Iran’s automakers need a rescue, but face a reckoning

Bourse and Bazaar – 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.