St. Petersburg Automobile Industry Crashes

Valentina Matvienko, the Governor of the Leningrad Region, long dreamed of turning the city of St. Petersburg into a major production center for the Russian automotive industry. As a result of her administration’s concerted campaign to woo the world’s major automobile manufacturers, the Venice of the North seemed by 2009 well on the way to re-making itself as the Detroit of Russia.

Now the worldwide economic crisis may have driven those dreams off a cliff. And as with all questions of foreign import and export activity, the Russian Federal Customs Service was along for the ride. First, some background.

Russia’s appetite for foreign automobiles has been one of the most stable features of its economy since the fall of the Soviet Union. What Russian doesn’t love a fast ride? – goes the proverb; and throughout wrenching currency reforms, defaults, booms and busts of the past 20 years, Russians have bought and imported foreign cars in vast quantities.

However, importing new and used cars has always been fraught with difficulties – the general inefficiency of the Russian transportation system and its capricious tariff policies add hidden transaction costs, and the Russian government long wanted the prestige of partnerships with the world’s major auto manufacturers. General Motors made a few tentative inroads into opening a plant in Togliatti, on the Volga River, back in the 1990s. The much heralded “Russian-built” Blazers were actually knock-down kits from Brazil, imported in shipping containers and put together on site by Russian workers, or fully-built cars needing only to have the bumpers bolted on and mirrors bolted on to earn the “manufactured in Russia” imprimatur.

The market really began to turn around after Vladimir Putin took over as President in 2000. Rising oil prices stabilized the Russian economy and put spare cash in people’s pockets. Local Russian production became attractive to the world’s auto majors. Ford Motor Corporation was the first to strike; by 2009, Ford, Toyota, Nissan, Honda, Hyundai and General Motors are among the major automobile manufacturers with a significant presence in St. Petersburg. The Ford plant in Shushary is one of the first ‘landmarks’ a visitor sees along the road into the city from Pulkovo Airport.

All foreign automobile manufacturers in Russia operate in the same basic way. They produce certain models in Russia – generally, affordable ones such as the Ford Focus – employing local labor and a certain percentage of Russian-produced parts, in exchange for relief of taxes and customs duties. Ford, for example, set its initial contract for Russian production for a 50% Russian-parts content by 2007. Other manufacturers cut deals allowing them longer holidays.

The manufacturers import other models – generally, more expensive ones – directly into Russia to complement brand selection. Manufacturers ship cars in shipping containers or on roll-on, roll-off vessels to Finland, and then arrange to dray or rail them to dealerships in Russia. Private citizens purchasing automobiles generally do this through a series of middlemen; these cars go either directly into Russian ports or into the Baltics, where the buyer takes care duties and customs clearance.

Overall, the Russian automobile market was, until the beginning of 2009, remarkably vigorous. Experts quoted on the website www.just-auto.com, in June 2008 predicted that Russia would produce 4 million new cars per year by 2012, surpassing even Germany as Europe’s main automobile manufacturer.

Now that prediction is in the ditch. Nationwide, Russian automobile manufacturing now is down almost 70% compared to 2008. At the beginning of the year, the Russian government introduced new tariffs on imported cars and prices rose up to 40% for some models. Anticipating the new tariffs, St. Petersburg auto majors Toyota and General Motors ramped up local production of popular models including the Captiva and Camry, and January and February pumped out 80% more cars than in the same period in 2008.

This number does not, however, reflect increased demand; many 2008 models remain unsold, in stock, and production fell off sharply in March and April. Toyota halted its production lines altogether from March 30 through April 6 to cope with falling demand, although it is now working normal hours. Ford has had a series of labor disputes with the local union over wages and hours as falling demand threatens their plant with layoffs.

Dealerships throughout St. Petersburg are closing as demand wanes, and there seems to be no end in sight. The European Business Association reports that sales of new imported cars in Russia for January and February 2009 fell on average by 36%. The biggest losers were Mitsubishi, at 64%, Hyundai at 49%, Suzuki and Land Rover at 42%, Opel and Renault at 39%, Nissan and Toyota at 37%, and Ford at 22%.

The Russian transportation system is in general so fragile, and so laden with inefficiencies and illogic, that the result of virtually any disruption is congestion to the system. If it is true that when the American economy sneezes, then the world catches a cold, then sclerotic Russia is flat on its back with viral pneumonia about now. Reserve lots in Finland are backed up with unsold cars earmarked for Russian buyers – many analysts say there is at least a six-month inventory at some locations. The crisis affects Finnish ports such as Kotka and Hamina, whose bread and butter servicing transit cargo to Russia, most of it automobiles. They report overall import volumes down by at least 20% since the New Year.

Russia insists on itself as a special case in the automobile industry, with needs to support indigenous automobile manufacturers while encouraging gradual growth in foreign production. Prime Minister Putin’s recently bailed out the Tolyatti Auto Works in Samara, not out of love for the Lada or to support the criminal gangs reputedly infesting the plant, but to ensure social stability. A few billion rubles keep a lot of disgruntled workers off the streets.

At the same time, the recent increase in tariffs on imported automobiles is hard to understand. Some St. Petersburg buyers found themselves faced with a stiff price increase on vehicles they already bought but that had not landed in Russia before the tariff increase. Russians overwhelmingly prefer foreign made vehicles to Russian made ones in any case – and maybe this would be an opportune time to bring in more foreign manufacturing, while the ruble is cheap.

Russia, however, is nothing if not contradictory. It wants the auto majors but is not willing to do what it takes, to make them feel secure about their future in Russia. As www.just-auto.com reported, major automobile manufacturers in Russia are concerned most about lack of infrastructure, customs regulations and low worker productivity. Add in the recent protectionist tariff policy and the economic outlook gets cloudier, not clearer.

As I mentioned earlier, the Federal Customs Service may not have driven the auto market over the cliff in Russia, but it was certainly along for the ride. In 2006, Customs revoked the duty free status on about 10,000 Focus automobiles, claiming that they did not have sufficient local content, and hit Ford with a $25 million dollar bill. Shipments of spare parts get held up in the port of St. Petersburg for long and tedious customs inspections, impacting the supply chain and hurting plant productivity at Shushary.

Even arranging for a green-corridor regime of minimal inspections entailed Ford going to work with a special dedicated Customs broker. This broker gets paid rates of up to $2000 per container shipment – a number, not surprisingly, near the amount that Business Transparency International cites as the average amount of a bribe to clear a shipment through Russian Customs.