until March 21. Some electric vehicle importers accept customer reservations without principal allocation. Thus, the imposition of higher tariffs on electric vehicles could have a limited impact.
So while SBP may believe that a surgical strike on auto sales with limited funding would do the trick – and under normal circumstances, it would. Efficiency would be limited because car sales are already shaken due to production constraints. As supply improves, current account concerns may ease, as the increase in supply may come with falling global commodity prices which mainly boost imports.