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New vehicle assemblers need more support

Assembly of new motor vehicles declined in the first quarter of 2016 by 35.3 per cent. this decline is alarming as  motor
vehicle assembly is the only path through which Kenya will  transition into a motor vehicle manufacturer and ultimately get a step closer to becom- ing  an  industrialized nation.

Despite the general weakness in vehicle assembly in the first quarter of the year, the market fundamentals are still relatively good. this is because assemblers mainly assemble trucks, buses and pickups, which have wit- nessed sustained demand on the back of infrastructure projects such as the standard gauge Railway (sgR) and road works.

the only problem is that infrastruc- ture projects will one day slow down as the demand is temporary. this means that the motor vehicle assemblers need more than just stable demand: they need a friendly regulatory environment which can make business accommo- dative and hopefully allow assemblers to reduce costs in order to access the consumer market, which is charac- terized by an expanding middleclass largely served by used car  dealers.

an accommodative regulatory environment can only be guaranteed by government. Initially, the govern- ment was very supportive of the local vehicle assembly subsector. Nothing illustrates this more clearly than the fact that local vehicle assemblers have for a long time paid zero import duty on completely-knocked-down units used for assembly. In contrast, importers of fully assembled units pay a 25 per cent  import  duty. this tax exemption for local assemblers remains in force to this very   day.

However, despite longstanding support, the government’s stance towards local vehicle assemblers has slowly but surely changed in recent years. this started when it imposed value added tax (Vat) on the vehi- cle    assembly    industry    in  2013.

Expectedly, the industry voiced its protest against the new tax, rightly arguing that the Vat served to off- set the gains from the import tax exemptions.

It, however, appears that new vehicle assemblers need to lobby the government much  harder. this is because rather than heed the industry’s call and scale back on taxes, the government has done the exact opposite—it has  significant- ly increased taxes for new vehicle assemblers, increasing their costs and consequently putting a strain on assemblers’ business growth.

the government introduced a flat excise tax of 150,000 on cars last year but recently scrapped this off in favor of an excise tax of 20 per cent of a car’s value. this has dealt new vehicle assemblers a fatal blow as the value of new cars is generally higher than used cars, meaning that they will remit more cash to the exchequer in form of taxes.

these measures are already affecting the industry. assemblers observed that they have already laid off 415 workers in the first five months of 2016, reflecting the neg- ative impact that the flat sh150,000 rate had on assemblers, and further painting a portrait of how worse things could get if the harsher replacement of a 20 per cent excise duty persists.

Motor vehicle assemblers have also reported an average production decline of 30 percent in the first five months of the year, leading to  a capacity utilization rate of just 20 per cent. this is significantly lower than previous years, indicating that vehicle assemblers are downing their tools in the face of a hostile tax regime.

If the unfriendly taxes are not scrapped off, Rita Kavashe, chief executive of gMEa warns that:“pro- duction will fall and availability of some vehicles will be threatened.”she further observed that the increase in

 

prices of locally assembled vehicles will strengthen the appeal of used cars from Japan. used cars are up to 50 per cent cheaper than their newer counterparts.

In a memorandum to the treasury, the Kenya association of Manufacturers (KaM) urged the exchequer to stop the application of the 20 per cent excise tax with immediate effect, arguing that the tax should be amended to expressly exempt vehicle parts used in assem- bly from taxation. KaM, which is manufacturers’ umbrella body and official lobby, was speaking on behalf of thika-based Kenya Vehicle assemblers (KVM), Nairobi-based general Motors East africa (gMEa) and Mombasa-based associated Vehicle  assemblers  (aVa).

 

Job loss

If the KaM’s pleas fall on deaf ears, the impact in terms of job loss-   es will be immense. Higher taxes are increasing the overall costs for assemblers and in turn compelling them to make adjustment in other areas such as labor. this in essence means that they are scaling back their staff count—a term HR man- agers euphemistically call ‘rational- izing’.

as earlier stated, 415 jobs have already been lost since the com- mencement of the year. these are the direct losses, there are also indirect job losses in other sectors linked to vehicle assembly—such as suppliers of paint, steel, tires, cushions and services. these are essentially sectors linked to the vehicle assembly indus- try by way of forward and backward linkages.

Backward linkages can be defined as“the growth of an industry leads to the growth of the industries that supply inputs to it” whereas forward linkages exist when “the growth of an industry leads to the growth of other industries that uses its output as  input.”

the difficulties in the vehicle assembly subsector therefore have a ripple effect across the economy in that they affect other sectors that the subsector has forward and backward linkages with. “Imposition of this duty on locally assembled vehicles will disincentivise the motor vehi- cle industry, leading to the ultimate collapse of the industry with signif- icant ripple effects on the forward and backward linkages, whereby the local content suppliers and dealers may have to close shop,” KaM said in a memo to the treasury.

If the unfriendly taxes persist, industry officials project that a fur- ther 10,000 jobs could be lost by the end of the year. this could all but erase the gains that Kenya has made in building a competent pool of skilled workers in the motor indus- try.

Without the requisite competen- cy in the motor industry, motor vehi- cle assembly will not pick up and, consequently, vehicle manufacturing in Kenya will remain a mirage. this will have a wide range of negative implications on Kenya’s dream to become a manufacturing hub.

KPMg’s 2014 Manufacturing africa sector report, which explores the key drivers in the manufactur-  ing sector, says very few countries have been able to grow and accu- mulate   wealth   without    investing in their manufacturing industries. Manufacturing is the path to indus- trialization  and  wealth creation.

“the manufacturing sector is widely considered to be the ideal industry to drive africa’s develop- ment. this is due to the labor-inten- sive, export-focused nature of the industry,” reads part of the KPMg report.

according to the firm, a strong manufacturing industry contributes to the development of the private sector, which increases an econo- my’s resilience to external shocks. Furthermore,    it     adds,    domestic manufacturing   improves   exter- nal accounts by both decreasing imports  and  diversifying exports.

“Producing goods to  supply the domestic market has a positive impact on the structure of the trade balance, and manufactured exports have a much wider scope and more stable demand than commodity exports,” KPMg notes.

the present circumstance, char- acterized by  shopping  malls  that are filled with imported product, as exciting as it may seem, can never lead to sustainable economic growth for Kenya. a strong manufacturing base  is crucial.

the government’s support of the vehicle assembly subsector there- fore helps prop up the country’s ambition to become industrialized. In this respect, support ought to be more pronounced. the government should not only cut back on taxes, but also ensure that policy is fol- lowed up with resolute action.

Last year, Kenyan motor vehicle assembly firms were guaranteed at least 40 per cent of the government’s annual car lease contracts, which could translate into lucrative deals  for the firms that stand to get orders running into hundreds of units every year. these promises need to materi- alize faster.

Furthermore, the government can take a cue from south africa, which has modeled itself as the paragon of best practice in automobile manu- facturing in africa. south africa has expanded its incentives to manufac- turers and assemblers, a move that has since seen it emerge as  one  of the largest consumers and exporters of motor vehicles on the continent. tellingly, south africa produces more than 600,000 vehicles each year (more than 60 times the volume of Kenya), and motor vehicles account for close to 10 per cent of its total export revenue.

Many  multinational  auto  makers  have  chosen  south  africa  as  a location  for  auto  production  and assembly for both local and international   markets,    and    as a  source  of  vehicle   compo- nents. BMW, Ford (incorporating Mazda), general Motors, toyota, Volkswagen, Mercedes Benz, Nissan and Renault have production plants in south africa. Component man- ufacturers such as arvin Exhaust, Bloxwitch, Corning, and senior Flexonics have established produc- tion bases in south africa, according to southafrica.info.

 

Coherent plan

More than just scaling back on steep taxes and offering innovative incen- tives, Kenya needs a coherent plan— for both the motor industry and  the broader manufacturing sector. Plans exist, no question about that. the problem  is  that  these  plans fail to address, or otherwise address quite casually, important aspects of industrialization such as skills devel- opment.

there is currently a very limited pool of skilled labor. Players like toyota have had to partner with local   learning institu

tions to develop their own unique curriculum for their technicians and staff. the problem is that  techni-  cal  skills,  important  as  they  are  in the process of industrialization, are being looked down upon as everybody flocks to university for seemingly better career options such as commerce.

the government therefore needs a coherent plan to ensure that there is closer collaboration between indus- try and the academia. Education institutions need to produce what is needed by the job market.

the kind of skills needed in the manufacturing sector is increasingly scarce. Building and construction; plant and machinery operation; car- pentry and joinery; electrical and mechanical skills; air-conditioning and refrigeration; motor-vehicle repair and assembly; agribusiness and value addition; plumbing and so forth are no longer in vogue.

It also doesn’t help that the prevailing urban culture looks down upon these kinds of jobs. In this regard, some existing  trends  need to be challenged, especially in areas where the youth cannot join campus for one reason or the other. Because of a negative attitude toward blue-collar    jobs,    parents

would rather buy their children boda bodas instead of taking them to voca- tional training centers and polytechnics, where they can  learn and    acquire

vital skills that will make them self-reliant years after they exit the youth bracket.

In the long-run, policy makers also need to appreciate that a time will come when restrictions will need to be made on imports. this calls for a delicate balancing act as Kenya would not want to come across as protectionist, given its increasingly strong voice in promoting multilat- eralism as a platform to grow trade and investment. this notwithstand- ing, it is a path that the country will need to take.

“One of the greatest inhibitors to the advancement of Kenya’s auto- motive sector is the proliferation of second-hand vehicles available in the market,” observes global professional services firm Deloitte in a recent report on africa’s automotive sector. Deloitte warns that: “Kenya’s auto- motive sector is relatively stagnant and runs the risk of being side-lined in the long  term  by  other  region- al players such as Ethiopia, which has a more progressive approach to industrialization.”

a good illustration of Kenya’s dependence on imports is the fact that the steady demand for cars from the expanding middle class is almost exclusively being met by imports  from Japan. Kenya needs to proac- tively find ways to meet this demand locally by reducing its cost base. although  this  may  mean   stepping on the toes of a few importers, it is    a small price to pay considering the pie is big enough for  everyone.

If Kenya does not take swift and definitive steps to rescue the local vehicle assembly subsector, it will never be able to transition into the big boys  club  of  parts  producing and full scale automobile manufac- turing. the government needs to put local vehicle assemblers back on a growth trajectory, and scrapping off the current high taxes is a  crucial  first step that should take foremost precedence.