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Indego / IndeGo Forum / Russia - Riches or Ruin?

Russia - Riches or Ruin?

 

Monday, 01 September 2008 17:15

The Moscow Auto Show last week was held against a backdrop of continuing high growth in the car market.The first half of 2008 saw an almost 20% increase in car production in Russia, and the first 7 months of the year saw a 46% increase in sales of foreign brands.  However, in parallel, politicians are talking about the return of the Cold War and there is sabre-rattling on both sdies.  So is Russia one of the few places for the auto industry to make money in today's environment, or is it a fool's paradise where huge investments will need to be written off in the coming months or years?


The Russian goverment has encouraged inward investment by foreign manufacturers through "Decree 166" which provides tax breaks as long as local content is progressively increased in vehicles assembled in Russia.  This has seen plants opened and joint ventures formed in recent years by Ford, GM and Renault, with other plants under construction by Hyundai, PSA (in collaboration with Mitsubishi) and Volkswagen.  Manufacturers are looking to Russia for the growth to compensate for flat or declining markets elsewhere.  Meeting the requirements of Decree 166 is however not easy.  Local supplier quality generally falls well short of any other location I have come across globally, despite which prices are uncompetitive and subject to high inflation.  Henrik Nenzen, who until last year was the President of Ford Russia, in an interview with Automotive News Europe described localization as "a very big task", 6 years after production started at their plant in St. Petersburg.  In an interview last week, Petr Krusov, head of the Russian Carmakers Association told Reuters that "the technological base of our industry has not been renewed since the 1980s.  That's why we are so far behind.  It will take a change of generations for this to change.  That can start in three years, and it will take as long as 10 years to complete."

When executives talk in terms of 10 year timeframes, the reality is probably 15-20 years.  It is clear that Russia is not therefore going to provide quick or guaranteed returns, and that the investment in respect of supplier development and skills transfer will be substantial, over and above the major financial investment in new plants and product over 2-3 product cycles.  Volkswagen formed its original partnership with SAIC in China in 1984, but it was only in 2005 that the export of Chinese-built cars became feasible, when Honda launched their dedicated factory in Guangzhou.  In Russian political terms, this means that we need to look beyond the second term of President Medvedev, and a possible further two terms of a re-elected Vladimir Putin, for when a Russian investment made now might mature.  It is impossible to assess the political risks over that timescale associated with a country going through the type of change which is required in Russia in almost every area of political, economic and social endeavour.  However, I think everyone would recognise that those risks are significant.  The Lex column in the Financial Times last week carried a good commentary entitled "Russia's risk premium".

My own experience as CEO of LDV under the ownership of GAZ gave me some insights into the Russian auto industry and also the way in which the political and industrial evolution of the country are intertwined.  Russia is a proud country with huge national resources and a long history as a major power.  It will not allow itself to be industrually colonised by inward investors who sieze on the unique growth opportunities present today as their only salvation in a troubled global economy, and nor should it.  Decree 166 was smart in that it provides enticingly low barriers to entry to a manufacturer and leaves them to do the hard work on supplier development which in the end will be the platform on which domestic players can be reborn.  But there will not be a "laissez-faire" approach on the part of government.  Russian government is by it's nature interventionist, but so to a lesser extent are those in France, Germany and Italy.  Behind the scenes, the Russian leadership encourages the oligarchs to pursue paths that are aligned with state objectives, and there is a track record of state intervention, including returning assets to direct or indirect state ownership, when deemed necessary.  From a Russian perspective, this may make great sense, but for a shareholder in a company which is making major inward investments in Russia, it should set off alarm bells.

Vehicle manufacturers and their suppliers should aim to participate in Russian growth, but they should be doing so with a 15-20 year view, and a very different business case model to that which they use in more mature and stable economies.

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