The Kremlin calculates its love for AvtoVAZ

27.09.2010 — Analysis

Russian factories began manufacturing foreign automobiles in 2005. Leading global auto manufacturers were given special inducements to import component parts to Russia, provided that they produced at least 25,000 cars a year. The seven-year agreements they concluded with their Russian partners stipulate that semi-knocked-down assembly should eventually move to full-scale production with 30% fewer imported components.

But today the Russian government is no longer satisfied with this industrial assembly system. Prime Minister Vladimir Putin claimed at a meeting with leading auto manufacturers that they would only be able to renew their agreements under new conditions. Incentives would be provided to those companies that are able to assemble up to 300,000 cars a year. And by the sixth year of work, at least 60% of the manufacturing should be done locally. The amount of foreign investment was also specified - at least $500 million to be spent on modernizing existing businesses and more than $750 million to create new ones.

Sergei Tselikov, the director of the AVTOSTAT agency, thinks that the Russian market isn't big enough to absorb 300,000 cars. Companies whose industrial assembly contracts are due to expire soon will have to make a choice - either increase production or combine their platforms. This expert thinks it is possible some of the automotive companies might leave.

Viktor Loshkarev, the assistant manager of the public corporation IzhAvto, told RusBusinessNews that the Hyundai Motor Company, who was planning to resume production of the KIA Spectra and KIA Sorento at their plant in Izhevsk in November of 2010, will not agree to continue working in Russia under these new conditions. The Korean company's stance is undermining the statement made by German Gref, the head of Russia's Sberbank, (the Izhevsk auto plant's prime creditor) that IzhAvto is planning to produce up to 350,000 cars a year by 2018. The company's management confirms that it is currently difficult to enter the market making 300,000 cars, even with the inexpensive, classic VAZ models that have been assembled in Izhevsk for several years.

Ekaterina Khaimenkova, the PR director of the private company AMUR, suggests that the target number of 300,000 cars a year is too high and that it deprives the company of the chance to work with investors who might be ready to invest in production at a somewhat slower pace, not taking on more than the current market conditions allow.

In July of 2010, Amur, which is located in the Sverdlovsk region, signed a contract with Renault Trucks Vostok to assemble the Midlum medium-duty truck at its plant. They also plan to produce fire-fighting, snow-removal, and garbage-collection equipment for sale in Russia, Kazakhstan, and Belarus. At the initial stage of investment in the production, no allowance was made for the capacity of the Urals factory, which allows assembly from semi-knocked-down kits. The production of automotive components on site has not been ruled out for the future, but the management is currently afraid to give any figures that would automatically put an end to the concessionary terms granted to the alliance between Amur and Renault Trucks.

"We are actively searching for investors and partners for projects to assemble trucks and passenger cars at our site," says Ekaterina Khaimenkova, "but the Russian government's campaign to change the conditions for industrial assembly might shut out some manufacturers and put them in competitive price conditions that are known to be unfavorable."

Sergei Udalov, the executive director of the AVTOSTAT agency, suggests that the federal authorities had no choice. It is not possible to start producing auto parts if not enough cars are being assembled. Russia is already not producing enough car seats and floor mats, but is counting on getting the technology to produce engines. The best way to get that technology, this expert suggests, is to limit the activity of foreign manufacturers. This is what China did when they allowed the creation of joint ventures only if the Chinese side maintained majority control. Originally the Middle Kingdom adopted the technology, and then it began to create its own auto production companies. Global manufacturers agreed to the rules of the game, since the Chinese market is very big. But Sergei Udalov suggests that in Russia there is no other way to stimulate the production of components at domestic plants other than by establishing a high quota for producing cars.

Natalya Shcherbakova, an automotive industry partner at PricewaterhouseCoopers Russia, says that getting components manufacturers to come to Russia depends on more than the automotive giants. With a low volume of automotive sales, it is not profitable for automotive component suppliers to arrange to have these components manufactured at Russian plants. The solution could be to work for several companies at once, but incentives are needed for that, which only the Russian government can provide. And they don't need to be the same incentives given to the automotive giants to encourage automotive assembly in Russia. If the government is not able to attract the interest of automotive component manufacturers, there won't be any local production of cars, and as a result, the automotive giants will shut down assembly at Russian plants.

The decision about whether global brands will remain in Russia won't be made tomorrow. The automotive giants should understand by now whether they can restructure their manufacturing processes. Some of them have contracts that won't expire for another seven years. If the market should change during that time, then new opportunities for foreign manufacturers might appear.

But experts are not too optimistic. Considering the size of the Russian market, the overwhelming majority of foreign brands will not be able to increase their production in the near future. Analysts predict that 1.6-1.7 million passenger cars will be sold in this country in 2010. And according to data from PricewaterhouseCoopers, AvtoVAZ produced 200,700 cars in the first half of 2010. Other manufacturers boast much smaller numbers, ranging from 35,000 to 67,000. And some auto giants are showing a negative trend. The GM Group has reduced automotive production in Russia by 20%, Ford - by 18%, and Toyota-by 15%.

These numbers indicate that only AvtoVAZ is meeting the Russian government's requirements. Accordingly, only Renault can rely on the government incentives under which the new system of industrial assembly was developed, confirm some officials behind the scenes.

A number of experts believe that the French company won't stay in Russia for long. As soon as AvtoVAZ brings out its new car models, Renault will be put out to pasture as well. But the French company isn't suffering. The new system of industrial assembly gives it eight years to assemble semi-knocked-down kits and to recoup the investment from its joint projects with AvtoVAZ. As usual, the losers will be ordinary Russians, whose incomes limit their ability to buy modern cars.

Vladimir Terletsky