JESSE SNYDER

New Russian outlook: 'Slower, lower, weaker'

COMMENTARY
Jesse Snyder is editor of the opinion page at Automotive News.
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Days after Russia annexed a province of Ukraine and U.S. and European forces mobilized, hoping to prevent more regions from hoisting the Russian flag, you’d expect a conference on the future of the Russian auto industry to be pessimistic.

And the speakers last week at a University of Michigan Transportation Research Institute session certainly were.

One after another, they explained why short-term Russian auto sales would fall, foreign investment is drying up and long-term prospects are dimming. One forecaster entitled his presentation, “Slower, Lower, Weaker.” Even a Russian Federation trade representative looked dispirited on the video link from New York.

One twist: these experienced Russian hands seldom mentioned the Russia-Ukraine flare-up.

To them, this wasn’t a turning point, but just the latest symptom of Russia’s bigger problems, another example why development is so labored. Not compared to Russia's economic collapse in 1999-2000 or the 2008 global meltdown that halved Russian auto sales to under 1.5 million units by 2009.

I’m not surprised by the latest gloom. Russia is full of contradictions. By 2005, just five years after private vehicle ownership was officially legal, auto sales were booming and you’d see Moscow streets jammed with high-end imports. Foreign automakers were falling over each other to build assembly plants and recruit suppliers to follow them.

Bureaucrats drew up maps of the country’s triple hub of auto production -- St. Petersburg, Moscow and Togliatti-Samara -- and envisioned imported-parts tariffs creating a massive self-sufficient supplier network brimming with the latest technology.

Everybody speculated how soon Russia would surpass Germany as Europe’s largest car market.

But even then there were lumps in the batter. Foreign suppliers setting up shop to avoid the import-part tax discovered Russian steel wasn’t usable, Russian ports were choked and logistics were erratic.

Every automaker wanted in -- European, Japanese, U.S., Korean, Indian and Chinese – so the market became fragmented. Lower-tier foreign brands struggled.

Russia’s car market recovered slowly. By 2012 it was almost back to 2008 levels at near 3 million, but sales slid in 2013. Post-Crimea, IHS Automotive is forecasting another 7 percent decline this year to about 2.6 million.

Mind you, this is in an energy-rich country with huge driving distances and a low auto density. Auto sales ought to be hot. Yet post-2008, Russia has been the weak sister of the BRIC bloc, substantially trailing the growth rates of China, India and Brazil.

What’s wrong? Lousy fundamentals and frequent crises, say U-M speakers. As a result, foreign automakers are increasingly reluctant to invest or reinvest.

“The most important parts of conducting international business are predictability and stability, two things we don’t have now,” says Daniel Russel, CEO of the U.S.-Russia Business Council, a consultancy that advises foreign companies on doing business in Russia. “U.S.-Russia relations haven’t hit bottom yet.”

The Russian government will continue to support domestic automakers because they provide so many Russian jobs, acknowledges Innokenty Deryagin, a Russian Federation trade representative. He notes that AvtoVAZ’s Togliatti plant, with capacity of roughly 750,000 vehicles annually, still directly employs 100,000 workers. He doesn’t say it, but that’s a pretty lousy productivity level, even for a complex that mimics the old Ford River Rouge on vertical integration.

The Russian legal system has contradictory and vague laws, open to broad interpretation by judges who are often corrupt and hostile to businesses, says Ekaterina Mishina, a Russian lawyer who is a U-M visiting professor from Moscow’s National Research University. She fears retaliation against U.S. and EU automakers and suppliers if Western sanctions tighten further.

Mishina notes that the Russian legislature has already drafted bills to retaliate against U.S. and European businesses if the West expands sanctions. The language includes “confiscation of property, assets and bank accounts,” she adds.

“It would be unwise to ignore this,” she adds. “Russian xenophobia is becoming a risk.”

The last decade’s rush by foreign automakers to build in Russia slowed even before 2008. Foreign automakers and Tier 1 suppliers still avoid Russian steel and Tier 2 suppliers and import as much as possible.

“It’s crazy to invest in Russia,” one veteran supplier exec says. “We all have workarounds to beat the tariffs.” And suppliers minimize how much proprietary technology they transfer to the country.

“The pre-2009 belief that Russian would become the No. 1 market in Europe this decade is dissipating,” says David Teolis, senior manager of international economic and industry forecasting for General Motors.

When I lived in Germany last decade, even the Germans expected the Russian market to eventually surpass theirs, perhaps even before 2010. Didn’t happen then. Hasn’t happened so far this decade. Now, Teolis’ long-term forecast shows Russia still No. 2 in 2024 -- next decade.

Short-term auto sales forecasts use all kinds of factors, but over the years GM forecasters learned the best long-term projections use two primary factors: expectations for per-capita gross domestic product growth and per-capita vehicles in operation.

And since 2009, each new 10-year forecast is less upbeat, Teolis says. He sees only slow growth. That’s because Russia’s economic virtues of the go-go 2000s have flipped since 2008: slower labor productivity growth, weaker middle-class expansion, investors are risk-averse, capital is fleeing, and the ruble is overvalued. The Russian depopulation that began last decade is accelerating.

And Teolis says Russia missed an opportunity to diversify its exports while its oil industry was racking up huge trade surpluses in the 1990s and 2000s. These days its current accounts are barely positive, and Russian exports are still almost entirely based on raw materials.

“If the price of oil drops below $110, Russia [falls into to trade deficits],” he says.

World Bank forecasters are also gloomy. Of the six five-year GDP forecasts for Russia that it has issued since 2008, each is lower than the one before it.

Wrap it all together and Russia’s potential as an auto market is shrinking and the risks are rising. In a world full of opportunities and limited resources, that’s a losing proposition.

You can reach Jesse Snyder at jsnyder@crain.com.

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