The many Mercedes cars now cruising the streets of Moscow are one of the most potent symbols of Russia’s dramatic transition from bankrupt communism to Western consumerism. Yet when it came to building a Mercedes plant in the country, its parent company Daimler dithered.
Former executive board member Klaus Mangold made a promise to build such a factory in 2000, when he became chairman of the Committee on Eastern European Economic Relations. But by the time Mr. Mangold stepped down from the committee position in 2010, competitor BMW already had an auto assembly plant in Russia, while Daimler was still hesitating.
But now the company is on the verge of building an assembly plant in the country, Handelsblatt has learned from industry insiders.
It has apparently been decided already that the plant will be built in the Moscow vicinity, for a total investment of about €200 million ($224 million). Daimler is pinning its hopes on the East, despite an ongoing sales crisis in the Russian market.
The Russian ruble, traditionally closely tied to changes in the oil price, has lost about half of its value against the U.S. dollar and the euro since the summer of 2014.
Russia would have liked to announce Daimler’s plans at the International Economic Forum in President Vladimir Putin’s native St. Petersburg this week. But a number of details have yet to be ironed out. Daimler is in talks with Russian officials “to examine whether the basic economic conditions exist for a local automobile production plant,” said a Daimler spokeswoman. A spokesman for the Russian industry ministry said that the process is underway.
Apparently Daimler plans to build a so-called CKD assembly plant, where cars are assembled from imported kits. Although the planned capacity of up to 30,000 vehicles a year is still modest by Daimler standards, it is an act of faith, the message being that Russia is still a market with a future, despite its economic crisis.
The situation is serious, and not just because of the sanctions imposed by the West in 2014 over the violent annexation of Crimea. Russia’s gross domestic product declined by 3.8 percent in 2015, and a further decline of 1 to 2 percent is expected this year. The biggest strain on the economy is the oil price, which has declined from a high of more than $110 (€98) a barrel in 2014 to as low as $30.
But not all businesses are doing badly in Russia. Continental’s tire factory in Kaluga, with about 1,000 employees, is in full swing. The plant produced 3 million tires in 2015, and the company plans to expand capacity by 2018, provided the market develops accordingly. The plant’s entire production was originally intended for the Russian market.
But when Russian consumers cut back on new car purchases and tire replacements during the economic crisis, the company shifted some of its production to exports, said Jaron Wiedmaier, the general director of Continental Tires RUS. “Suddenly the Russian ruble was so weak that it paid to export tires from Russia.” A third of the tires produced at Kaluga are now exported – not just to countries that were once part of the Soviet Union, but also to Western and Northern Europe.
The Russian ruble, traditionally closely tied to changes in the oil price, has lost about half of its value against the U.S. dollar and the euro since the summer of 2014. This was accompanied by year-on-year, double-digit inflation and the population losing more than 10 percent of its real purchasing power. Consumption-oriented sectors such as retail, as well as automobile manufacturing, have been particularly hard-hit.
Now the advantages of the weak ruble are emerging. “Labor has become cheaper in Russia than in China,” said Michail Matownikow, chief analyst at Sberbank, a Moscow-based bank. When the ruble reached its lowest point at the beginning of the year, the average monthly income in Russia had fallen to $433, which was lower than the average income in China.
Using the Chinese growth model, the Russian economics ministry has presented a scenario that includes limits on wages and pensions to stimulate economic growth. Under the scenario, if the oil price does not recover significantly and for the long term, real income will decline by another 2.8 percent this year and 0.3 percent in 2017. As compensation, investments in Russia are expected to increase again. The hope is that GDP will increase by 4.5 percent by 2019. When that happens, wages can be increased again.
The Kremlin plans to provide foreign investors, such as Daimler, with benefits through special investment agreements. Daimler is also expected to receive subsidies and locational advantages from the Russian Federation and at the Moscow regional level. The Western sanctions against Russia do not apply to investments in the automobile sector. They only affect the financing of state-owned banks on a “black list” and a few state-controlled companies, as well as the supply of high technology in the areas of offshore technology for the oil and gas industry.
But Daimler also has other strong incentives to build its own plant. There is great pressure on foreign companies to manufacture products in Russia. Otherwise, market access becomes far more difficult.
The Kremlin’s official policy is the strategy of import substitution, or substituting domestic products for imports. Under the policy, foreign goods are only to be purchased by state-owned companies or government agencies, and only after localization has occurred. In 2014, Daimler and Fiat-Chrysler were excluded from requests for quotations by the Kremlin vehicle fleet administration, because the companies were not producing in Russia.
Times are currently tough for German carmakers with footholds in the Russian market. Overall car sales in Russia declined by almost 15 percent between January and May this year to 548,119 vehicles. Mercedes sold only 15,830 cars during the same period – 17 percent less than in the same time period the previous year, when sales were down 15 percent.
Meanwhile, BMW sales went down 23 percent last year, to 27,486 new cars, while Audi saw a fall of 25 percent and Porsche 12 percent. VW announced a downturn in sales of 39 percent, bringing the number of cars sold down to 78,390. Opel, owned by General Motors, completely stepped down from its business in Russia.
For Daimler, building its own plant in Russia would not only mean the elimination of large portions of import duties, but also renewed market access to the Kremlin vehicle fleet and the fleets of Gazprom, Rosneft and other state-controlled behemoths.
Wolfgang Büchele, chairman of the Committee on Eastern European Economic Relations, criticized the growing pressure on foreign providers. “More German companies are now willing to build production plants in Russia again,” he said. But that should mean that German subsidiaries should also have the same market access as Russian companies, he added.
The Chinese concept of ultimately stimulating investment through low real wages isn’t the only thing currently vying for Mr. Putin’s approval. As the new head of the Center for Strategic Research, former Finance Minister Alexej Kudrin is calling for institutional reforms, fiscal discipline to stabilize the ruble and less government intervention in economic affairs.
However, he was already put in his place for calling for an easing of tension to soften the sanctions when Mr. Putin said that Russia would not give up its sovereignty. Now a third group is holding out hope that its concept will be implemented. The Stolypin Club, headed by government business ombudsman Boris Titov, is calling for strong government spending instead of austerity to revive the economy.
Mr. Putin has not decided on a concept yet. But even if the World Bank predicts slight growth for the Russian economy next year, it will still fall far short of the self-imposed target of 4 percent growth. But that level of growth is necessary if Russia hopes to catch up with other industrialized nations.
André Ballin is Handelsblatt’s correspondent in Moscow. Mathias Brüggmann is the head of Handelsblatt’s foreign affairs desk. Markus Fasse covers the aviation and automobile industry. To contact the authors: firstname.lastname@example.org, email@example.com, firstname.lastname@example.org