In January, German car manufacturer Volkswagen AG made headlines when it announced it would establish a new car assembly plant in Rwanda, the first-ever automotive investment in the small East African nation. The plant is poised to launch this month and should produce up to 5,000 cars per year across three different models for local sale.
The deal is not Volkswagen’s first foray into the region: in December 2016, the company opened a plant with equivalent capacity outside Nairobi, Kenya. PSA Group (Peugeot) followed suit in 2017 and several European and Asian manufacturers are reportedly in talks to establish similar production units in the coming year. Four decades after shutting down most of their African assembly lines, established carmakers are returning to the continent with a renewed, if cautious, appetite.
The case for local investment
On paper, the case for investing in local production capacity is getting stronger every year. Rising incomes and better infrastructure are easing obstacles to mobility and driving accelerating rates of car adoption. Motorisation rates are well under global averages, suggesting great potential for progress.
On the supply side, the investment environment for capital-intensive manufacturing is also becoming more favourable. Headline political risks which long discouraged manufacturers from putting down major capital investments and forced many to close shop in the 1970s and 1980s have all receded. East African countries have made significant strides towards improving the kind of transport (road, rail, air, ports) and electricity infrastructure required to sustain the automotive industry’s elaborate supply chains. Finally, in the era of ride-hailing and car-sharing, East Africa’s young and relatively well-connected population also presents an attractive testing ground to roll out new mobility solutions. Volkswagen has cited the latter criteria as key to its decision to start operations in Rwanda, a country that has eagerly embraced digital innovation.
Government policy: eyes on the prize
Governments are also making efforts to woo would-be investors. Manufacturing features among the top priorities of Kenyan President, Uhuru Kenyatta, his Rwandan counterpart Paul Kagame and several other regional leaders; car manufacturers, with their promise of skilled jobs and high-value exports, are particularly prized. Rwanda’s dynamic investment facilitation agency, the Rwandan Development Board, has certainly helped boost the country’s attractiveness; where they are implemented effectively, Special Economic Zones (SEZ) can also offer an attractive package of tax and customs incentives. For example, Volkswagen has established its Rwanda operations in Kigali’s SEZ, where it will be eligible to a seven-year corporate income tax holiday if it invests over USD 50m. At a regional level, investors willing to develop a regional, export-focused strategy will be able to leverage free trade arrangements under the East African Community (EAC) and the wider Common Market of Eastern and Southern Africa (COMESA).
Still, more could be done. In particular, most governments still maintain lenient regulations around the import and trade of second-hand cars from Europe or Asia. These continue to flood the market, representing up to 90% of total sales and undermining the viability of local manufacturing ventures. Kenya and Tanzania have made progress towards introducing (and lowering) the age limit for imported cars and tightening inspections, but other countries are lagging behind and proposals to harmonise age limits at a regional level have not yet been successful. Vested interests – car imports represent a lucrative business for well-connected elites – will likely continue to hamper reforms in the coming years.
Still a frontier market
East Africa’s automotive potential remains tentative: car sales from newly-opened assembly lines in Kenya were slow to take off in 2017, albeit in a peculiar pre-election context. Rwanda’s troubled neighbours, Congo and Burundi, will rein in the country’s ambitions to emerge as an export-oriented manufacturing hub. Regional volumes are set to remain low for several years.
At the same time, newcomers can also expect their operations to see a hefty amount of political interference: governments keen to tout the success of their industrialisation policy will likely encourage factories, especially ahead of elections, to hire and produce in greater numbers, accelerate production timelines or reduce prices. Political pressure could also extend to the selection of local country managers, joint venture partners or suppliers, requiring careful due diligence to avoid unwitting political associations. Government entities will be important clients for new vehicles given the shallow private market, in some contexts raising non-payment as well corruption risks around public procurement.
These circumstances will encourage caution. Volkswagen’s success story in Rwanda could well provide momentum for other pioneers, but manufacturers will continue to favour engaging with a handful of contract plants over developing their own production units to avoid major capital outlays. Semi-Knocked Down or Completely Knocked Down (SKD/CKD) production models – whereby operators assemble parts that have already been partly put together in another country – are also likely to remain the norm in the next 5-10 years in the absence of a local ecosystem for components.
CREDIT: CONTROL RISKS