Analysis

Russia’s automotive sector: emerging from the doldrums

  • Automotive
  • Russia
  • Delivering Growth and Opportunity
Anna Walker

Anna Walker

Russia’s automotive sector: emerging from the doldrums

 

Recent data from Russia suggest that 2017 will be the first year since 2014 that an increase in domestic automotive sales is expected. In November 2017 the Association of European Businesses reported that more than 125,000 units had been sold, a 15% year-on-year increase, while year-to-date sales grew by nearly 12% to 1.43m. The growth in sales is a positive sign not just for car manufacturers and distributors. The automotive sector is traditionally seen as a bellwether for the broader economy. Both have had a difficult few years, damaged as the impact of low oil prices, devaluation of the rouble and falling real wages have fed through to dampen consumer demand. 

Slow recovery after precipitous collapse

The 2017 sales data indicate that a slow recovery is under way, but the collapse in the past few years has been precipitous – sales in the first half of 2017 were still only one-quarter of those in the same period of 2008. Russia until 2008 was the second-largest car market in Europe after Germany, but the market crashed after the global financial crisis. A rebound in 2012 was short-lived: plummeting oil prices in 2014 drove automobile sales down from 2.6m units in 2012 to just 1.5m units by 2015. 

The collapse in sales had a significant knock-on effect on Russia’s vehicle manufacturing and assembly industry. By 2016, only about 50% of its car manufacturing facilities were in use, leaving the country with considerable excess manufacturing capacity – production amounted to just 1.12m units in 2016, down from 1.97m in 2012, and around one-third of the country’s 3.1m unit capacity. Factories were mothballed and workers laid off as manufacturers sought to cut their losses. 

Shifting consumer preferences and incentives

But the recent monthly data indicate that the sector is emerging from the doldrums, albeit slowly and with changing consumer preferences reflecting the economic difficulties of recent years. Consumer demand is shifting away from premium, foreign-manufactured brands and towards locally made, cheaper cars. 

Changing incentives, financing structures and regulations are also influencing vehicle manufacturing and purchasing trends. Subsidies for car leasing, for first-time buyers and for public-sector bodies to procure vehicles have helped to support the sector in recent years, though are now being phased out as sales targets have been met. 

State support is now shifting towards incentivising local manufacturing. Amendments to the tax and customs framework for vehicle manufacturers are likely to boost Russia’s attractiveness as a manufacturing location, and thereby support an increase in domestic production. These changes provide for customs and value-added tax (VAT, sales tax) exemptions from 2018 for the import of raw materials used in local production. The application of these duties had meant that it was often more cost-effective for vehicle manufacturers to import finished products, because of the lack of availability of locally produced, high-quality parts that met international standards. Changes to the tax and subsidy structures are also partly aimed at encouraging global car manufacturers to increase their production – rather than assembly – within Russia, as part of the authorities’ broader localisation drive, and to entice major automotive manufacturers back to Russia. 

Financing structures

Modernisation of financing structures is likely to encourage further growth in the sector. Russia lags behind automotive markets with more developed car financing arrangements, indicating that there is considerable scope for catch-up for finance providers and for take-up by consumers. In the UK, for example, around 86% of new cars are sold under a Personal Contract Purchase scheme (a form of hire purchase), a large share of these being arranged by so-called ‘captive’ banks. In Russia around 50% of cars are sold on credit, but only around 20% of sales are financed by captive lenders. Falling interest rates are likely to encourage growth in this area – the Central Bank of Russia in late October 2017 cut its key rate to 8.25%, down from a recent high of 17% in 2014 – benefiting both finance providers and consumers, the latter also finally seeing real wage growth as inflation has fallen.

Another area in which Russian automotive entities lag more developed markets is in the share of spending on research and development. Local market leader AvtoVAZ, for example, spends only just over 1% of its revenue on R&D, while the share of spending that major global manufacturers dedicate to R&D is typically around 4%, giving them a longer-term competitive advantage. One concern has been that there is insufficient protection of intellectual property (IP) rights in Russia for companies to focus their R&D efforts there. 

Electric roll-out

The promotion of new technology in the sector – particularly electric vehicles – is nevertheless gathering pace. A national roll-out of charging stations across major cities started in 2012, taxes on imports of electric vehicles were cut for a 12-month period from mid-2016 and free city centre parking has been introduced in some areas to encourage take-up. Officials have stated that up to 200,000 electric vehicles might be in use by 2020. This is probably an optimistic target (just 50 were sold in the first eight months of 2017, adding to the existing stock of about 920, according to Avtostat). 

However, demand is likely to increase as the availability of charging infrastructure improves. Considerable new investment is still required in the infrastructure necessary to make ownership of electric vehicles a practical option for consumers. More broadly, the take-up of electric vehicles is likely to have spillover effects in other sectors. Russian nuclear entity Rosatom in September said that it intended to start mining and trading lithium, a key battery component.    

Export promotion

As well as benefiting from the slow recovery in the domestic market, vehicle and parts manufacturers are hoping to turn some of their unused capacity to develop their export potential. According to reports, German entity VW plans to double the share of vehicles manufactured in Russia that it exports from 10% to 20% in 2018. French company Renault in October announced that its exports to Algeria from its joint venture with AvtoVAZ were likely to increase from 15,000 to 18,000 in 2017, after it opened up a new production line.

With labour and other costs having fallen in the past few years, Russia has now become a more competitive location than China, for example, particularly given the tax exemptions. Automotive component manufacturers are also using Russia as a base from which to export to China, though are likely to face growing competition from within China itself. Moreover, logistical barriers common to other export-oriented sectors, as well as the small size of the nearby CIS markets and their limited purchasing power, will constrain the scope for a significant expansion of automotive exports. Given that car density is still relatively low compared with other markets – at just 358 units per 1,000 adults in 2016, compared with 615 in Western Europe – the domestic market is likely to prove the main driver of growth for some time to come.

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