/ 12 April 2013

Motor sector support hits a cul-de-sac

Motor Sector Support Hits A Cul De Sac

Upping the local content requirements under the department of trade and industry's incentives programmes for the automotive industry may be a way to address the growing weight the sector has on South Africa's large trade deficit, according to industry players.

But longtime critics of South Africa's industrial policy argue that this risks burdening taxpayers and consumers, and would prop up an industry whose success has been determined by the level of government support rather than by its own competitiveness.

Last week, Business Day reported that the structure of incentives for the industry has resulted in it contributing 40%, or R49-billion, to the country's trade deficit.

According to Roger Pitot, executive director of the National Association of Automotive Component and Allied Manufacturers, the industry has been aware of the problem for some time.

It was a concern under the department's motor industry development programme (MIDP), which operated until the end of last year, he said. The programme was designed to encourage exports through, among other measures, the issuing import rebate credit certificates on exported vehicles and components to offset customs duties on imported components used in light vehicle manufacturing.

Problem expected to continue
In January, it was replaced with the automotive production and development programme (APDP), which includes a similar rebate mechanism. This rebate is geared towards local production and value addition rather than exported local content. The problem is expected to continue under the APDP, said Pitot, because a R9-billion surplus in these credits is still left over from the MIDP.

The industry's contribution to the deficit has been exacerbated by the increase of imported motor vehicles, which made up roughly two-thirds of the market last year, said Pitot.

In addition, local content made up, on average, only 38% of exported vehicles last year, weighing on the trade figures. "We need to increase the level of local content," said Pitot.

But critics have questioned continued state support for the industry. The professor emeritus of economics at Queens University in Canada, Frank Flatters, is a longstanding critic of the MIDP.

He said that the furore around the trade deficit was consistent with his analysis that "the ability of MIDP and other government policies to attract investment and promote exports reflects not the industry's competitiveness but rather the value of government incentives".

On his blog, Flatters warned that the department could seek to solve this "sectoral trade deficit 'problem' in ways that will increase the burdens on consumers and taxpayers", such as increasing local content requirements or tariffs.

Differences between APDP and MIDP
The APDP, much like its MIDP predecessor, includes a productive asset allowance, a duty-free allowance and a tariff element. Differences between the programmes include:

• An investment allowance under the APDP in the form of a cash grant;
• A duty-free allowance that is lower under the APDP but earned on all vehicles assembled locally. Only those assembled and sold in the local market qualified under the MIDP;
• Import rebates earned under the APDP are based on local production of light motor vehicles and not on exports, as under the MIDP; and
• Import tariffs under the APDP are constant, but gradually declined under the MIDP.

One of the aims of the programmes is to encourage light motor vehicle manufacturers to produce a narrower range of vehicle models locally, allowing the balance of their models to be imported.

Garth Strachan, acting deputy director general at the department of trade and industry, said that because the APDP has been operational since January it is incorrect to state that it contributed to the trade deficit. It remains to be seen what the impact of the new programme will be on the trade number. Nevertheless the matter "has been and is a source of concern", he said. An early review of the APDP is planned for next year.

Despite criticism of the programmes, the government's support saw vehicle and automotive component exports increase from less than $1-billion of vehicles and components a year in 1994 to $8-billion by 2011, according to the department.

Tariffs on both vehicles and components have been reduced, resulting in a rapid increase in imports of both. This substantially benefited consumers in both the price and range of vehicles, said Strachan. Tariffs on imported vehicles dropped from more than 100% in 1994, to 25% in 2012.

An overvalued exchange rate for much of this period dampened "what would have been even better export performance", said Strachan. It also contributed to the surge in imports, weighing on the trade balance.

A drop in demand and resultant global overcapacity in the vehicle market, following the international financial crisis has not helped either, heightening what Strachan termed "cut-throat competition".

"Recent reports about the size of the trade deficit have been used to argue that South Africa would have been better off without automotive support programmes," said Strachan. "If no such programme had been in place the sector would have effectively … collapsed."

The country would not have imported fewer cars, he said, and instead of a R136-billion deficit the trade deficit would have exceeded R200-billion, and the economy would be without a major non-commodity export industry in the face of falling commodity prices.

Questions over the cost of the industry
Nevertheless, the cost of the industry still raises questions. In 2011 the treasury noted that the motor industry enjoyed more than R51-billion in state support in the preceding three years. According to Strachan, total support to the industry in the past two years amounted to about R14.5-billion.

"The costs of supporting the automotive industry are far outweighed by the economic benefits and multipliers to the economy, including … to employment retention and creation in the industry and related up and downstream sectors," said Strachan.

The global automotive industry was characterised by significant, growing state support in both developed and developing countries, he said. South Africa, by contrast, "provided quite moderate levels of support".

Increasing local content is expected to be high on the agenda for the expected upcoming review. The department of trade and industry believed that there needed to be a rapid change in the level of localisation and it had been engaging intensively with the industry on this, said Strachan.

According to Peter Maxwell, a director of financial advisory firm Deloitte, there has been concern for some time that the local content requirements of automotive components and, particularly, light motor vehicles have not been high enough. This could be achieved in many different forms, including changes in the various percentages used to calculate the customs duty credit certificates, known under the APDP as production rebate credit certificates, as well as those used to calculate other incentives.

For instance, for automotive component manufacturers to earn a production rebate credit certificate under the APDP they must meet a local content requirement of 25%.

No such local content requirement exists for light motor vehicle manufacturers to earn production rebate credit certificates on vehicles they produce. But if the trade imbalance persists, the government may seek to re-examine this, said Maxwell.

Although this may have been considered when the APDP was designed, it probably received a "fair amount of push back" from vehicle manufacturers. "The reality is that for various reasons and factors, imported components still make up a large proportion of the cost price of a motor vehicle," said Maxwell.

Reasons put forward include quality criteria, labour related issues and the lower unit cost of components in some countries, since far longer, more cost effective production runs could be carried out overseas.