The Russia Journal

With local production and greater affordability, Russians can now indulge in their passion foreign cars more easily.

Brazil, China and India may seem flattering comparisons to draw, but, according to market leaders, Russia’s automobile sector should be placed alongside them as one of the world’s major growth markets.

So far, there is only one fully foreign-owned car factory in Russia, but blossoming demand from an increasingly wealthier population that dislikes its own domestic brands is encouraging many foreign automakers to think of producing locally.

After five years of less-than-successful joint ventures with Moscow Mayor Yury Luzhkov’s favorite Moskvich, French auto giant Renault last month announced a $250 million investment in its Russian affiliate, Avtoframos, to finance producing its X90 model in Moscow in 2005.

And, last year, the world’s two largest automobile manufacturers, General Motors and Ford, both set up production facilities here, the latter being the first and only fully foreign-owned production facility in Russia.

"We are only at the beginning of an intensive period of investment in the domestic market," said Heidi McCormack, general director of GM-Avtovaz, a joint venture between the world’s largest car manufacturer, General Motors, and the producer of the ubiquitous Lada.

"Latin America, Asia and Russia are the markets where the majority of growth in the global automobile industry is projected for the next 10 years. Any manufacturer should be looking to have links with these markets," she told The Russia Journal.

According to McCormack, the Russian market is on a comparable level to those of Brazil, China, India, Thailand and Poland. These are high-volume-production markets in which the average retail price is under $10,000 per vehicle.

According to the Ministry of Industry, Science and Technology, 1.5 million cars were sold in Russia in 2002, a 7 percent increase on last year. Of these, 970,000 were Russian cars, principally AvtoVAZ (Ladas) and GAZ (Volgas).

The government has used a swath of protectionist measures to force Russians into buying Russian-made cars. They are cheap, but their quality often leaves much to be desired.

Sales of foreign vehicles reached about 504,000 last year, according to the State Customs Committee, 80 percent of which were second-hand. One hundred and eight thousand vehicles sold were new models sold through official dealers in Russia, an increase of 40 percent on the previous year and representing about 7 percent of total car sales. Almost all foreign companies experienced growth in sales, some of them up to 130 percent.

In the past year, however, demand for Russian automobiles has taken a severe battering, with sales down by 5 percent year on year. Both AvtoVAZ and GAZ have been forced to stall production for several weeks.

In comparison to India, one of McCormack’s "high-volume-production markets," penetration by new foreign cars is relatively low. In the first half of 2002, 30 percent of the 415,000 new cars sold in India were foreign brands, albeit made or assembled in India. But a 40 percent rise in demand in Russia is concrete evidence that the market for foreign cars is looking healthy.

Improved conditions for retail finance over the past two years have greatly increased consumer purchasing power in Russia. In 2000, for example, 2 to 3 percent of car sales were financed by consumer loans. In 2002, this figure was up to 20 percent.

According to Andrei Kormilitsin, an automobile analyst from Troika Dialogue, a Russian investment house, these loans increase purchasing power by about 40 percent.

As a result, Russian consumers with greater-than-average disposable incomes – around $800 per month – and improving consumer-finance options are turning away from spartan Russian cars in favor of more comfortable and reliable foreign automobiles that cost almost as little. A new Daewoo or Skoda costs only about $1,000 more than a new Lada.

In a move to protect domestic production, the Russian government last year increased import tariffs by 35 percent on second-hand imported cars older than seven years. Russian drivers clearly preferred 10-year-old German or Japanese cars over new Ladas rolling off the production lines. Lobbyists, in an attempt to protect themselves from this competition, are now pushing for further increases in younger second-hand car imports. New foreign cars face a 25 percent customs duty when imported into Russia.

By producing in Russia, foreign manufacturers can bypass these extra costs and sell their cars more competitively. An imported Ford Focus costs $13,900 in Russia, but the Focus model made at the company’s $150 million factory in northern Russia costs only $10,900.

The move to Russia has opened new markets for Ford, which now has the potential to target consumers from the three most influential markets – new foreign cars, new Russian cars and second-hand foreign cars.

But Henrik Nenzen, managing director of Ford Russia, admits that the price range that Ford offers is still not huge, and therefore, penetration is low.

With second-hand imports continuing to flood in and with Russian cars still dominating the bulk of the market, the largest problem for foreign producers is the restricted market.

"The market size for foreign cars is one of the lowest in Europe," he explains. "The big used-car market and domestic market put off other foreign manufacturers.

"It is not the case that Russians particularly want these second-hand cars over new foreign cars, but because the conditions for importers are better; they don’t pay value-added tax (VAT), and duties are competitive."

Nenzen suggests that, in order to create a level playing field, it is not a question of increasing tariffs on second-hand cars, but decreasing VAT on new vehicles.

Ford does, however, benefit from a free customs warehouse, which allows it to avoid paying duties on its imported parts. In return, the company must use 50 percent local materials in production. Such a deal is a reflection of the government’s endeavor to give a boost to the domestic manufacturing sector and encourage more foreign investment in Russia.

Last year, Russia’s Ford factory produced 4,000 Ford Focuses and already has orders for a further 6,800 through to July, more than the factory can produce in that time frame, according to Nenzen.

As well as Ford, GM and Renault, and Kia and BMW have joint-venture assembly plants in Kaliningrad and Hyundai and Citroen have production interests in Taganrog. There has also been much speculation about future investment by German car giant Volkswagen, though the company states that nothing has yet been confirmed.

Japanese companies are still non-existent on the Russian manufacturing floor, but experts are predicting that it will not be long before more investment comes from the East.