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Russian resolution

02 January 2018 | Nick Gibbs

Russia’s automotive industry is cautiously expressing confidence again after the car market there emerges from a three-year slump

Lada Priora production lineSales have increased in Russia every month for the last eight as the country adapts to its new economic normal of low oil prices and continued European economic sanctions; the two biggest causes of the preceding crisis.

Car and light van sales in 2017 were expected to reach 1.6m, the Automobile Manufacturers’ Committee, part of the Association of European Businesses, predicted in November, a rise of some 13%, giving beleaguered carmakers hope that their investments may yet return profits in a country that, at one point, was all set to overtake Germany to become Europe’s number one car market.

Q&A: Adil Shirinov

Back in 2012, that goal seemed entirely believable after the market finished at a record 2.93m. But then Russia’s economy, over-reliant on raw materials, crashed along with global oil prices, and the market sunk to a low 1.42m in 2016.

In a country that operates a wide range of levers to ensure automakers build in the country rather than import, companies were left with no choice but to slash spending and ride it out. Analyst LMC Automotive estimates that the average capacity utilisation for assembly plants is now just 40%.

Market upheaval topples Lada
Companies were chasing production targets of 300,000-350,000 to qualify for tax breaks under the government’s Decree 166 act, so had made big investments in production. Ford for example has three assembly plants and to keep them going, CEO Adil Shirinov tells AMS, the company had to take “severe and aggressive” steps to restructure the business, including cutting jobs. It’s still losing money, as is Russia’s biggest carmaker, AvtoVAZ, producer of Lada brand cars. Such has been the upheaval, the best-selling model in 2017 was poised not to be a Lada, but the Kia Rio.

Manufacturers were also exposed to the falling value of the rouble, which was allowed to float freely in 2014. Despite agreeing to meet high localisation rates of 60%, another element of the Decree 166 agreement, makers weren’t localised enough to absorb the currency shift and car prices rose dramatically, some by as much as 50%.

But, despite volumes halving, the only company to shut a plant because of the crisis was General Motors, which closed its St Petersburg facility in 2015 after announcing it was quitting the country altogether. Korea’s Ssangyong also pulled out, but for everyone else it was a case of ‘batten down the hatches and wait for the storm to pass’.

Now manufacturers and analysts are predicting good times ahead, albeit with a little more caution. Ghosn, CEO of the Renault Nissan, which owns AvtoVAZ via Renault, said recently that he expects the market to return to three million, without giving a timeframe. “The recovery in Russia has started and it will benefit us as the largest player there,” he said. “When you have 35% market share, even if the market goes to 2.5m sales, that’s an opportunity for us.”

Ford’s Shirinov is another being cautiously optimistic, predicting it could one day beat Germany, which bought 3.3m cars in 2016. “That probably won’t happen in 3-5 years because of the geopolitical situation, but in 7-10 years it could, if we don’t have any big challenges,” he says, predicting steady growth of 10-15% a year.

Analyst firm LMC Automotive is slightly less optimistic, predicting the country will reach 2.47m by 2025. “The pace of recovery is likely to be much more gradual than the rapid revival we saw in Russia following the global financial crisis [in 2008], mainly because oil prices have not picked up like they did after the last downturn,” says Carol Thomas, Central & Eastern European analyst, at LMC.

Thomas believes government incentives for car buyers will remain in place for another two years unless oil prices improve dramatically, but she says the country has largely adapted to EU sanctions, which are due to be reviewed in March 2018 and perhaps will be weakened. “Some countries in central Europe are in favour of lifting the sanctions, mainly because of the impact upon their exports,” she says.

Optimism and investment increase
The level of optimism is such that automakers are investing again. Mercedes owner, Daimler, laid foundations for a new plant in June in Moscovia, near Moscow, with start of production scheduled for 2019. Daimler already builds Mercedes vans in Russia through an agreement with the contract manufacturing arm of GAZ and trucks via a joint venture with Russian maker KAMAZ. This factory will add Mercedes cars to the list, starting with the E-class sedan and adding GLE, GLC and GLS SUV models. The plant represents an investment of $250m for the firm and it will be able to build cars based on several different platforms on a single assembly line, the company said. The bodies will be joined and painted on site. Mercedes was the best-selling premium brand in Russia to the end of the October, selling 30,440 cars, slightly down from the year before.

Also considering opening a plant is Mercedes’ rival BMW, which currently contracts Avtotor to build cars from kits in Kaliningrad. The automaker has said that Kaliningrad is a possible location for the plant.

Other automakers looking to increase investment in Russia include VW, which is in talks to buy a stake in GAZ, sources told Reuters late last year [2017]. GAZ builds Skoda models for VW, but is better known for being the leading van maker in Russia. It has also has a healthy truck and bus business. Meanwhile, Mazda is likely to build a second plant in the country, Russian media have reported, to give the Japanese automaker a base in the west of the country. It already builds cars all the way to the east in Vladivostok.

Mercedes’ decision to build cars in Russia came following a “very, very successful conversation” with the Russian government, according to Mercedes board member Markus Schaefer. It’s a reminder that the Russian government can be extremely financially accommodating to carmakers who want to set up assembly sites in Russia, and will do everything in its power to favour locally made vehicles over imports.

Russia - LADA_Vesta

Russia’s biggest carmaker, AvtoVAZ, maker of Lada brand cars looks to regain market share

That puts them at odds with the World Trade Organisation, which has set a deadline of September 1st, 2019 for Russia to drop import duties for new vehicles to 15% in return for full membership. The rates drop to 17% next September, down from 25% when negotiations started. However, Ford’s Shirinov believes Russia will continue to favour local makers. “I don’t want to use the word barriers, that is not right, but I’m sure the government will develop a formula that will help to make business more interested to be present in Russia,” he says.

LMC’s Thomas is more explicit. “From what I hear the drop in import duties will simply be offset by other taxes,” she says, suggesting they will probably just increase the “utilisation fee”, a tax that’s ostensibly levied on automakers to pay for end-of-life vehicle disposal but is waived for local manufacturers.

Those already based in Russia welcome the protective arm the government throws around them. “To OEMs, that is a guarantee of stability. Because the more you localise in the local currency, that’s the most stability you have,” Shirinov says.

Ford has met the 60% target set by Decree 166, one of the few to do so do, according to LMC’s Thomas. She believes VW may have also reached it, while Renault/AvtoVAZ definitely has, with most Ladas running at over 70%.

Mercedes, reportedly, was one of the first to sign a new form of agreement with the government in return for lower taxes. SICs or SPICs (special investment contracts) are bespoke agreements and the contracts are unique from company to company, but include a provision to reduce local content requirements if the automaker exports – a key aim of the Russian government.

Winners and losers
The much-needed expansion of Russia’s supplier base, needed to fulfil Decree 166 agreements, was largely halted by the crisis, but the downturn benefited one OEM: Spain’s Gestamp, a metal parts supplier that has four plants in Russia. “We have been able to take most of the important orders because there wasn’t too much competition,” says chairman and CEO Francisco Riberas. “Some of the local competitors went bankrupt. Some of the global players left or didn’t invest. Now we need the market to recover.”

What is clear is that this recovery is going to be a lot more subdued than the gold-rush between 2009 and 2012. There just isn’t the money, Ford’s Shirinov says: “Purchasing power will not come back to levels they were before, this is just impossible.”

Tagged with: AvtoVAZ, Ford, GAZ, Lada, Russia