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. Last Updated: 07/27/2016

Auto Sector's Bumpy Ride to the WTO

Itar-TassThe Lada, produced by AvtoVAZ, is one of Russia's most popular models. AvtoVAZ has seen its share price rise some 35 percent in the past three months.
Russia is moving full steam toward entry in the World Trade Organization in 2003. But auto industry lobbyists are ready to put on the brakes, saying the sector is not ready for the inflow of foreign cars that would result. Simon Ostrovsky reports on how automakers want another 10 years of protective duties -- a "transitional period" -- to improve their factories, attract investment and develop better models.

Auto lobbyists fear that if import duties are lowered to between 10 percent and 15 percent -- as WTO member states, most notably Japan and South Korea, are requesting -- the domestic car industry will be in peril.

"There will be serious economic consequences for the Russian auto industry if it is immersed into the WTO because it will not be able to compete on the same level as well-known European producers," said Nikolai Pugin, general director of the Gorky Auto Factory, or GAZ, Russia's No. 2 carmaker.

The Economic Development and Trade and the Industry, Science and Technology ministries have come to the rescue of domestic car manufacturers, drafting a protectionist plan for the sector's development over the next 10 years that includes demands from the carmakers themselves.

Auto lobbyists are demanding import duties between 30 percent and 35 percent to stifle foreign imports. The lobbying charge is being led by metals giants Severstal -- which controls No. 3 carmaker UAZ -- and Siberian Aluminum, or SibAl, which controls No. 2 carmaker GAZ. No. 1 carmaker AvtoVAZ has also joined up.

Economic Development and Trade Minster German Gref envisions gradually lowering tariffs, letting carmakers get accustomed to competition a little bit at a time. Manufacturers are in agreement, eyeing a transitional period of about 10 years after which tariffs would be lowered to between 10 percent and 15 percent.

Gref, who supports WTO entry, had delayed tariff hikes. But now Russia's delegation to the WTO, headed by Gref's deputy, Alexei Medvedkov, has asked the government to incorporate the auto industry's demands into its WTO policy.

AvtoVAZ board chairman Vladimir Kadannikov said the tariff hikes are logical, pointing out that Russian consumers spend around $13 billion a year on foreign cars and parts -- money that could go to domestic producers.

"This is Russian money," he said.

However, foreign imports should be allowed because AvtoVAZ can't keep up with demand, Kadannikov said earlier this year.

"We don't consider it possible to lobby the issue," he said. "In 2000 alone, out of 1.4 million cars new to the Russian market, 400,000 were imported from abroad. If they had not been imported, we would have nothing to offer our consumers in their place."

Eduard Shpakovsky, general director of the Ulyanovsk Auto Factory, or UAZ, Russia's No. 3 carmaker, is more outspoken about the role the government should play in the regulation of the car industry.

"When we made an analysis of what happened in other countries when they opened their borders, we found a tendency," he said. "If the government enforces rational protectionism ... if it rationally sets out tariffs and follows a plan of gradually lowering them to zero during the transitional period and firmly sets out the rules of the game without making exceptions for any one producer, in these places not only did the auto industry not die, globalists came and set up their own factories.

"But in those places where they opened the border right away, the auto industry died within a year," he said.

Not all carmakers are in agreement on the length of the transitional period. Shpakovsky, for example, thinks it should last a maximum of six years. "If we make it any longer, than we'll be stuck in the same position we are in today," he said.

Whatever the plan is, its effect will depend largely on how it is implemented, Shpakovsky said.

"There should be a rational rigidity in announcing what the time frame is so that everybody understands that now is the time to get moving," he said.

The rules of the game should be set in stone, Shpakovsky said.

The government should say "guys, we're not gonna go back on this, there will be no discounts and there won't be any changes," he said. Carmakers are always hoping that "oh, the government will change its mind in a couple years or, oh, I'll go and ask them for a discount."

The main threat for Russian cars if tariffs are lowered, automakers say, are used foreign cars, which are about the same price as domestic models and pose direct competition. The cheapest Russian cars and the cheapest used foreign imports start at around $2,500.

Used car imports have been growing dramatically, analysts say. Various estimates place used car imports from 200,000 to 400,000 last year, up from 195,000 in 2000. More than 60,000 new foreign cars were imported last year

Yulia Zhdanova, an analyst at United Financial Group, expects a 150 percent decrease in used car imports this year if duties are not raised, and a 200 percent decrease if they are. She said that much of last year's growth was the result of speculation that the government was going to raise duties, causing many who had planned to buy a car in 2002 to do so in 2001 instead.

In 2002, growth is not expected to be as dynamic. "That was a one-time effect," she said. Nevertheless, she predicted new car imports would grow by 10 percent regardless of whether import duties are changed.

GAZ has lobbied the government to put up duties on imported foreign automobiles older than seven years, the most accessible to Russian consumers price-wise.

But higher duties don't mean carmakers can rest on their heels, Zhdanova said. "Higher rates will only be beneficial to the industry if carmakers get their act together and use the elbow room they gain to modernize production and come out of the transition period with a line of competitive products," she said.

Road to Recovery

Carmakers have already taken a significant step in their goal to compete with Western cars, paying off mountains of debt to return to financial health.

Ulyanovsk-based UAZ, one of Russia's traditional automakers, owed its creditors a staggering $243 million just last year but is now in the black for the first time in its post-Soviet history.

UAZ began paying off its debts after metals giant Severstal took control of the company and installed new management.

The company was able to start working again with a clean image. UAZ began accepting only cash as payment for its vehicles -- ditching the promissory note payment schemes that have hampered cash flow and prevented development at nearly all of Russia's auto manufacturers.

"When half of the turnover is in barter you can't work with your creditors very well," said UFG's Zhdanova. "When they offered to their creditors to switch to a purely cash system -- instead of giving them cars they would later have to sell -- the creditors were happy to restructure their debt for a longer period of time in order to get real money."

GAZ then restructured its debt with Vneshekonombank and other local banks by using shares as collateral.

Nearly all the auto majors are on their way to better financial health, largely after switching to purely cash payment schemes, Zhdanova said.

No. 1 truck maker KamAZ posted a profit for the first time in its post-Soviet history, netting 42 million rubles. "A small sum," said Ildar Khalikov, KamAZ's vice president of finance.

Last year, KamAZ settled its mountain of debt by giving its creditors equity. A number of banks now own significant stakes in the company: Vneshtorgbank has a 19.4 percent stake, while Sberbank has 2.8 percent and the European Bank for Reconstruction and Development has 6.8 percent.

As before, the federal government is the main shareholder with a 34 percent stake.

"The company has been focusing on restructuring its operation, cleaning up its balance sheet and has moved to purely monetary forms of accepting payment, which is making it more transparent and correcting its figures to reflect its real situation," said Andrei Kormilitsin, an analyst with Troika Dialog.

According to Khalikov, KamAZ's financial health has translated into a soaring stock price, with KamAZ shares rising a whopping 30 percent to $0.435 in the past four months.

"On the securities market, a company's stability and profitability are the main stimulus for activity," he said.

But analysts see a different reason for the rising stock -- the likelihood that KamAZ is about to be bought.

Industry Consolidation

An analyst who declined to be identified named LUKoil and other oil companies -- which have expressed their interest in the auto sector -- as likely buyers for KamAZ.

Oleg Deripaska's metals holding Sibal was another candidate, as controlling KamAZ would give the metals giant a virtual monopoly on truck production, the analyst said.

AvtoVAZ is also rumored to be a takeover target.

The expected new wave of consolidation comes close on the heels of a previous round of takeovers.

SibAl bought up a 14.18 percent stake in GAZ in 2000 through its auto holding Ruspromavto and also has a Stake in Avtobank, which holds a 10.16 percent stake in GAZ. SibAl's exact share in the car giant is unavailable.

Another metals holding, Severstal, headed by Alexei Mordashov, created an automotive wing in 2000 that encompasses UAZ and various parts producers.

AvtoVAZ has seen its shares rise 35 percent in the last three months, presently hovering around $29. But the company says its stock is still undervalued.

Avtovaz will account for most of the 1 percent to 3 percent growth forecast for automobile production this year and is one of the only automakers that is predicting any growth at all

Kim Iskyan, an analyst at Renaissance Capital, said the company was ripe for takeover, naming as possible buyers "the usual suspects" -- SibAl and Severstal.

Unlike GAZ and UAZ, AvtoVAZ is not owned by any major holding, but companies have shown interest in the former Soviet behemoth.

The company is largely owned by shareholders in packages of less than 5 percent, mostly management employees. Boris Berezovsky's LogoVAZ has around 30 percent, and Automobile Finance Corp., an organization controlled by management, has 20 percent.

Foreigners Want In

Metals magnates are not the only ones eyeing Russia's auto sector -- foreign investors have shown an interest as well.

AvtoVAZ has thrown its lot in with General Motors in a $332 million joint venture. The Chevrolet-Niva factory in Tolyatti is almost complete and is expected to produce 8,000 vehicles by the end of this year. The partners are planning to boost production to 100,000 a year.

GM and AvtoVAZ each have a 41.5 percent stake in the project, with the EBRD holding the remaining 17 percent, which it plans to divide evenly between its two partners after about 10 years. The EBRD will provide $100 million in loans and another $40 million in equity.

AvtoVAZ is also looking for $500 million in investment to put out a new Kalina hatchback, which it hopes to roll out by 2006.

Meanwhile, KamAZ is about to finalize a contract with the International Cooperation Bank of Japan, a stop-and-go project that was frozen after the August 1998 financial crisis. The bank has pledged a $150 million credit line to produce engines using Japanese technology from Kanematsu Corp. and Mitsubishi.

"There is a potential for growth in the future if KamAZ finishes up talks with its Japanese creditor ... which will make it possible for the company to modernize its equipment for building engines," said Troika's Kormilitsin. The company should "focus on production in its line of heavy trucks, a very promising niche with a lot of demand in Russia."

Ford is building a plant of its own near St. Petersburg, which is to start producing Focuses by the end of 2002. The company is planning to use mainly foreign parts in producing the model, tapping Russian manufacturers only for rug mats and windshields.

But Russian producers believe that as the industry develops and companies start producing parts to Western standards, foreign carmakers will begin using more locally produced goods.

"[Ford] has made calculations: If they use 80 percent local parts, than the price of the car falls 24 percent, and that's not counting the money they save on import duties," GAZ's Shpakovsky said enthusiastically. "They end up coaxing their traditional suppliers to come over here and open up production facilities. We're talking about clutches, transmission and even engines -- the things that account for the main expenses in an automobile."

When foreign parts makers do hit the market, Russian companies will be able to take advantage of their services and make cars that can compete quality-wise with foreign models, Shpakovsky said.

New Models on Market

Russian automakers currently earn the majority of their revenue from selling models that have not changed significantly in the past 20 years, along with parts to service these "morally outdated" vehicles, as the manufacturers themselves call them.

And while carmakers have pledged to make improvements to compete with the foreign models at the end of the transitional period, the prospects of an auto revolution are slim.

AvtoVAZ, for example, is planning only to restyle its existing models -- not make an entirely new car.

The company is planning to stick to its back-wheel-drive models to avoid investing in a costly new production line.

"We don't want to get rid of our classic models because there is still demand for them," said Vladimir Peresipkinsky, AvtoVAZ's vice president of personnel. "And if we did, a large part of our customers would not be able to afford a car.

"The restyling will push the price up only slightly," he added.

Traditionally thought of as a factory making cars for the rough outdoors, UAZ has plans to restyle its 3160 series jeep into an SUV for the city.

GAZ wants to diversify as well.

"Of course, we would like to expand into other sectors of the market," said Alexei Lipman, head of the GAZ's information department. "We want to create a line of completely new cars smaller than Volgas."

But as with the rest of the industry, any new developments require an injection of capital.

"GAZ is looking for a strategic partner to develop the production lines for a new D-class automobile," he said, using the industry term for compact cars.

To economize, the company employs a strategy of universal components that can be used in a number of its models, making it hard to develop a new line of cars.

"But our universal strategy makes it possible to cut the cost of parts to a minimum and develop new models more quickly," Lipman said.

Not Next-Generation

GAZ has pledged $10 million toward refurbishing its heavier medium-sized truck line.

"By the end of 2002, we will have changed the dashboard, lights, the upholstery and the cabin of our GAZel and Sobol vans, plus we're going to change the car body technology," Lipman said.

GAZ reported production figures of 116,000 last year and estimates it will be making less this year, only 80,000 vehicles.

UAZ ran 40,000 vehicles off the production lines last year, and also expects production to be down by almost a quarter this year to 34,000.