UZBEKISTAN: AUTOMOTIVE POWERHOUSE OF CENTRAL ASIA

UNCLAS SECTION 01 OF 04 TASHKENT 002098 SENSITIVE SIPDIS DEPARTMENT FOR SCA/CEN COMMERCE FOR DANICA STARKS E.O. 12958: N/A TAGS: ECON ETRD EIND EINV ELTN BEXP UZ SUBJECT: UZBEKISTAN: AUTOMOTIVE POWERHOUSE OF CENTRAL ASIA ¶1. (SBU) SUMMARY. 2009 has proved to be one of the most difficult in the history of the U.S. auto industry, but in Uzbekistan business is booming as consumers rush to buy new vehicles and traffic has become noticeably heavier. GM-Uzbekistan announced a $124.5 million USD project to produce the new Chevrolet M-300 in addition to its current line, and GM is moving forward with a Powertrain engine and casting plant outside Tashkent. JVs with Isuzu and MAN Nutzfahrzeuge AG are flourishing in Samarkand. ¶2. (SBU) The paradox of the Uzbek automotive miracle has a simple explanation: strong government support combined with strong domestic demand. The automotive industry is the government's official showcase illustrating the success of its import substitution, export-oriented industrialization policy. Although exports of Uzbek automobiles have dropped by half since the onset of the world financial crisis, the GOU compensated by allowing increased domestic sales for hard currency. In the long term, continuation of the Uzbek automotive miracle will depend on greater efficiency, greater local value-added, and a new generation of trained automotive engineers. END SUMMARY INDUSTRY OVERVIEW -------------- ¶3. (SBU) Uzbekistan's automotive industry is the largest in Central Asia. GM-Uzbekistan, a joint venture (JV) with General Motors, has two manufacturing/assembly plants, one in Asaka (Fergana Valley) and one in Tashkent, with a combined annual capacity of 250,000 passenger cars. (NOTE: The Asaka plant assembles the Matiz, Nexia, and Lacetti passenger cars. A smaller plant on the grounds of the Tashkent Aviation Production Association assembles the Chevrolet Epica and Captiva.) In a separate venture begun this year, GM is building an engine and casting plant near Tashkent that will have an annual capacity of 360,000 engines. Two JVs with Japanese ISUZU and German MAN Nutzfahrzeuge AG for production of commercial vehicles are in operation in Samarkand. More than 60 domestic companies and JVs produce more than 800 types of automobile parts and components. By some estimates the automotive sector provides 20,000 jobs in the country. ¶4. (SBU) The following factors have driven the growth of the Uzbek auto industry: - Duty-free access to neighboring markets -- in particular Russia -- under the CIS free trade agreement; - Stable demand in the domestic market, the largest in the region, which is protected by high import tariffs that effectively keep non-CIS auto manufacturers out (NOTE: Russian auto manufacturers are blocked in a different manner, as will be explained shortly.); - Strong government support, which includes not only a wide range of preferences but also financing of a large part of the cost of foreign investors' doing business in the country (e.g., co-financing, soft local loans, guarantees for foreign loans, tax holidays, and access to foreign exchange); - Industrial infrastructure inherited from Soviet times and low-cost labor resources. IN THE BEGINNING -------------- TASHKENT 00002098 002 OF 004 ¶5. (SBU) Shortly after declaring independence in 1991, the GOU chose an import substitution policy and export oriented industrialization as its route to economic development. The government identified priority industrial sectors in which most firms would remain wholly or partly state-owned. A system of multiple exchange rates -- later abolished but replaced by limits on access to foreign exchange -- acted as an effective tax on non-favored sectors. These and other taxes served to divert resources to favored industries. ¶6. (SBU) The automotive industry has been a high priority from the beginning. The industry was born in 1992, when the GOU and the Korean Daewoo Corporation established a 50/50 JV named Uz-Daewoo Auto. The government created exclusive, protected conditions in the domestic market for this JV, exempting it from all taxes for 10 years, guaranteeing all foreign loans, and giving $250 million USD as government investments and soft loans. The GOU granted similar preferences to all foreign investors in the automotive sector, including producers of commercial vehicles, automotive parts, and auto components. ¶7. (SBU) Uzbekistan also provided duty-free access to the growing Russian market as a member of CIS free trade agreement. At the same time, prohibitively high duties were imposed on imports of new and used cars from outside the CIS. This protectionist policy forced most non-CIS brand dealers to suspend operations in the country, and severe limits on currency conversion have effectively blocked Russian brands from the market. (NOTE: The Russian Trade Representative in Tashkent has gone so far as to approach the American Chamber of Commerce on behalf of Lada dealerships for advice on how to speed the conversion of soum to hard currency.) Uz-Daewoo focused its marketing on the export market, and growing demand in Russia consumed most of the cars produced in Uzbekistan. ¶8. (SBU) Later, in 1999, Uzbekistan stepped further into the automotive industry when it formed a JV with the Turkish Koch Group in Samarkand. Named Sam-Koc Auto, the new JV produced medium trucks and small busses. GROWING PAINS -------------- ¶9. (SBU) In the early 2000s the Uzbek auto industry had to contend with the bankruptcy of Daewoo in Korea. Daewoo's post-restructuring management turned its back on Uzbekistan and told Uz-Daewoo to come up with its own self-rescue plan. The GOU reacted by nationalizing Uz-Daewoo and by building its relationship with Daewoo's new owner GM on a purchase contract basis. In other words, Uzbekistan changed its role from that of investment recipient to that of a large importer and assembler of car kits and related parts. Furthermore, the GOU invested an additional $255 million USD of its own money into plant modernization. ¶10. (SBU) It was clear that the company needed a new foreign partner to maintain the technical and engineering capabilities at the needed level. (NOTE: Daewoo had provided most of the senior technical staff, while local employees had done the more routine manufacturing tasks.) The company needed technical assistance and access to updated technologies in light of greater competition and the external market's increasing technical and safety standards. Uzbek officials actively courted GM to replace Daewoo as its JV partner, but at first GM was not interested. GM had its own plants in Russia, the primary market for Uzbek cars, and did not want to compete against itself. Only when the GOU began negotiations with Hyundai did GM agree to become a minority stakeholder in what was renamed GM-Uzbekistan, in which GM holds 25 percent of the shares and the GOU holds 75 percent. TASHKENT 00002098 003 OF 004 ¶11. (SBU) Uzbekistan's venture in small trucks and busses experienced a similar crisis when the Turkish Koch Group pulled out in 2006. In this case the GOU turned to the Japanese Isuzu Motors Company. In 2007 it concluded a technical assistance agreement with Isuzu, which later became its new JV partner after buying 8 percent of company's shares. The company was re-named Sam-Auto. In 2009 the government managed to attract yet another foreign company, German MAN Nutzfahrzeuge AG, to partner with it to produce busses and trucks at the Sam-Auto factory. GLOBAL FINANCIAL CRISIS -------------- ¶12. (SBU) In 2008-09 the Uzbek auto industry faced a new challenge as exports fell by half due to low external demand brought on by the global financial crisis. (NOTE: Sales in Russia of the GM-Uzbekistan Nexia and Matiz fell by 50 and 52 percent, respectively, in the first ten months of 2009, and sales could fall still further if Russia takes measures to protect its own auto industry.) The GOU responded aggressively by increasing financial support in the form of loans and tax holidays, guaranteeing payments to external and internal suppliers, providing soft loans to foreign dealers, and allowing domestic sales of the most popular models for hard currency only, thereby creating its own domestic export market. ¶13. (SBU) The steps taken by the GOU have given positive results. A dozen new companies including eight JVs for production of auto parts and components were established this year. Despite difficulties in other markets, GM announced the beginning of a $124.5 million USD project to produce the new Chevrolet M-300 city car model in its GM-Uzbekistan JV, and it is moving forward with construction of the power-train plant near Tashkent. Eight new JVs, mainly with Korean manufacturers, were established to produce parts and components for GM-Uzbekistan. ¶14. (SBU) Unlike in much of the rest of the world, the global financial crisis has been a boon for the Uzbek auto consumer. In early 2008, auto dealerships in Tashkent were empty, but by mid-2009 they were full not only in Tashkent but in the regions. New cars, in particular the popular 3-cylinder Matiz that sells for roughly $7000 USD, are everywhere. Even young people are buying cars as families pool resources to make the purchase. The black market for currency conversion that has taken on new life over the past year was undoubtedly fueled in part by Uzbek consumers converting soum to dollars to make their automotive dream a reality. (NOTE: A few less-in-demand models can be purchased for soum, but such purchases usually require payment of hard currency "service fee.") INEFFICIENCY: A HIDDEN PROBLEM FOR THE FUTURE -------------- - ¶15. (SBU) Despite its visible successes, the Uzbek auto industry is plagued by inefficiency, a weakness the GOU chooses to ignore. Although foreign partners frequently express appreciation for the GOU's strong support to the automotive sector, a closer look shows they are more interested in their own profit than committed to assembling automobile products in Uzbekistan. The volume of direct foreign investment is negligible in comparison with sales income, which since 2002 has averaged $500-600 million USD annually. Much of the technology at the JV plants in Uzbekistan is overvalued and out of date; even the new GM Powertrain facility will be building engines that fail to meet the advanced emission standards observed by the EU, Japan, and some U.S. states. There is little local value added during the production process, certainly less than 10 percent for engines; even seats are built from kits shipped from Korea. Uzbek industry is not able to provide many basic materials and equipment, not to mention engineering and equipment maintenance services. All of these are imported from abroad, and thus the TASHKENT 00002098 004 OF 004 GM-Uzbekistan and Sam-Auto factories are little more than assembly plants. To date there has been little to no foreign investment in the after-sale services market. ¶16. (SBU) Inefficiency is also manifest in the Soviet-style centralized management exercised by government bodies. There is no competition between local vendors, a fact that would be seen as a disadvantage in any other country but is looked on as a positive in Uzbekistan. All prices are regulated by the GOU. Credits and budget funds are allocated administratively, much as they were in Soviet times. In addition to being inefficient, this helps to fuel corruption as unofficial paybacks and "reimbursements" to government officials are seen as part of the cost of doing business. ¶17. (SBU) Finally, the auto industry suffers from a serious shortage of qualified managers and engineers. The GOU has insisted that foreign partners bring not only investment but also educational opportunities. A prime example of this is the new Tashkent branch of the University of Torino, which was brought to Uzbekistan under the umbrella of the GM-Uzbekistan JV specifically to train engineers to work in the automotive sector. COMMENT -------------- ¶18. (SBU) The automotive industry is the GOU's official showcase illustrating the success of its import substitution, export oriented industrialization policy. Uzbekistan can rightly make this claim, as cars bearing the "Made in Uzbekistan" label have come to occupy a solid position for economy cars in Russia and other export markets. The GOU's direct financial support and use of administrative mechanisms have to a great degree compensated for market challenges and internal weaknesses, particularly during the current global financial crisis. There is every reason to believe that Uzbekistan will continue in its role as the automotive powerhouse of Central Asia. It will flourish even more so if it can remove systemic inefficiencies and evolve a more value-added manufacturing capability. ¶19. (SBU) But past experience shows the GOU can be fickle in its choice of foreign partners. Newmont Mining and Coca-Cola are just two examples. Recently the GOU failed to provide a large payment to GM at the scheduled time, and senior GM management has had to come to Tashkent frequently to keep the relationship on a sound footing. In the months and years to come, the GM-GOU relationship will be the barometer by which other U.S. corporations judge whether they should come to Uzbekistan. BUTCHER