Five
years of straight economic growth following the crash of 1998, Russian consumers
are buying more foreign cars and luxury goods. The car market is also being fuelled
by cheap finance deals being offered by western automakers and a bid by the Russian
government to restrict the import of used vehicles. Report by Chris Wright with
additional analysis by Dave Leggett.

In a market size of around 1.5 million vehicles, cheaper, low-technology domestically
built vehicles still dominate. New imports account for around 10 percent of
the market while a massive half a million used cars cross the border each year
from western Europe.

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It is with these used models, typically costing under Euro 10,000, that foreign
new carmakers and importers have to compete. Recently introduced import taxes
on used cars don’t go far enough, they say.

Duties have been increased only on cars more than three years old, a move aimed
at improving emissions, and do more favours to Russia’s domestic volume manufacturers
whose prices range typically from Euro 4,000 upward. Even so, the signs are
looking good, particularly for those western manufacturers setting up operations
in the country. Their models are selling out to Russians with more money in
their pockets these days.

Ford has had to put on a second shift at its St Petersburg Focus factory, less
than a year after it opened to keep up with local demand. It is now producing
25,000 cars a year with plans to raise this to 37,000 in the short term. Ford
has invested Euro 150 million in the plant, the first fully foreign-owned car
factory in Russia.

GM has now produced 8,000 Niva sport utility models at its joint venture plant
with AvtoVAZ, which makes Lada vehicles, in Togliatti. This model uses all Russian
parts and built to GM manufacturing standards and quality. It sells in Russia
for just Euro 8,000 for the entry model. The Niva is badged in Russia as Chevrolet,
a name likely to be used when exports to other markets start to climb next year.
The Togliatti plant will eventually be able to produce 100,000 Nivas a year,
half of which will go for export.

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Engineers are working on putting Opel’s 1.6-litre Family One engine in the
car for export markets, replacing the Russian-built 1.7-litre. GM has invested
Euro 100 million in the joint venture, a figure matched by AvtoVAZ with a further
Euro 40 million coming from the EBRD bank. GM Russia president Heidi McCormack
said she would like to see the co-operation develop further.

“There is enormous potential in the Russian market and AvtoVAZ is a big
player. It has truly excellent research and development capability, many, many
great engineers but it has been held back by lack of money.”

Renault is expected to complete its new Moscow plant within 18 months where
it will produce the X90, currently under development with its Romanian unit,
Dacia.
The Euro 250 million Moscow plant, on part of the old Moskvitch factory, now
assembles the Symbol in kit form. When finished the Avtoframos plant, a joint
venture with the City of Moscow, will build around 60,000 vehicles a year for
the Russian market.

Renault and Ford and also stimulating the market by offering good finance terms,
considerable lower than the 14 percent being offered by Russian banks. Ford
offers 4.9 percent on the Focus while Renault has just announced an 8 percent
finance package.

New car sales projections until 2010 vary, but they all look good, a reward
for Ford, GM and Renault who have pressed ahead with their investments even
during the economic crash. As well as consumers becoming more affluent there
is an estimated car parc of some 25 million old cars that will need to be replaced
in the short term.

Murray Gilbert, plant manager at the Ford St Petersburg factory, said the operation
there, with further investment, could rise to 200,000 vehicles a year – all
of them for the domestic market. He said: “When you look at the figures,
even 200,000 is a small percentage.”

Renault’s country director Jean-Michel Jalinier said that its plant would be
producing 60,000 cars solely for the Russian market by 2005.

Ford of Russia’s Henrik Nenzen said: “Since the economic crash of 1998
we have seen a big recovery in the Russian market. We sold 1,400 cars here in
2000 and this year we will sell 20,000. All the projections forecast big growth
for the future.”











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GM has seen double-digit growth for the third year running. McCormack said:
“We are seeing a big increase in sales of the Vectra which is catching
up with our traditional best sellers Astra and Corsa while Saab is doing really
well. We recently relaunched Cadillac in Russia with the CTS and that is really
selling well. Overall we have seen a 15-20 percent growth in the import market
over the past three years.”

All three companies urged western suppliers to start looking closely at Russia
where the domestic component industry was improving enormously in terms of quality
and manufacturing systems.

Labour, raw material and energy costs are also very low. With demands that
Ford and Renault gradually increase their local content, western suppliers will
have to consider moving to Russia to compete on cost if they want to keep the
business in the future.

Gilbert said that Ford has to reach 50 percent local content by 2007, including
labour costs. It currently has 15 percent on Focus. “We are already trialing
some stampings, non-coated steel parts and some plastics components with local
suppliers. “We have seen big improvements in the way they do things and
there is certainly no shortage of excellent engineers in Russia,” he said.

Other automakers are watching the situation closely. Volkswagen has confirmed
that it is looking at the market with a view to building cars, probably Skoda,
in Russia, while GM is also looking at the viability of producing a second model,
probably Astra, with AvtoVAZ at Togliatti.

Russia – good demand growth prospects
Demand prospects look very positive in Russia in the medium term,
provided the economy continues to grow and incomes rise, writes David
Leggett.

Car ownership levels in Russia are low and Russia is a country that –
in population density and land use terms – ought to be able to absorb
a lot of cars. One risk is that the government may move towards adopting
an excessively protectionist stance towards the automotive industry and
snuff out imports. While the government has moved towards favouring more
protection – higher tariffs – over the past year, we believe that the
government’s WTO ambitions will act as a major constraint.

New car sales in Russia are estimated at 1,050,000 units in 2002 – approximately
2% ahead of the previous year. The recent growth of car sales in Russia
has been driven by rising real incomes and plenty of new model activity
– especially from import brands. The market is dominated by products from
local producers, most notably AvtoVAZ and GAZ, who have a combined market
share of around 85%. However, imports are growing as Russian consumers
are attracted to more modern and reliable products – albeit more expensive
to purchase. Local producers have had to trim output at times over the
past year as stocks have ballooned.

Medium-term market growth in Russia will be driven by growing disposable
incomes, the development of consumer financing and rising replacement
demand as consumers increasingly look to renew their ancient locally made
models. Per capita car ownership is still low in Russia, but will be heading
towards 200 cars per thousand by 2008. The Russian car market is expected
to be heading towards 1.5 million units per annum by 2008.

While we expect the local producers share of the market to continue to
be under pressure, we also believe that domestic makes will continue to
dominate the market through 2008. The main reason for that is that local
producers’ vehicles will remain considerably cheaper to purchase and maintain
than imported cars. AvtoVAZ models typically retail at around $4,000 against
more than $10,000 for a western brand vehicle.

Last year, Russian carmakers appealed to the government for help and
won some protective tariff barriers on imports. On average, new foreign
cars now face a 25% duty, while tariffs on old second-hand imports are
set at 35%. The import challenge posed to them is considerable. On average,
sales of new foreign cars increased by 40% in 2002. Competitive credit
has enabled the growing import presence. Before Ford launched production
of the Focus last summer near St. Petersburg, less than 10% of its customers
used credit to finance purchases, a figure that has now grown to 25%.
That figure has a lot of upward mobility to – in Europe the vast majority
of new car purchases are credit financed.

Toyota boosted its sales in Russia by 111% in 2002 to over 8,300 units
and much of its gain is attributed to a credit programme it has been running
with Raiffeisenbank, a leading credit lender.

The foreign car brand sales leader in Russia is Daewoo, with vehicles
produced at a plant in Uzbekistan. The Uzbek plant has reached an agreement
with Daewoo’s new owner (GMDAT) and signed a contract with the new brand
owner for at least three years; through that they have secured access
to kits for assembly and retained exclusive distribution rights in Russia.

How will the structure of Russia’s car industry change?
The big question facing the Russian car industry and market is how
it may restructure and modernise in the future. AvtoVAZ has made it clear
that it is looking for a strategic partner to help it to modernise and
become more competitive. GM has a JV with AvtoVAZ (Chevy Niva) and could
conceivably step up its involvement in the future, but GM’s management
is likely to be wary.

But Western firms may look to acquire Russian automotive companies or
conclude more joint ventures in order to gain access to the Russian market
and circumvent any restrictions on built-up imports. The level of foreign
direct investment (FDI) in the industry is still very low. Local production
by Western brands is still low, but will be rising. The GM-AvtoVAZ Chevrolet
Niva is being prepared for export production and Ford is planning to increase
output at its plant.

Toyota is said to be looking to build a car plant in Russia, aiming to
start production in three to four years. A feasibility study is underway
and it is said that a Russian plant may be used by Toyota as a manufacturing
base for increased shipments to Europe. The Land Cruiser is rumoured to
be the model earmarked for a possible Russian plant.

Russia’s economy gets energy boost
Since the devaluation of 1998, high oil prices and a big boost in
oil output have helped the beleaguered Russian economy recover. Russia’s
treasury is reportedly so cash-rich that even if oil prices fell to $10
a barrel, the central government could end the year with its books in
balance.

However, economists are expressing concern that while oil prices are
relatively high there is little pressure to develop other parts of the
economy. Thus, according to the World Bank, from 2001 to 2002 growth accelerated
in the industries that export natural resources but slowed in those that
produce goods for the home market. Moreover, small and medium-sized businesses
grew more slowly than the overall economy.

Fixed investment in 2002 grew more slowly than the year before – seen
as an ominous sign given the dire need to modernise dilapidated factories,
equipment and public services. Some economists reckon that fixed investment
in new plant and capital should be around 11% of GDP a year; the current
rate in Russia is just 6% – far too little to sustain a real recovery
in the long-term. And foreign direct investment into Russia is also still
low.

But these structural worries aside, private consumption has been lively
enough to promote rising purchases of consumer goods, including cars.
Economic performance has been strong in the first part of 2003 – real
GDP growth was 6.4% in the first quarter. We expect performance to weaken
over the remainder of the year, with real GDP growth of 4.8% for the year
as a whole. International oil prices, in particular, will be considerably
lower in the second half of 2003 than the January-April average. In 2004
a combination of slow growth in the EU and a sharp fall in oil prices
will lead Russian real GDP growth to decelerate to 4%.