What imperils the mobile phone industry?

Another day another industry raising its voice about issues it is facing with regards to doing business in Pakistan. It is a common enough trope – industries complaining and asking the government to fix things for them. While most of the time it is just industry associations cribbing, on rare occasions the complaints point towards deeper issues that we may have. This time around it is the Mobile Phone Importers and Manufacturers Association (MPIMA), a group that represents significant players in the Pakistani market. 

Their concerns revolve around measures being taken by the country to save foreign currency, which are scarce and are leading to sustained depreciation of the rupee. The issues being faced by the industry are yet another exhibit of why Pakistan continues to struggle when it comes to attracting investment, both domestic and foreign, into new manufacturing sectors.

The issues identified by MPIMA are as follows: a hundred percent cash margin on imports of mobile phone kits into Pakistan; increased red tape from the State Bank of Pakistan for import of goods by the industry; failure to issue an SRO related to an approved duty drawback scheme; and an increase in research and development allowance that is comparable to peer countries such as India and Vietnam.

While the merits of the above issues can and should be debated by folks much more knowledgeable than this author, it is important to recognize that the cash margin imposition and increased red tape around import approvals is a result of macroeconomic instability the country is experiencing at this point in time. 

Additionally, delays in issuing an SRO, following an agreement, is also indicative of bureaucratic hurdles being created to find a way to reduce the pressure on the fiscal balance. Both are a result of a consistent failure, across governments over the decades, to provide investors with an environment where volatility is the exception, not the norm.

For investors looking to set up manufacturing units, such volatility is unacceptable. Think of a world in which there are only two mobile phone manufacturers, and one is deciding to set up an assembly unit in Pakistan. When developing the financial models to figure out the expected returns and profitability of the said unit, the manufacturer makes a set of assumptions on a whole host of issues, including operating capacity, cost of electricity, currency value, and taxation rates. 

Based on these assumptions, the manufacturer develops comfort around the expected rate of return of the said unit, which in most cases has a lifespan of over 5 years. What this means is that should the assumptions prove to be wrong in the coming years, or should the government change its policy environment related to things such as tax rates or cost of power, the financial viability of the entire investment is put at risk.

This said investor, when looking at Pakistan, would of course look at the sovereign’s behavior in the past. Based on this analysis, an astute investor would conclude that the Pakistani government cannot be taken at its word, meaning that the investor must bake in a high-risk premium when assessing the viability of an investment.

Now assume that despite these issues, one of the two investors moves ahead and sets up shop in Pakistan. It quickly runs into the issues identified by MPIMA which are mentioned above, meaning that its operations are not as profitable as they were expected to be. In such a scenario, if the issues remain unresolved, this investor is likely to cut production, delay investments in further expansion, and plan to divest its operations in the coming months and years. The second manufacturer, who may have been looking at Pakistan following the entry of its peer into the country, is also scared away, given that the first mover in Pakistan is facing an uncertain and volatile policy and macroeconomic environment.

Given this outcome, the mobile phone manufacturing industry in Pakistan is likely to face a premature death or face stagnation. What ends up developing is a stunted sector where the investor is unlikely to reinvest its profits to improve capabilities and manufacture next-generation mobile phones or their components.

The ongoing experience of mobile phone manufacturers in Pakistan is a perfect case study of how and why foreign investors look at other jurisdictions, while domestic investors either siphon off their wealth abroad or stash it into Plotistan. After all, why bother with all this uncertainty and drama when one can buy a few plots, pay literally no taxes on profits, and declare the wealth gains by paying a pittance when the next real estate amnesty is declared?

Some may argue that mobile phone manufacturers are not manufacturing phones in Pakistan, they are just assembling them, meaning that there is little value addition in the country. 

This is a fair argument, but one must recognize that any new industry begins in this way. It is only through the right incentives and stability that investors grow their local capacity and catalyze the development of an ecosystem. Such things do not happen overnight, and they are surely not going to happen when first-movers are left dealing with a sovereign that is neither able to provide macroeconomic stability nor interested in honoring its commitments.