Local Content Policy Extended by Two Years

When the government encouraged the local assembly of motor vehicles in the 1960s, it also introduced a policy of requiring assemblers to use components sourced locally. At that time, the issue of outflows of foreign exchange (through purchases of parts from overseas) was not so significant and the motive of the policy was more to help the development of the local automotive components industry by ensuring that they had ready customers.

However, when Malaysian became a member of the World Trade Organisation (WTO), it became obliged to conform to the various agreements which were intended to enhance global trade. Among these agreements was the Trade Related Investment Measures (TRIMS) pact signed in 1994 which forbids measures by a WTO member which require particular levels of local procurement (use of locally made parts or local content) by any business enterprise company or which restrict the volume or value of imports such an enterprise can purchase or use to an amount related (an example being the requirement to have an import permit which is not issued freely to all bonafide applicants).

Malaysia was to comply by 2000 but got an extension (together with some other countries) till the end of 2001. In July this year, the government was still not satisfied with the competitiveness of the component makers in the country and decided to apply for another two years, thus requiring the use of local content until the end of 2003.

Over the years, the local content policy has been reviewed and the percentage of local components in a vehicle raised; depending on the engine size, the amount could be from 40% (for low-volume models like the BMW 7-Series) to 60% (for popular models like the Toyota Corolla and Daihatsu Charade). According to the assemblers, getting locally-made components can be cheaper or more expensive, depending on the supplier. However, the fact that the volume is relatively small does mean that the local supplier does not have the sort of economies of scale a supplier in Japan might have. It is obvious that a company making 10,000 steering wheels a year would have a higher production cost per unit than one which makes 100,000 steering wheels a year. Nevertheless, there are some components which are cheaper to source locally due to savings in import duties and transport charges.

Another policy which has been in force for decades has been the Mandatory Deleted Items (MDI). This policy, also introduced to promote growth of local industries, requires locally-assembled vehicles to use specific components obtained from local sources. Exemptions are only granted if the supplier declares that it cannot supply the required component for a particular model. Should an assembler choose not to use the component listed among the MDIs even though it is available, then the cost of the component cannot be included in the price computation; in other words, it has to be included ‘free’.

Due to the MDI policy, car companies have to order their CKD (completely knocked-down) packs without those components. At the manufacturer’s factory where the packs are prepared, the process of leaving out specific items can sometimes be troublesome because many components (eg wire harnesses and shock absorbers) are connected to other bigger systems. Furthermore, the value of ‘rebate’ offered by the manufacturer for an item that is deleted is usually ‘peanuts’ according to one assembler and never equals the cost of buying the locally-made equivalent.

The MDI list is as follows:
1. Battery
2. Tyre
3. Seatbelt
4. Mudflap
5. Bodyside protector
6. Weight balance (for wheels)
7. Glass
8. Exhaust system
9. Carpet
10. Seat pad
11. Wiring harness
12. Alternator
13. Starter motor
14. Shock absorber
15. Horn
16. Wiper motor
17. Windshield washer
18. Radiator
19. Air cleaner
20. Fuel tank
21. Coil spring
22. Brake tubing
23. Damping sheet
24. Flasher unit
25. Wheel nut
26. Screw jack
27. Radiator hose
28. Seat
29. U-bolt
30. Leafspring

While Malaysia has sought to extend the local policy, it is believed that, as a compromise to get that extension, the government has agreed to remove 11 items from the MDI list by January 1st 2002. These items include coil springs, exhaust systems, fuel tanks, seat assemblies and shock absorbers. According to MITI minister Dato’ Seri Rafidah Aziz, the manufacturers of the 11 components have achieved international competitiveness and therefore do not need such benefits. In other words, the prices of such components are now comparable to those that would be made in other countries and therefore, local assemblers would not see any additional benefit in not buying them; in fact, they would find it cheaper since the parts would not be subject to import duties.

Another related move is the removal of the Local Materials Content policy. This was introduced in the late 1980s to prevent local component makers from having merely ‘screwdriver operations’ – importing disassembled components from other countries and just putting them together again. The policy was aimed at making them also source a percentage of the materials used in the components from Malaysia. The government has agreed to abolish this policy by December 31st 2001.

The local content policy was not controversial when it was first introduced by many developing countries as a means of developing their industries. However, in the past decade, as globalisation has become a major issue and carmakers have been trying very hard to reduce production costs, the issue of using local content has been considered unacceptable. Thus, as part of WTO membership, one of the conditions is that such a policy must be discontinued.

Different countries have applied local content policy in different ways. Some specify a percentage of the vehicle’s value or parts while in South Africa at one time, the government there wanted 66% of the vehicle’s weight to be of ‘local content. It was actually an impractical approach as some car manufacturers found ways to beat it. Mercedes-Benz decided to just make its cars heavier by using thicker sheet metal (obtained from local sources) and for a while, the Mercedes-Benz cars assembled in South Africa were 150 kgs heavier than the same ones made in Germany! Later, the government changed the basis to the value of the vehicle and while the German maker no longer makes the heaviest cars, it makes the most expensive.

The automakers also prefer to have local content requirements abolished because of the delays in localising components. It can take as long as 9 months for a local supplier to produce the component since his operation cannot commence till after the car is launched. Such a delay is not considered good for marketing competitiveness.

“Buying locally is fine if the components are the right price and quality but if the local content requirement is abolished, at least we can start off assembly using imported components and then when the local supplier can make them, we can switch over,” said Rocco Basta, Fiat Auto’s Regional Director for Asia.

However, the situation is changing too in the way the car manufacturers and their local assemblers work with the local suppliers. According to Dato’ Michael Lim, Managing Director of UMW Toyota Motor, the local suppliers are involved at a much earlier stage, even before the model is launched in Japan. This means that localisation time can be shortened significantly.

Dato’ Lim also noted that although there is concern about the competitiveness of local suppliers when the auto sector opens up under AFTA eventually, there are actually a number of companies here which are already able to price their products at a comparable level to the global players.

“You can see this from the fact that there are already some companies which export their products, which means that their prices must be attractive enough for companies overseas to buy them,” he explained. He added that in the case of T&K Autoparts Sdn Bhd, a joint-venture between UMW Toyota Motor and Toyota, 90% of the steering gears it makes are already being exported to places as far as South Africa, Turkey and Taiwan. For Toyota assembly locally, the cost of acquiring the steering gear from a Malaysian-based supplier like T&K is 50% lower than if it were imported from Japan.

Furthermore, a number of local suppliers are also benefitting from AICO, a trade agreement for ASEAN members which allows the exchange of components at preferential tariffs (as low as 5%, which is the same as the AFTA maximum level). For such companies, AFTA will have no effect since there are already exporting at AFTA duty levels. However, Dato’ Lim said that there will be vastly decreased paperwork because there will no longer be a need to balance the exchanges between countries, as what is required by AICO, and also no need to get approvals of governments for the exchanges.

What about quality of local components? This is often an issue raised by car manufacturers and one which can be quite frustrating. A source at one plant told AUTOWORLD.COM.MY’s Chips Yap that one of the main problems with local suppliers is inconsistent quality. They can make very good parts that meet all quality standards but they cannot always maintain it.

“When we detect a drop in quality, we inform the supplier and ask for improvements. Then for one or two months, the components are good. But after three or four months, the quality starts to go down again. So we have to put in an unnecessary extra attention to checking component quality all the time,” he said, adding that it seems to be a common problem from his discussions with people in other assembly plants.

The Japanese car manufacturers, keen to support local industries, are willing to buy locally but have great concerns about cost and quality. In an effort to assist the industries, the Japan Automobile Manufacturers Association (JAMA) has been sending teams of production engineers to some suppliers in ASEAN countries to offer advice on how to increase quality while lowering costs. According to a senior executive from one Japanese company, there is no specific policy to only buy from their own Japanese suppliers and any component manufacturer in any country which can offer the right price and right quality will get the business.

Now that the government has provided a clear picture of what is happening over the next few years with regards to the local content policy, local car company executives can breathe easier. Earlier in the year, there was uncertainty whether the policy would really be abolished by December 31st and because of this uncertainty, it was difficult to decide on the composition of the CKD packs for 2002.