RUSSIAN PHARMACEUTICALS MARKET TAKES OFF (C-TN7-00763,

UNCLAS SECTION 01 OF 03 MOSCOW 004043 SIPDIS SENSITIVE SIPDIS DEPARTMENT FOR OES/IHA AND EUR/RUS USAID FOR GH, E&E HHS FOR OGHA E.O. 12958: N/A TAGS: TBIO ETRD EINV EIND RS SUBJECT: RUSSIAN PHARMACEUTICALS MARKET TAKES OFF (C-TN7-00763, C-TN7-00791) REF: A. Moscow 976 ¶B. 06 Moscow 12814 MOSCOW 00004043 001.2 OF 003 THIS CABLE IS SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY ¶1. (SBU) SUMMARY: Russia's pharmaceuticals market has grown by leaps and bounds in the last three years, and experts predict continued robust growth in the short term in almost all major market segments. Foreign firms continue to dominate the market and account for an estimated 75-80 percent of all sales. The GOR wants to reorganize the domestic industry to compete more effectively, because it views the dependence on foreign firms as a long-term national security risk and as one factor that has led to the development of a large counterfeit drugs market. International firms argue that there is no link between foreign market dominance and the counterfeit drugs market, noting that the bulk of counterfeits are domestically produced. Even so, some foreign firms are beginning to realize that an investment in domestic production would not only be profitable, but also help ensure a continuing long-term market share in Russia. However, it is likely that European drug makers will be more interested than U.S. firms in investing in existing Russian plants or in building production facilities from scratch. END SUMMARY. -------------- Pharmaceuticals Market Growing Astronomically -------------- ¶2. (SBU) Russia's pharmaceutical market has seen some of the fastest growth in the world over the last three years and is expected to continue humming along in coming years. In 2006, the pharmaceutical market was worth $10.7 billion, according to market analysts, up 27.4 percent from 2005, when sales grew by 35 percent compared to ¶2004. Over the counter (OTC) drug sales accounted for 53 percent of total sales in 2006. The head of Russian operations at one U.S. pharmaceutical company told us he expects sales growth of 25-30 percent in 2007 in the OTC segment and growth of 20-25 percent in prescription drug sales. The Russian Government is the largest single buyer, accounting for 47 percent of total sales through drug tenders, subsidies to hospitals, and the federal drug benefits program. ¶3. (SBU) Despite the impressive growth prospects in almost all 
segments of the market, the government's drugs benefit program for social welfare beneficiaries has been a drag on growth in 2007. The program, which is known as the Additional Drug Supply or "DLO," was plagued by deficit spending and distribution problems in late 2006 and early 2007 (reftels). Some foreign firms tell us they are still waiting to be fully paid for drugs they supplied under the program in 2006. Market analysts estimate the DLO accounted for at least 10 percent of total sales in 2006. ¶4. (SBU) Sales of imported drugs have actually declined 17 percent during the first five months of 2007 compared to the same period in 2006, according to the market analysis firm DSM Group. Most observers believe the decline reflects continuing problems with the DLO, which will act as a drag on sales growth throughout 2007. Full year sales in 2007 are expected to increase by only 10-12 percent over 2006. French drug-maker Servier's sales reportedly declined by 27 percent during the first five months of 2007, while British firm GlaxoSmithKline's sales dropped by 33 percent, probably because a greater portion of their sales were made through the DLO. ¶5. (SBU) Many industry contacts expect the DLO will continue to have problems in 2008, because of the potential for chaos when the federal government transfers procurement authority for part of the program from the federal to the regional level in the fall of 2007. Despite the program's difficulties, the DLO could account for as much as 20-25 percent of total drug sales in 2008 as the government expands the program to provide benefits both for chronic patients who need expensive drugs or long term medication (primarily hemophiliacs, leukemia patients, and diabetics),and for pensioners, veterans, and the needy. -------------- - Foreign Market Domination Worries the Russians -------------- - ¶6. (SBU) Foreign firms maintain a firm grip on the Russian market and account for 75-80 percent of total sales, according to industry contacts and market watchers. (NOTE: While President Putin stated at a March Cabinet meeting his displeasure that foreign firms MOSCOW 00004043 002.2 OF 003 control nearly "90 percent" of the Russian drugs market, Deputy Health and Social Development Minister Starodubov has since stated that foreign producers actually control slightly less than 80 percent of the market. END NOTE.) The current dominance of foreign producers represents a gradual decline in the fortunes of domestic producers, who controlled 60 percent of the market in 1991 as the Soviet Union and Warsaw Pact began to disintegrate. ¶7. (SBU) With such a large percentage of sales going to foreign firms, the Russian government is attempting to reform the portion of the domestic market controlled by the state. The Kremlin sees Russia's dependence on foreign drug suppliers as a long-term national security threat and would like to establish a strong, integrated domestic pharmaceutical production system. By the end of 2007, the Russian Agency for Industry (Rosprom) reportedly hopes to establish a pharmaceuticals holding company, which would control five state-owned production facilities and nine research institutes. The government has been short on the specifics of how this reorganization would work. However, up to half of the shares in the new holding company could reportedly be sold to foreign drug companies, probably to take advantage of their technical expertise in good manufacturing practices. ¶8. (SBU) By increasing the competitiveness and capacity of domestic drug companies, the GOR believes that Russia will achieve a more stable and secure supply base, increase drug safety, and achieve cheaper prices for consumers. Moscow Mayor Luzhkov has also long wanted to promote the city of Moscow and the surrounding region as a prime location for large-scale drug production. The most difficult obstacle for Russian firms to overcome will likely be the poor quality standards of domestic firms, few of which currently comply with good manufacturing practices or other international norms for drug production. -------------- -------------- Will Foreign Firms Invest in Russian Drug Production? -------------- -------------- ¶9. (SBU) Historically, few international pharmaceutical firms were interested in investing in domestic drug production in Russia. According to our contacts, this was partly because of a generally cautious approach among drug company boards towards investments in Russia and the lack of a clear economic advantage to domestic production versus importing. However, there are growing signs this conservatism is beginning to change. One industry representative told us that the recent tremendous growth in drug sales and the concomitant strong growth in fast moving consumer goods (e.g., toiletries, soaps, cosmetics, toothpaste, shaving needs, and detergents) are both persuasive signs that Russians in the coming years will begin spending lots of money on OTC and prescription drugs. ¶10. (U) Servier, the second largest French pharmaceutical company, became the first big drug company to establish domestic production in Russia in early July with a 40 million Euro investment in the construction of an 11,500 square meter full cycle pharmaceutical plant near Podolsk in Moscow Oblast. Servier is the largest seller of prescription drugs in Russia and the third biggest drug company in Russia in terms of overall sales. Servier's Russian plant will produce 20 drugs for the treatment of diabetes, cancer, cardio-vascular and nervous system diseases. Production will start by the end of 2007 with an annual capacity of 60 million pills and will reach 4.5 billion pills per year by 2011. ¶11. (SBU) German drug-maker Stada purchased one Russian pharmaceutical firm in 2005 and is now in the process of acquiring a second, Makiz-Pharma, for a reported 135 million Euros, which would be the largest-ever foreign acquisition of a Russian drug company. Pfizer announced in late July it is also considering opening its own plant in Russia, or acquiring and revamping an existing facility, though the company has not made any final decision yet. Foreign manufactures are likely thinking that a domestic presence will allow them to increase both overall sales and sales to the government through the DLO and other tenders. Other foreign firms, such as Johnson and Johnson and GlaxoSmithKline, have established joint ventures with local firms to manufacture HIV/AIDS drugs and some seasonal flu and hepatitis vaccines. Industry contacts tell us the GOR has not offered any concrete incentives like tax breaks for establishing domestic production, but locally manufactured drugs do enjoy a preference in government tenders. ¶12. (U) Some international banks have also been attracted by the pharmaceutical market's impressive growth and have been willing to MOSCOW 00004043 003.2 OF 003 back innovative financial mechanisms to support the industry. Financing in the pharmaceuticals industry is generally on standard commercial terms. However, 36.6, Russia's largest drug store chain, has financed its expansion by selling for $85 million a nearly 25 percent stake in its pharmaceuticals manufacturing subsidiary, Veropharm, to a consortium of international banks led by the South African-based Standard Bank. Separately, 36.6 has been looking for a buyer for Veropharm, and GlaxoSmithKline is reportedly the main interested suitor. Whoever ultimately buys Veropharm will pay off the international bank syndicate or retain them as a minority partner. Later this year, 36.6 is also expected to become the first Russian firm to issue short-term commercial paper (a novelty in Russia) to fund its operations. -------------- Fake Drugs Spark Controversy -------------- ¶13. (SBU) Experts estimate that sales of counterfeit drugs in Russia are at least $200-$300 million per year, with some 70 percent of fake drugs being produced domestically. Foreign pharmaceutical companies have argued that more rigorous domestic enforcement and stiffer penalties for "pharma-pirates" could help control the problem. Government officials counter that establishing a stronger domestic industry and eroding the dominant position of foreign firms will allow the government to weed out counterfeit production, claiming that the higher prices for imported drugs act as a profit incentive for pirates to enter the counterfeit market. In a February 2006 speech to prosecutors, President Putin stated that "the trade in counterfeit medicines is a real threat to our nation's health, and the distribution of counterfeit products without a doubt discredits Russia as a reliable business partner." ¶14. (SBU) In a highly publicized counterfeiting case in 2006, a Moscow court fined domestic drug company Bryntsalov-A 40,000 rubles ($1,500) for the improper storage of drugs at its facilities. This was a lesser offense than counterfeiting, with which Brynstalov was also charged. The court found there was insufficient evidence of actual counterfeiting by Bryntsalov, and it also stopped short of revoking the company's manufacturing license, as foreign pharmaceutical firms had demanded. The decision was widely regarded as a completely inadequate punishment for a company that Western drug makers estimated had sold at least $30 million worth of counterfeit drugs in the Russian market, including about $1.5 million in sales of fake bottles of Bayer aspirin. The company is owned by Vladimir Bryntsalov, a former Duma Deputy and former presidential candidate, and is still mired in other criminal investigations. Tatyana Brynstalov (Vladimir's sister) and several other company managers currently stand accused of illegally selling alcoholic beverages as a medicine in order to avoid paying the excise tax on spirits. ¶15. (SBU) COMMENT: Despite strong market growth in Russia, we believe many American drug companies will take a conservative approach in the near term and prefer investing in other BRIC countries such as India and China. As the Russian office head of one U.S. drug company told us, "The Americans are aggressive in China, while the Europeans are aggressive in Russia." RUSSELL