Iran's Automakers Need a Rescue, But Face a Reckoning

Iran’s giant automakers, Iran Khodro and Saipa, are in a tug of war with the Rouhani administration over demands to lift price controls. The state-owned firms are seeking to increase prices by 40 percent.

Executives in Iran’s automotive industry, which counts among the country’s largest employers and includes both state-owned and private sector enterprises, argue that rising inflation and the increased cost of parts and raw materials justify increasing automobile prices, which have long been subject to controls. Rising inflation in Iran has been spurred by the depreciation of the rial, first triggered by the reimposition of secondary sanctions by the administration of U.S. President Donald Trump.

The final say on any price increase lies with the Market Regulation Authority of Iran’s industry ministry. A meeting of the authority on May 4 led to a disappointing outcome for the automakers, as the authority’s board gave preliminary approval to a price increase of just 5 percent.

Despite the outcome, market regulators appear increasingly sympathetic to the demands of automakers and further deliberations are planned. The deputy minister who chaired the meeting, Hossein Modarres Khiabani, acknowledged the challenges facing Iran’s automotive sector, stating “For 15 months, the price controls have remained unchanged while many of the production costs have jumped during the period in question.” While carmakers have been unable to increase their prices, the price of automobiles on the secondary market has surged as inflation picked-up. The growing margin between the two prices has given license to many car dealers to engage in enormous profiteering.

However, regulators are reluctant to allow automakers to increase prices without demonstrating some new economic value. The 5 percent price increase preliminarily approved earlier this month is conditioned on a  “70 percent improvement in efficiency,” although no detail was provided as to how improved efficiency is to be assessed.

For decades, the poor-quality of locally produced automobiles has been at the core of growing discontent among Iranian consumers with state-owned carmakers. Iran Khodro and Saipa are accused of exploiting an uncompetitive market, operating as a duopoly and disregarding customer satisfaction in order to produce cars with fewer features and worse build quality. Even Iran’s Supreme Leader appeared to acknowledge the lagging quality of domestic cars in a recent tweet.

Despite the role that the price controls have played in deepening losses, Iran Khodro and Saipa have also been repeatedly bailed out by administrations unwilling to swallow the political consequences of mass layoffs. Iranian carmakers, particular those that are state owned, benefit from unfettered access to financing and cheap foreign currency, despite a track record of contributing to the non-performing loan crisis at many Iranian banks and a reputation for corruption among senior management. By one estimate, Iran Khodro and Saipa have received over USD 4.7 billion in foreign currency at the subsidized government rate. With the Rouhani administration now facing an unprecedented fiscal crisis spurred by sanctions, low oil prices, and the COVID-19 crisis, observers of the automotive sector are wondering whether the state remains able to support the embattled auto industry.

Any prolonged shutdown at Iran Khodro or Sapia would hammer Iran’s many parts manufacturers, which constitute the backbone of the auto industry. These companies have already been squeezed as sanctions have made sourcing the foreign currency needed to pay for imported raw materials far more difficult. Parts manufacturers are also owed huge sums by the likes of Iran Khodro and Saipa, who use their dominance in the domestic market to bully suppliers.

But the increasingly dysfunctional supply chain is catching up to the automakers. A recent report from Donya-e-Eqtesad estimates that up to 50,000 cars remain unfinished, parked in storage yards, due to a lack of parts. Falling productivity in the automotive sector, which accounts for 4 percent of Iran’s gross domestic product, could have a significant impact on the wider economy. The negative outlook for the sector stands in stark contrast to the optimism that followed the implementation of the nuclear deal. In 2017, buoyed by the resumption of industrial cooperation and investment by European automakers such as France’s PSA Group, automobile production hit a record high of over 1.4 million vehicles.

The swift decline in output spurred by the reimposition of U.S. secondary sanctions the following year has only been accelerated by the global pandemic. In the period from March 21 to April 20, corresponding to the first month of the Iranian calendar year, Iran Khodro manufactured just 23,246 vehicles, registering a stunning 43 percent decline in production year-on-year. The automaker has discontinued production of seven models, which relied on imported complete knock-down kits, including the Peugeot 2008 SUV and the Suzuki Vitaras. Production at Saipa fell even further, registering a 56 percent decline year-on-year, with just over 9,000 cars produced in the same period. Part of this slowdown is attributable to measures being taken to reduce the risk of transmission of COVID-19 among assembly line workers. Nonetheless, the collapse in production and the controversies around price controls contributed to the ouster of industry minister Reza Rahmani earlier this week. Khiabani has been appointed as caretaker.

The Rouhani administration finds itself at a crossroads and the auto industry faces a reckoning. While regulators have been unwilling to increase the price of automobiles for fear of angering a public already facing diminishing purchasing power, the government cannot simply continue to rescue automakers that have failed to operate efficiently and transparently, selling their products into a profoundly dysfunctional market.

Photo: IRNA

Iran Automakers Face Rocky Road as Output Falls While Demand Rises

Iran’s automakers have pre-sold more than 1 million vehicles, most of which are earmarked for delivery to customers in the current Iranian year that started in March. But with vehicle production declining at a steep rate, fulfilling these orders will be no easy task.

Following the reimposition of US secondary sanctions in November of last year, the Iranian economy has begun to contract. Inflation is driving up the price of goods, including automobiles. 

For instance, the cheapest vehicle in the Iranian market, SAIPA’s Pride sedan, is now sold at IRR 450 million, just over USD 10,000. The same model was offered for just IRR 200 million one year ago. Despite the sharp increase in prices, demand for cars has also increased.

With the rial losing around 70 percent of its value over the past few months, many have rushed to convert their cash into safe-haven assets—including foreign currency, gold coins, real estate and even cars. Iranian consumers see cars as a safe investment and it is not uncommon for used cars to actually appreciate in value during periods of high-inflation.

Pre-orders for entry-level models like the Pride have also increased as consumers typically interested in more expensive models, such as locally produced Peugeots, are priced out of the luxury bracket.

Mounting Pre-Orders

With US sanctions taking a toll on the country’s auto industries, Iran’s automakers face an uphill battle to deliver the pre-ordered cars on time.

In order to service mounting debts, state automakers Iran Khodro and SAIPA sought permission from authorities to launch extended sales periods in which they racked-up 1 million preorders, with cash being injected into company balance sheets.

But just as the orders are becoming due, sanctions are restricting the import of critical parts and raw materials needed for the automakers to produce sufficient vehicles. Production output has declined significantly.

During the 11 months to February 20th, Iranian automotive companies produced 873,243 cars and commercial vehicles, indicating a 38 percent year-on-year decline in output. Output at Iran Khodro fell to 386,523 vehicles compared to 653,593 at the same period last year, reflecting a 41 percent decline. Meanwhile, total vehicle output at SAIPA has fallen to 381,085 from 605,348 at the same point last year—down 37 percent.

Foreign exchange rates have hit all-time highs and production costs have soared, forcing car companies to increase prices. With production plummeting, prices in the automotive market have been further distorted by dealers and middlemen who have sought to raise prices in the secondary market.

Persistent Hopes

Iranian automakers must therefore strike a balance between supply constraints and robust demand. Pre-sale deposits are an important source of cash flow for car companies, but delays in delivery can cause negative publicity and also add to financial pressure. In a quirk of #Iran’s automotive market, pre-sale terms entitle customers to get back their deposit with accrued interest in the event they decide not to take delivery of the vehicle—in effect customer deposits are a kind of loan made to the automaker.

Given these pressures, Iran’s automakers must aim to sustain output despite headwinds. Firms have actually targeted increased output in the coming year. Leading automakers plan to produce at least 1.2 million vehicles in the 2019-2020 fiscal year, leveraging their experience in the previous sanctions period to boost local capacities and establish new supplier relationships.

Iranian car companies have tried to forge new ties with international automakers like Russian car company AvtoVAZ. SAIPA is in talks with AvtoVAZ to import auto parts and completely knocked down (CKD) kits from Russia to restore production to normal levels.

Iranian automakers have also sought to expand operations outside of Iran to help earn much needed cash. Earlier last week, a joint venture between Iran Khodro and Azermash OJSC started pre-sales of a jointly-produced Peugeot 206 in Azerbaijan.

The joint venture was inaugurated during a state visit to Baku by President Hassan Rouhani last March. In addition to the Peugeot 206, two sedan models designed by Iran Khodro, the Dena and Dena+, will be produced at the Khazar Car Factory, located in the Neftchala Industrial District in southeast Azerbaijan.

With an initial annual production capacity of 10,000 vehicles, the Khazar Car Factory will increase output to 15,000 vehicles. The joint venture partners hope to produce 6,000 vehicles this year.

Photo: IRNA

For Iran’s Economy, the Price of a Car Matters More Than the Price of Oil

The combination of reimposed sanctions, a slowing economy, and a devalued currency have put Iran’s automotive sector under severe pressure With nearly 1 million jobs linked to the automotive industry, the price of a new car could be even more important than the price of oil for the Iranian economy.

In an interview with Bourse & Bazaar, Saeed Madani, the former CEO of SAIPA, Iran’s second largest automaker, warned that price controls are squeezing state-owned automakers as sanctions effect the overall economy.

State-owned firms Iran Khodro and SAIPA, account for 90 percent of the 1.5 million vehicles manufactured in Iran each year, but are in many respects these firms are least prepared for the bumpy road ahead.

Madani, who led the SAIPA for three years during the height of sanctions from 2012 to 2015, warned that dependence on imported raw materials and parts leaves Iranian automakers vulnerable as the economy slides into a recession.

“With the rial weakening, carmakers’ purchasing power has been slashed. The input costs of auto parts industry have also increased significantly,” Madani explained. The rial has lost 70 percent of its value against the US dollar since the current Iranian fiscal began in March, making manufacturing inputs significantly more expensive.

Automakers Face Pricing Squeeze

These costs cannot always be passed onto the consumer. Presently, Iran’s Competition Council retains the power to set prices for many domestic products, including cars that are categorized as affordable, meaning their sticker price is less than IRR 450 million.

Madani believes that even if the state is reluctant to deregulate the auto market at large, authorities must give a green light to the carmakers to increase prices. “The upgraded prices need to be set for each model depending on the share of imported auto parts in its production,” he said.

The price increases are especially crucial for models assembled from imported completely knocked-down (CKD) kits, as these vehicles have a higher foreign parts content than those designed locally. Madani thinks prices for the vehicles assembled from CKD kits should be “at least doubled.”

SAIPA’s most popular model is the entry-level Pride, based on a design from Korean automaker Kia. The Pride is the cheapest car made in Iran. To manufacture each Pride, “it is necessary to import USD 1,500 worth of parts and raw materials,” Madani explained.

But while earlier this year, automakers were receiving foreign exchange at the subsidized rate of IRR 30,000 per dollar, today their currency is purchased through the NIMA system, established by the Central Bank of Iran to coordinate foreign exchange purchases and to track forex transactions involving banks, exchange houses, importers and exporters in real time. Over the last month, the average NIMA rate was IRR 92,304 per dollar.

In Madani’s estimation, looking just to cost of inputs, and ignoring increased overheads facing SAIPA, the price of the Pride needs to be raised by IRR 90 million (USD 600) to bring its sticker price to IRR 320 million (USD 2200).

The official price of the Pride was last raised in June, bringing it to IRR 227 million (USD 1,500). Today, the Pride is regularly selling for IRR 340 million (USD 2,300) in secondary markets, demonstrating the heavy subsidization enforced by the government.

Failing to readjust prices could have dramatic consequences for the auto industry, warned Madani. “If the government does not let carmakers increase prices, they will go bankrupt. Firms will be forced to shut down many production lines and output rates will nosedive,” he said.

Faced with this dilemma, the government will be tempted to throw the automakers a lifeline by providing financial aid and loans. But Madani considers such aid to be a burden for manufacturers, which will struggle to pay back debts in the future.

Uncertain Government Response

In recent weeks, government figures have repeatedly signaled that they are considering giving carmakers the green light to increase car prices. Financial newspaper Donya-e Eqtesad recently reported that industry stakeholders and officials are well aware that the car prices need to be increased, but are afraid of the political cost of such a decision as it will be seen as placing pressure on Iranian consumers.

On October 31, Iran’s newly appointed industry minister, Reza Rahmani, told IRNA, “Automakers are not permitted to change car prices [on their own]. There is a designated legal mechanism for introducing new car prices. No decision has been made yet about changing car prices.”

In the interview, Rahmani also questioned the credibility of the unaudited financial statements reported by the local media, which suggested that Iran Khodro and SAIPA had made losses amounting to IRR 21 trillion (USD 142 million) and IRR 29 trillion (USD 196 million) respectively in just the last six months.

“Iranian automakers are not loss-making. By producing certain models local carmakers may incur losses. However, this is not an issue which cannot be resolved by better management of resources,” the minister countered.

Rahmani revealed that a “specialized task force” had been established in coordination with industry executives “to study the problems which have hindered auto production over the past few months.”

But time is short. “With every day passing carmakers’ loses will further pile up… Automakers should not be forced to foot the bill for subsidizing car prices in Iran,” Madani said.

His assessment is shared by Maziar Beiglou, a board member of the Iran Auto Parts Makers Association. Beiglou recently stated in an interview that the “The situation has been worsening by the day,” pointing to the rising price of inputs such as iron ingots used by companies that produce automotive steel. In Beiglu’s assessment, more than 300 auto parts makers have been forced to stop production.

Total vehicle production in Iran is down 15.1 percent looking to the first half of the current Iranian fiscal year, which began in March. Already, economic headwinds and slowing production have led to mass layoffs.

Sate-owned companies such as Iran Khodro and SAIPA are unlikely to “resort to laying off workers” given the difficult optics for the Iranian government, Madani predicted. But private sector auto parts companies have already been forced to layoff “100,000 to 150,000” workers because of the deteriorating situation.

Photo Credit: IRNA

Autoneum Deal Underscores Huge Potential in Iranian Auto Parts Industry

Switzerland’s Autoneum, a world leader in the acoustic and thermal insulation for automotive applications, has signed a new exclusive license agreement with Ayegh Khodro Toos (AKT), an Iranian auto parts company that specializes in noise and vibration damping materials.

Autoneum and AKT will establish a new production like at AKT’s facility in Mashhad in order to begin producing carpet systems and dashboard parts. The first parts will come off the production line in 2019. According to company materials, AKT employs 95 technicians and controls 75% of the market for automotive insulation.

These parts will support the production of a new "SUV" by IKAP, the joint venture between Iran Khodro and Groupe PSA. The unnamed vehicle is most likely the Peugeot 3008, for which imports to Iran of complete vehicles will begin in early 2018. 

Commenting on the new agreement, Martin Hirzel, CEO of Autoneum, highlighted Iran’s potential as “a central automotive hub for the Middle East, Far East and the Caucasus region.” Hirzel sees “strong sales potential” as the company seeks to meet the needs of customers in this regional market.

The new licensing agreement follows a common model in the Iranian auto parts industry, in which a foreign company brings technology and manufacturing specifications to a local partner, in order to supply the Iranian joint-ventures or CKD contract manufacturing agreements of the likes of PSA Groupe, Renault-Nissan, and Daimler. These parts are the lifeblood of a burgeoning Iranian automotive sector, which produced over 600,000 vehicles in the first half of 2017, registering 18% year-on-year growth.

The Iranian Auto Parts Manufacturers Association (IAPMA) estimates that there are 1200 parts manufacturers in the country generating USD 8 billion in annual sales. IAPMA ambitiously projects that Iranian auto parts market could generates sales of USD 32 billion by 2025. A major contributor of growth will be an expansion in exports, which are currently less than USD 200 million, but are expected to rise to USD 6 billion by 2025, a thirty-fold increase.

Major Iranian auto parts manufacturers such as Ezam and Crouse manufacture under license for global players such as Bosch, Mahle, Mando, and Valeo. The new agreement between AKT and Autoneum shows the potential for smaller, specialist parts manufacturers to strike similar deals that improve the quality and sophistication of the parts available for the local market and for export.

Photo Credit: Autoneum