Russia Automotive Production not Without its Challenges

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Old habits die hard, it would seem, and no where harder than among the self styled hard men. Vladimir Putin likes to pose for the cameras with his shirt off in complete disregard for good taste and this week in complete disregard for the months of hard work that bureaucrats have put into moving Russia forward on the path to acceptance by the WTO. Mr Putin came out with another one of his strong man comments which promptly put the whole process back to square one. Well if not square one then raised serious questions about the time frame for eventual approval. Among many conditions set by the WTO for membership is a reasonable level of tariffs protecting domestic industry world trade after all rests on the concept that countries will trade with each other on reasonably level terms (China accepted did I hear you say, we won’t go there). Although Russia raised auto import duties in December 2008 from 25% to 30% it was seen as only a temporary measure against the global economic crisis. According to the Financial Times under terms agreed with the Geneva based WTO, Russia must reduce import tariffs on cars from the current rate of 30% to 15% over seven years from the time it joins.

Mr Putin who has always seemed somewhat ambivalent to WTO membership, sending out mixed messages on occasion probably to the exasperation of his long suffering President, Dmitry Medvedev, who made an announcement this week that if foreign car companies don’t come to Russia and set up manufacturing operations they will have tariffs raised against them if they import. The process is called “localization according to Mr Putin and is designed to bolster car production within Russia creating jobs and transferring manufacturing skills and automotive technology to the local market. The FT article explains foreign competition has decimated Russia’s domestic car industry since the fall of the Soviet Union. Avtovaz is the only significant producer remaining in the market. Some foreign companies have already begun producing in Russia. Germany’s Volkswagen has built a factory producing cars in the city of Kaluga, while French car maker Renault has bought a 25% stake in Avtovaz.

But as speakers at the Automotive Logistics conference explained, there are many challenges to manufacturing in Russia, not least of which is the lack of a consistent legal framework in which to operate as many foreign firms have learned to their cost. Parts sourcing is a major problem. The generally accepted formula is 30% local 70% imported as manufacturers struggle to find reliable high quality local suppliers. According to Alexey Serezhenkin, deputy executive director for the Association of Russian Automakers, only 5% of Russian suppliers meet international quality standards.

Another is the infrastructure. Many of the car plants are in western Russia but the big growth markets according to Mark Brenneiser of Rolf SCS are east of the Urals. Road transport is problematic for several reasons. One the road network is in a poor state of repair. Two, once road transporters travel potentially thousands of miles to deliver finished vehicles there are no back-loads to cover the return journey making transport costs high. Even so road is still often cheaper and safer than rail because rail carriages are horribly obsolete and largely unsatisfactory for moving new cars without the risk of incurring damage. Before 2008, only second hand cars moved by rail and the industry has not invested in new rolling stock to meet rising demand. Damage in transit is typically twice west European levels.

Although Russia experienced a profound drop of some 60% in car production in 2009 the general trend is for high single digit growth. It may take years before the market regains its 2008 peak of 3 million cars, but volumes this year may reach 1.5-1.7 million driven by a rising affluence and a low car ownership base of just 124 vehicles per 1000 people compared to the US at 765 vehicles per 1000 according to NationMaster.

Hopefully, Mr Putin will refer to history and see protectionism and/or strong-arm tactics do not work. Creating the right regulatory framework, infrastructure and actively encouraging the development of a competitive supply base would go much further to developing the modern automotive manufacturing capability Russia needs.

–Stuart Burns

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