Submission to the Standing Committee on Finance

The Impacts of Canadian Dollar Appreciation on the Canadian Automotive Industry

By the Association of International Automobile Manufacturers of Canada

November 2007

David Adams, President Association of International Automobile Manufacturers of Canada 2 Bloor Street West, Suite 1804 , Box 5 Toronto ON M4W 3E2 Phone: 416-595-8251 x22 Fax: 416-595-2864 Email: [email protected]

Introduction:

The Association of International Automobile Manufacturers of Canada (AIAMC) is the national trade association that represents the Canadian interests of thirteen international automobile manufacturers (BMW, Honda. Hyundai, Kia, Mazda, Mercedes–Benz, Mitsubishi, Nissan, Porsche, Subaru, Suzuki, Toyota and Volkswagen/Audi) that distribute, market and manufacture vehicles in Canada.

In 2006, AIAMC members sold over 733,000 new vehicles in Canada, representing 45.5% of Canada’s new vehicle market. Additionally, our members sold 61% of all passenger cars and fully 50% of all vehicles purchased by consumers1. Additionally, 50% of the vehicles sold by our members in Canada were produced in North America.

While our members’ sales have grown, so has their Canadian investment. AIAMC members have invested over $6 billion in manufacturing facilities alone. Annual production from AIAMC member companies reached a record 900,839 new vehicles in 2006 out of the 2.54 million vehicles produced, with over 697,026 (or 77%) of these being exported out of the country. Member companies with production facilities in Canada include Honda, Toyota and Suzuki (CAMI 50/50 joint venture in Ingersoll, Ontario with General Motors).

Recent investments announcements from member companies have included the $1.2 Billion investment by Toyota in a new assembly facility in Woodstock, Ontario that will be operational in 2008 along with a $154 million investment by Honda in a new plant to produce up to 200,000 four cylinder engines in 2008.

Impact of the Appreciation of the Canadian Dollar on the Automotive Industry

The 20% appreciation of the Canadian dollar against the U.S. dollar since the beginning of the year has presented serious challenges for the automotive industry in Canada, affecting some components of the industry more severely than others.

Vehicle Manufacturers

AIAMC member manufacturers are more vertically integrated with their own stamping facilities, plastics shops and engine lines. Additionally key suppliers have been brought to Canada to ensure the local sourcing of key parts. Therefore, our members are less able to take advantage of a bit of a built-in hedge arising for other manufacturers that import up to 85% of their parts from the United States. Nonetheless, the cost of the finished vehicle assembled in Canada has become more expensive in export markets, mainly the United States, to which about 80% of production is exported.

Given the reliance of Canadian vehicle manufacturers on the U.S. market as a final destination for the vast majority of their production, there are a number of other

1 Vehicles purchased by consumers = total vehicle sales – fleet sales significant factors that are affecting Canadian assemblers over and above the appreciating dollar, namely:

• Higher energy costs – Higher energy costs are shifting consumer demand in the U.S. towards more fuel efficient vehicles. Apart from Honda and Toyota, the majority of the vehicles produced in Canada are larger cars and light duty trucks that Americans have traditionally favoured.

• Fall out from the reset of adjustable rate mortgages - According to Carlos Gomes, Senior Economist, Industry and Commodity Market Research with Scotiabank2, approximately 32% of all mortgages taken out in the 2004-2006 timeframe in the U.S. were adjustable rate mortgages. These mortgages have sub-prime interest rates for the first two years that “reset” at a higher rate after that. Gomes estimates that there are 4 million mortgages that will “reset” at higher rates in 2008. The impact of these resets will be varied. In less severe cases the higher interest rates will serve to reduce disposable household income, thus limiting funds available for vehicle purchases. In more severe cases, the higher interest rates will push some owners over the edge making their homes unaffordable and contributing to the significant decrease in housing prices in the U.S.

Consumers in the U.S. had been using equity loans from rising housing prices over the past number of years to purchase new vehicles. With decreasing housing prices this financing option for new vehicles is undermined. Further, with a glut of existing homes on the market in the U.S., new housing developments have tailed off and with it the need for light duty trucks from the development and construction industries. This has been a significant contributing factor – as opposed t the increased value of the Canadian dollar - to GM’s announcement earlier in the year that it is cutting one shift and laying off 1000 employees at its Oshawa truck plant early in 2008.

• Tighter lending standards – In the wake of the sub-prime mortgage crisis lending standards have been significantly tightened reducing the availability of vehicle loans for many consumers and increasing the cost of those loans for others. This has an obvious negative impact on U.S. vehicle sales.

All of the above-noted factors have contributed to a 2.4% drop in U.S. light vehicle sales through October, and a 2.7% reduction in North American production through mid November. The softening of the U.S. demand for new vehicles will continue to have a negative impact on the vehicle manufacturing sector

Parts Manufacturers:

The Automotive Parts Manufacturers Association will no doubt make their own representations with respect to the impact of the rising Canadian dollar, however it is apparent that the following factors are negatively impacting parts manufacturing in Canada. Indeed a recently released report by the Conference Board of Canada3

2 See Scotiabank Group “Global Automotive Report” October 4th, 2007 3 See Canadian Industrial Outlook: Canada’s Motor Vehicle Parts Manufacturing Industry – Autumn 2007. Released on November 7th by the Conference Board of Canada suggests that the parts manufacturing industry will lose 11,000 jobs this year, the equivalent of 10% of its workforce, and that both profits and production will be down 41% and 4.5% respectively. There are a number of converging reasons for these results.

• U.S. Competition – The strengthening value of the loonie versus the greenback has made American parts much less expensive than similar Canadian parts

• Higher Energy and Commodity Costs – In some cases, parts manufacturers may have been able to take advantage of the appreciation of the dollar to purchase raw materials and sub-components at lower relative prices, however in many instances commodity prices and energy costs have increased faster than the appreciation of the dollar, negatively impacting parts makers.

• Decreased Production from Primary Customers – As traditional North American manufacturers rationalize their production in the face of excess capacity and decreased market share, business for Canadian parts makers is subsequently reduced. Again, a generally negative environment in the United States for new vehicle sales is also negatively impacting parts sales.

• Lack of Adequate Capital Investment - According to industry analyst, Dennis DesRosiers, while Canadian parts makers have grown through the 1990’s largely on the basis of the low Canadian dollar, many parts makers did not invest in the latest technology and equipment leaving them very vulnerable to a strengthening dollar and better capitalized and more sophisticated American parts makers4. That said, the appreciation of the dollar has made equipment and machinery more affordable for parts makers that have the capital resources to invest in new machinery to make them more productive in the long run.

• Globalized Sourcing From OEM’s – Globalized parts sourcing has been increasingly undertaken by all manufacturers and in particular by the traditional North American manufacturers as a means of increasing their competitiveness by reducing the overall cost structures. Globalization efforts can mean less business for Canadian parts makers.

There are numerous other challenges being faced by the Canadian parts manufacturers arising from the appreciation of the Canadian dollar but I will leave it for the APMA to enumerate those additional challenges.

Vehicle Sales

As alluded to earlier, much of the current angst in the automotive sector is occurring as a result of the significant softening of vehicle sales in the U.S. market which is home to about 80% of Canadian production.

Despite the situation in the U.S., Canadian vehicle sales are moving ahead at near record levels. Through October 2007, Canadian light duty vehicle sales were up 3.8% year to date (1,416,304 vs. 1,364,895) over last year, which was the second

4 See Dennis DesRosiers - “State of the Canadian Automotive Sector” Observations Vol. 21, Issue 19, October 15th, 2007 best vehicle sales year in history. Even in October when the dollar strengthened considerably sales still advanced 2.1% over October 2006, in part because of very aggressive incentives that have been offered to offset the increasing Canadian dollar.

As the Canadian currency moved to par, and ultimately advancing to greater than par against the U.S. dollar Canadian consumers have been able to transparently compare the prices of merchandise in both markets and have been understandably concerned when television, newspapers and the internet seem to suggest that Canadian prices are higher on a common U.S. currency basis for the same vehicle.

It is important to note that the vehicles offered for sale in the Canada and U.S. markets are rarely exactly the same due to different standard equipment packages on the vehicles. However, even if the vehicles were equipped exactly the same, differing regulatory standards lead to higher costs for Canadian vehicles. For instance some of the disharmonized standards between Canada and the United States are: • Different bumper standards • Daytime running light requirements • Metric speedometer and odometer requirements • Dual language requirements • A unique immobilizer (theft deterrent) standard

If the vehicles were completely the same in both countries, the different cost structures in the two countries would still mean that vehicle prices would be higher in Canada. For instance, the United States has: • Greater purchasing power, being a market ten times the size of Canada’s • Lower tariffs on imported vehicles 2.5% versus 6.1% in Canada • A lower incidence of leasing (15% vs 45% in Canada), which is a very costly financing option for manufacturers • Lower distribution costs than Canada • Lower Hydro costs than other manufacturing jurisdictions • Lower levels of taxation for manufacturers domiciled in the U.S.

Therefore, while Canadian consumers are demanding price equality with the United States there needs to be an appreciation that – despite the integrated nature of the automotive industry – Canada and the U.S. remain different markets.

Nonetheless, based on Canadian vehicle sales alone one can assume that the manufacturers are working to bridge the gap between the prices in the two countries, otherwise 121,000 Canadians would not have purchased new vehicles last month. An automobile purchase is a highly deferrable decision and if action had not been taken to address Canadian prices we would have expected vehicle sales to slow down, as consumers stayed out of the market to wait for lower prices. The Canadian automotive industry has responded to the soaring Loonie to try and maintain the strength of the automotive sector in Canada and to retain employment in our country without which we would eventually see our economy enter into a decline. While the number of vehicle imports from the U.S. is expected to be in the 150,000 to 160,000 range, this number is increasing and represents 10 % of the new vehicle market and a potential loss of employment if allowed to continue to grow.

Conclusion:

All sectors of the automotive industry – assembly, parts manufacturing and vehicle sales - have been, and will continue to be, adversely affected by the rapid appreciation of the Canadian dollar. To assist in ameliorating the impact of the appreciating dollar we make the following recommendations.

Recommendations:

1. Immediate announcement of the 2008 eligible vehicles for the ecoAUTO rebate.

In early October the government announced that the criteria for the ecoAuto rebate would not be changed for the 2008 model year and requested that manufacturers confirm their lists of eligible vehicles with supporting data by October 19th. A month later, Transport Canada still has not posted the official list of eligible vehicles on its website. We are well into the 2008 model year and dealers and consumers are aware that the criteria for the rebate has not been changed, but they cannot take advantage of the rebate because the official list has not been published. The immediate publication of the list would allow manufacturers’ whose vehicles qualify for the rebate to advertise their availability – thus giving consumers one more reason to purchase their vehicle in Canada.

2. Temporary Tariff reduction on Vehicles from all Sources

A temporary measure to eliminate or at least lower duties to the equivalent U.S. rates would again address some of the structural cost difference between Canada and the United States. The 3.6% tariff differential between the U.S. tariff of 2.5% and the Canadian tariff of 6.1% adds about $1000 to the cost of a new vehicle in Canada.

3. Removal of the Excise Tax on Air Conditioning

Canada has long imposed a $100 federal excise tax on vehicles equipped with air conditioning. At one time air conditioning was considered a luxury item however today most cars are equipped with air conditioning. Indeed hybrid vehicles must be equipped with air conditioning to condition the battery so it is an essential element of an eco-friendly car. Further with the new refrigerants and electric air, air conditioners do not have the downside that caused the government to implement the tax in the first place. Again, its removal – while small- would assist in easing the structural cost differential between Canada and the United States.

4. Unique Canadian Standards

Unique Canadian standards for motor vehicles in an integrated North American market are very problematic and costly unless a thorough cost – benefit analysis suggests a pressing need for a unique Canadian standard. Harmonized standards allow the vehicle to be tested once for the entire North American market, enabling the integration of new technologies into vehicles more rapidly and at a lower overall cost. Unless there is significant benefit for Canadians from a unique standard, they simply impose cost without any appreciable benefit for Canadian consumers. There is an urgent need for the government to move swiftly to address regulatory disparities

5. Appropriate Funding for a Vehicle Scrappage program

Clean air is a priority for this government and it is a priority for the auto sector. With the introduction of advanced Tier II emission standards, smog has been virtually eliminated and according to environment Canada data in 2007 light duty vehicles were responsible for about 8.2 % of all smog causing emissions and this number is expected to decrease to less than 5% of all smog causing emissions by 2015. Adequate and separate funding should be established to incentivize Canadians to get out of their older polluting vehicles and into sustainable transportation choices or new motor vehicles. Funding for the scrappage program should not be tied to the ecoAuto/Green Levy programs. Any new potential demand for new vehicles could contribute to sustaining vehicle production in Canada.

6. Investment Tax Credits

The industry continues to request consideration for Investment Tax Credits or Manufacturing and Processing Credits to encourage investment in new Machinery and processes to improve productivity not only in our sector but in the manufacturing sector in general.

7. Clear Signals from The Government Concerning Fair Value of the Dollar

It is clear that there is some speculative element associated with the appreciation of the Canadian dollar. Clear signals from the federal government concerning appropriate medium term value for the Canadian dollar would assist in moderating the value of the currency and would also assist business in their planning.