Auto financing is used globally and helps in making cars accessible to the common man. The trend of financing vehicles in Pakistan jumped significantly in the middle of the previous decade when interest rates were low and all kinds of vehicles could be financed.
Auto financing takes multiple forms in Pakistan, such as:
- Fixed-rate financing – a pre-determined interest rate is applied throughout the tenure of the loan
- Variable rate financing – the markup of the bank is added to the KIBOR rate, which is the interest rate determined by the State Bank of Pakistan
- Islamic Car Ijarah financing – Islamic way of financing, the bank rents out the vehicle to the lessee
However, major changes in Government policies including the interest rate and blanket ban on the financing of imported vehicles have greatly hampered the quantity of car financing cases. Let’s delve into why consumers are not financing their vehicles anymore:
Ban on the financing of imported vehicles
To curtail demand for imported vehicles, the government imposed a ban on the financing of imported vehicles. With lesser purchasing power and the inability to spread the cost of ownership over a desired period, the ability to purchase a car got out of the reach of the common man.
This has been widely criticized as a one-sided decision. Many middle-class individuals who wanted to enjoy an imported vehicle (such as a 660 cc Kei category car) suffered at the hands of this policy; the elite class could still afford to buy luxury SUVs without financing. The cut down in demand mostly came from the mid-segment.
The low foreign currency reserves of the country forced the government to adopt this policy and it has successfully resulted in a major cut down in the demand for imported cars.
High interest rates
Pakistan has been seeing a consistent rise in interest rates for the last 6 years. A rise in interest rates is meant to control inflation by limiting demand for consumer products by reducing consumer financing.
The current effective interest rate is nearing 28%, which means that more than a quarter of the car’s price would go towards interest payments on an annual basis.
E.g. a car finance of Rs.3 million would result in almost Rs.800,000 being due to the bank in interest charges. This puts car financing out of the question for many individuals as the cost of borrowing goes up exponentially without incomes to match the rising costs.
Limits on financing
Several steps have been taken to cut down demand for the financing of vehicles, such as an increase in minimum down payment from 15% to 30%. Other measures include a reduction in maximum tenure of 3 years for vehicles above 1,000 cc and 5 years for vehicles below 1,000 cc. The aggregate amount of auto financing availed from all banks combined cannot exceed Rs.3 million at any given time.
Increase in prices of cars
In itself, the prices of cars going berserk have also caused a major decline in financing. Car prices have more than doubled in the last 2 years, painting a bleak image for the future as cars run out of the affordability of consumers.
This increase can be attributed to the rising USD/PKR parity and subsequent increase in the cost of manufacturing for companies. The prices of cars in Pakistan are on an upward trend and we don’t see any possibility of a retrace anytime soon.
Impact on the auto industry
Steps like these have managed to contain demand for financing demand and have inevitably hurt the auto industry as well as the banking industry. The banking industry has seen almost a quarter of its auto finance pending amounts shrink away, representing an amount of almost Rs.117 billion within 2 years.
Similarly, the auto industry has suffered from sales halving (yes more than 50% reduction) as car financing shrunk. In the first half of FY24, the sales of cars fell to almost 31,000 units, down from almost 69,000 units in the same period of FY23.
Conclusion
It can be deduced that auto financing has many negative as well as positive effects on the country. While the national balance of payments and the current account deficit along with State Bank Foreign Currency reserves may have been given breathing space, it comes at the cost of local manufacturing being cut down.
More than 3 million families are dependent on the auto industry, directly and indirectly. Many more rely on the banking industry flourishing for their livelihoods. The reduction in production capabilities in the wake of low demand has forced many manufacturers to shut down their plants for extended periods.
The government must make a decision: is it important to preserve the foreign currency reserves of the country or make cars accessible for the common man?
