SURVIVING THE CRISIS: THE RUSSIAN AUTOMOBILE

C O N F I D E N T I A L MOSCOW 003669 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR WARLICK E.O. 12958: DECL: 12/18/2018 TAGS: ECON EINV RS SUBJECT: SURVIVING THE CRISIS: THE RUSSIAN AUTOMOBILE INDUSTRY Classified By: Minister Counselor Eric T. Schultz for reasons 1.4 (b, d ) -------------- Summary -------------- ¶1. (C) Russia's deepening economic downturn has severely crippled the automobile sector. Car sales are starting to plummet for foreign and domestic companies alike, with the worst still to come. The slowdown in domestic manufacturing portends large job losses. Prime Minister Putin, who before the crisis intended to make Russian automotive manufacturing a showcase of the country's industrial potential, has included as it as one of the strategic sectors the GOR intends to support with bailout funds. However, while direct government subsidies may stave off massive layoffs, they will not ultimately make Russian cars more competitive vis-a-vis foreign brands. Foreign car manufacturers, including GM and Ford, say they are taking steps to weather the downturn but are counting on major growth in Russian sales when the Russian economy pulls out of its slump. That said, they are concerned that GOR protectionist measures - such as raising tariffs on foreign manufactured automobiles - could outlast the downturn and hurt long-term sales. End summary. -------------- Banks Cut Off Car Financing -------------- ¶2. (C) Until a few months ago, Russia's car market was on its way to becoming Europe's largest, lulling foreign car manufacturers into the belief that Russia was magically "delinked" from the world's economic woes, according to GM Executive Director Heidi McCormack. Enjoying strong brand recognition and phenomenal sales growth, GM opened a new USD 300 million assembly plant in November and Ford was scheduled to open a new line in January 2009. Similarly, Renault, Toyota, and Volkswagen had begun domestic car assembly operations. ¶3. (C) When Russia's cash-strapped banking sector abruptly stopped providing car loans in October, the shock was "like a bird flying into a plate glass window", according to Chrysler Russia CEO John Stech. As the financial crisis unfolded in September and October, the ratio of cash sales to credit sales shifted from 50/50 to 80/20. CEO Vardan Dashtoyan of Moscow's Rolf auto dealership told us that there had been a sense of panic in October among customers "trying to figure out what to do with their savings". ¶4. (C) Car dealers and manufacturers initially expected the Russian middle class, reluctant to hold rubles or dollars, to "invest" more heavily in automobiles and other durables. Foreign car sales in fact peaked in October but then dropped sharply as the crisis deepened, posting their first decline since the end of the Soviet Union in November. Rolf predicted that 2009 sales of foreign cars in would be comparable to 2005 levels, barely allowing the dealership to squeeze out a profit. -------------- Factories Reduce Hours, But No Layoffs -------------- ¶5. (C) Owing to the decrease in sales and available consumer credit for buyers, car companies manufacturing in Russia, domestic and foreign, began to ratchet down production to reduce burgeoning inventories of unsold cars. First hit were Russian concerns. GAZ and KaMAZ (truck manufacturer) went to shorter weeks and closed various lines for short periods, with Renault and Volkswagen following suit. U.S. firms soon followed. Ford, which had initially asserted that it would open its second line in January as scheduled, announced a delay as well as the closure of its first line for a month over the New Year's holidays. AvtoVAZ and GM will also celebrate a lengthy holiday. The former will close for three weeks, sending workers home on reduced wages. GM will close its facilities for two three-week periods and then go to a three-day workweek. None of these firms have reported any actual layoffs to date, though if the downturn persists this seems inevitable. -------------- Putin,s Support of Domestic Manufacturing -------------- ¶6. (SBU) The crisis notwithstanding, Prime Minister Putin has promised money to the domestic auto sector and has listed it as a priority sector of the real economy, largely in an effort to maintain its existing employment levels. However, little financial support from the banking sector has materialized to date. Complaining that current interest rates of 16% for business loans were too high, AvtoVAZ recently suggested that it would pay for its acquisition of Izhavto (a smaller producer) in Lada cars. ¶7. (C) Few doubt, however, that direct government aid will eventually come to the rescue. As Avtomir's (car dealer) Vladimir Petrov told us, much like the Big Three in the U.S., there is strong public pressure not to let the likes of AvtoVAZ or GAZ collapse. Petrov noted that GAZ was less crucial to Nizhniy Novgorod's economy, however, AvtoVAZ was central to Togliatti's. ¶8. (C) Furthermore, Petrov said Putin has always made much of supporting Russia's car industry. Describing it as the country's calling card and an indication of a country's level of technological sophistication and economic competitiveness, Petrov said the Prime Minister has long tried to prop up the sector. These efforts have included incorporating AvtoVAZ (manufacturer of Lada) into Rosoboronexport, a state corporation; creating special economic zones targeted to auto component production; and, imposing protectionist duties and taxes on cars. ¶9. (C) Nonetheless, even extensive government support is unlikely to make Russian cars competitive vis-a-vis foreign manufactures. Even when Russia's car sales market was expanding dramatically, Russian models inexorably lost market share due to poor quality and unreliability, Petrov observed. -------------- Post-Crisis Recovery in Foreign Car Sales? -------------- ¶10. (C) While foreign car manufacturers have had to scale down their ambitions, they realize their product is more competitive than the Russian alternative and hope to increase their market share once the crisis has passed. The immediate problem is how to get through the current crisis. Ford CFO Chris Caulfield told us that the key to surviving the crisis was to ensure the survival of the dealership network, enabling a speedy reboot once money starts to flow again. GM's Heidi McCormack told us that GM would slow hiring and the start up of its new plant in the near term but that the influx of managerial labor on the market would enable GM to "catch up" on its hiring needs later and thus position itself for the recovery. Chrysler's Stech, however, admitted that events were changing so rapidly that his company's plans were being revised every week. ¶11. (C) Weighing heavily on these strategies, however, are Russia's increasingly protectionist trade policies. The recent increase in import duties on foreign manufactured cars, as well as the need for most manufacturers to price in appreciating dollars, has made foreign imports more expensive. (Septel.) While foreign car manufacturers and dealers nevertheless hope that the Russian consumers will not lose their taste for foreign brands, they anticipate some sales losses owing to the increased import duties. -------------- Comment -------------- ¶12. (C) Putin's efforts to jump-start domestic automobile manufacturing -- through protectionist measures (import duties) and direct subsidies -- are unlikely to make Russian cars more competitive, internationally or domestically. More to the point, they are also not likely to mitigate the effects of the downturn on the sector. BEYRLE