State Makes a Risky Play With Cars

ST. PETERSBURG — On a cold February day in 1999, then-Ford CEO Jacques Nasser came to the Kremlin with a proposal: Ford would open a factory in Russia, building its inexpensive Focus model using both imported and Russian-made parts. Over the next five years, the U.S. auto giant would have to increase the use of locally made components until its Russian costs represented half the value of each car.

The Kremlin agreed, eager to draw foreign investment into an economy devastated half a year earlier by a debt default and ruble collapse.

Ford laid out $150 million to build a factory on the site of a former Russky Diesel plant in Vsevolozhsk, just outside St. Petersburg, and became the first foreign carmaker to open production facilities on Russian soil.

The arrangement worked well Ч too well, some might say.

The economy rebounded with a vengeance, and other foreign carmakers rushed to open factories in and around St. Petersburg with the enthusiastic encouragement of the local administration.

Prime Minister Vladimir Putin and President Dmitry Medvedev have been fixtures at groundbreaking and ribbon-cutting ceremonies in recent years, and in the first half of 2008 Russia managed to pass Germany as Europe's largest car market.

"St. Petersburg had the advantage over other candidates because of its close location to the car market, infrastructure and easy logistic access," Toyota, which opened a plant here in 2007, said in a statement. "And the support of St. Petersburg government, especially the assistance of Mrs. Matviyenko, was very important to us."

But the successful completion of "St. Petersburg's Detroit," as Governor Valentina Matviyenko termed it this week, also brought a rude awakening for Russia's native automakers, which had survived for years as the only game in town thanks to heavy import tariffs. And while Russia's three best-selling cars are all AvtoVAZ-made Ladas, six of the top 10 spots belong to foreign producers: Ford, General Motors, Renault and Daewoo.

The government, hoping to staunch the loss of market share to the invited competition, chose a bold but risky new strategy.

Late last month, Canadian ---auto-parts maker Magna and Sberbank bought control of Opel, the German unit of the now-bankrupt GM, and invited Oleg Deripaska's GAZ to join the consortium in order to share its production facilities.

The deal gives the Kremlin a chance to win the best of both worlds: keeping foreign automakers investing in Russia and using their technology to breathe new life into domestic producers. But the timing makes it feel like a last gasp, coming after months of generous loans and other support but no real effort at restructuring the industry.

Earlier this year, Tolyatti-based AvtoVAZ was forced to produce unfinished cars after local suppliers decided to stop delivering components because they had not been paid in months. On Thursday, Putin instructed the government to provide an additional 25 billion ruble ($806 million) loan to state corporation Russian Technologies, which owns a 25 percent stake in AvtoVAZ, to help the carmaker pay debts.

GAZ, best known for its Volga sedans and the boxy GAZelle van, said last month that it was selling loss-making British van maker LDV for less than a quarter of the ?22 million it paid in 2006. Adding insult to injury, the LDV buy was supposed to lead to localization of its Maxus vans, which would eventually serve as the basis for a new generation of the GAZelle.

The state's policy was to throw money at the problem, and its pockets seemed deep given the threat of unrest over layoffs and unpaid wages. The Opel deal, however, represents a different strategy altogether.

Sberbank will own a 35 percent stake and together with Magna inject up to 500 million euros ($709 million) into the German company. But Russia's investment in the European automaker is more about GAZ, which will give Opel the use of its Nizhny Novgorod production facilities and in turn gain access to German engineering.

Sberbank president German Gref, a former economic development and trade minister, called the deal a chance for Russia to get "one of the most technologically advanced European carmakers at an unprecedented low price" and said it would "make it possible to restructure the Russian car industry."

In particular, the deal offers new hopes of improving Russia's auto-components industry, which remains a hurdle to greater localization of production.

"The more foreign automobiles get produced in Russia, the more incentives auto-component makers will have for setting up operations here," said Sergei Udalov, an analyst with Avtostat, an automotive consultancy.

"GAZ and AvtoVAZ make everything themselves, from start to finish," he said. "Experience has shown that this is not the best way to do things."

Having local parts makers will raise product quality across the board for domestic and foreign automakers, he said.

But with car sales in Russia plummeting because of the economic downturn, no one expects the Opel investment to be an automatic panacea, especially after GAZ's experience with LDV.

Magna's goal of selling 1 million cars in Russia is "quite ambitious, and very unlikely anytime soon," said Mikhail Pak, an analyst at Metropol.

"Opel will use GAZ's production capacity and dealer network, but I don't see GAZ getting much from them on terms of technology," he said.

Vedomosti reported Thursday that the Magna-Sberbank consortium was also expecting to receive all of GM's assets in Russia and the Commonwealth of Independent States, including the plant that GM opened in St. Petersburg last July.

Chris Gubbey, president of GM CIS, said Thursday that all GM entities in Russia were "working as usual" and that GM Corp.'s bankruptcy filing did not affect overseas operations.

"At this point, detailed negotiations on the partnership with Magna have just begun. Clearly, the Russian operations are a critical part of GM's business in Europe and are of keen interest to all parties involved," Gubbey said by e-mail. "However, there are no firm commitments or details of what is being discussed that can be confirmed at this time."

And there are still the risks of doing a deal when the country's economy is anything but rosy.

Car sales have dropped drastically in Russia, with 44 percent fewer units sold between January and April than in the same period a year ago, according to the Association of European Businesses. The automakers committee of the AEB forecasts a decrease in Russia's annual output to about 1 million vehicles this year, from 1.8 million in 2008.

Nonetheless, foreign carmakers continue to flock to Russia, and their geographical opportunities are expanding as other regions Ч notably Kaluga, which saw a Volkswagen plant open last year Ч build on St. Petersburg's success.

On Tuesday, Nissan unveiled its plant in the St. Petersburg area, and Matviyenko said at the ceremony that Hyundai planned to open its plant in the city next year.

"Russia is our No. 1 market in Europe, and No. 5 globally," Fujii Takuji, general director of Nissan Russia, told The Moscow Times. "We're a company that strives to produce vehicles close to our market, since it gives us more flexibility and enables us to react more easily to changing requirements and preferences."

While Nissan expects the volume of the Russian market this year to be from 1.5 million to 1.75 million units, the plant will initially open its factory with one shift producing up to 17,000 units per year, he said.

Ford, which continues to soldier on seven years later, is still pleased with its 1999 deal, even though its Vsevolozhsk plant is now cranking out Focuses on a four-day workweek because of slumping demand.

The company instituted the shortened week "to avoid more dramatic restructuring," Ford Russia president Nigel Brackenbury said.

Despite the cuts, the company has managed to gain market share in the first our months of the year, he said.