New Procedure for Auto Parts Imports

A new customs procedure for the industrial assembly of automobiles will come into effect in Russia at the end of the month. The Ministries of Industry and Energy and of Economic Development and Trade are hoping that this will attract foreign auto part makers to Russia. However, even the developers of the new procedure acknowledge that there is no guarantee of fast development in that industry.

Expansion of Assembly

Industry and Energy Minister Viktor Khristenko stated last month that “a new page has been opened” in the history of the Russian auto industry. Previously, the Ministries of Industry and Energy and of Economic Development and Trade had only signed investment agreements on the construction of production facilities with foreign carmakers (Nissan, Toyota, Volkswagen and General Motors among them). Now, however, those ministries intend to attract car part makers to Russia. With that purpose in mind, a trilateral order has been issued by the Ministries of Industry and Energy, of Economic Development and Trade and of Finance to expand the list of car parts for industrial assembly that can be imported into Russia at a reduced customs duty (0-5 percent). The additions to the list are components for the assembly of hi-tech automobile systems (the motor, transmission and drive axle) as well as for the assembly of simpler parts (seats, upholstery, radiators, electrical parts, etc.).

The order is expected to be registered with the Justice Ministry and to go into effect in the near future. A copy of the order obtained by Kommersant indicates that investors can import parts for the assembly of larger components under the industrial assembly procedure if they sign an investment agreement with the Economics Ministry. Producers of hi-tech auto components will have the right to reduced import duties for seven years. Producers of other types of components will receive that right for five years. All producers will be required to reduce the quantity of the parts they import for assemble by a third within three years of when the investment agreement comes into force. Ten percent of the reduction should be undertaken within the first year and a half and 20 percent of it within the two and a half years. The producers will choose how to reduce imports. They can begin making the parts in Russia, buy them from Russian suppliers or continue to import them and pay full customs duties.

Parts of a Whole

Khristenko noted that KamAZ will be the first automaker to take advantage of the new industrial assembly procedure. There are two joint ventures with foreigners at that plant. They are ZF-KAMA, a partnership with the German Zahnrad Fabrik that makes transmissions for trucks, and a joint venture with the American Cummins Inc. that makes engines for small and medium-size trucks.

Two makers of automobile seats have expressed their interest in the new procedure as well. They are the joint venture between the SOK Group and the Slovenian TPV Group, which supplies AvtoVAZ, and Sotex Co. of Nizhny Novgorod, which will make seats for Severstal-Avto to install in the SsangYong off-road vehicles it assembles. The Economics Ministry will receive and approve their applications to take advantage of the new procedure after it is registered with the Justice Ministry.

A number of parts makers have expressed their willingness to open productions independently to operate under the industrial assembly procedure. The Austrian company Magnus Steyr will build a plant in St. Petersburg to make plastic details for car interiors, bodies and transmissions for Nissan and GM. Toyota subsidiary Toyota Boshoku will follow its parent to St. Petersburg to make car seats.

Last week, Siemens VDO Automotive AG announced its purchase of a controlling package in the Avtoeletronika and Avtel companies in Kaluga Region. They make fuel injectors and electronic control systems that they will supply to the VW plant that is being built in that region. ZF and Bosch intend to set up production in Togliatti of fuel system and transmission parts for use by AvtoVAZ. St. Petersburg Governor Valentina Matvienko mentioned that another large auto parts maker will come to that city before the end of the year. Kommersant has learned that that may be the Japanese Denso, which supplies Toyota. The Economics Ministry says that it is negotiating with several more companies, including the German Vierol.

Increasing Complexity

In spite of the impressive list of potential projects, officials admit that the order will not necessarily mean fast or large-scale development of the auto parts industry. Dmitry Levchenkov, deputy head of the Economics Ministry investment department, said in an interview that the ministry is so far only attracting producers of simple components to Russia.

No large-scale hi-tech producers are expected to show up in Russia in the next few years. Levchenkov noted that creating an engine plant requires an average investment of $500 million. That is almost twice as expensive as creating an assembly production. Nissan and Toyota each invested $200 million to set up assemblies in St. Petersburg, and VW spent €380 million, which is the record.

Levchenkov concluded that producers of hi-tech components will be ready for investing by 2009, when the first cars roll of the Nissan, Toyota, VW and GM assembly lines. The plants will produce a combined total of more than 490,000 (according to ASM Holding) and create a large market for the producers of complex components and systems in Russia.

Independent analysts doubt that foreign component production in Russia will go far beyond assembling simple car elements. AG Capital managing director Alexander Agibalov noted that the industrial assembly procedure does not require carmakers to localize production of complex systems in Russia or to bring their suppliers with them onto the Russian market. When an investor (VW or Nissan) signs an investment agreement with the Economics Ministry, it agrees only to reduce the quantity of its imported components by a third within seven years, thus resulting in the localization of 30 percent. The reduction is calculated not in terms of pieces, but in terms of value. Thus, the producer has the choice of stopping the import of a small number of expensive parts or a large number of cheap parts.

Agibalov added that it has been seen at the Ford-Vsevolozhsk plant that the second option is easier for the automaker. Ford-Vsevolozhsk reached the level of localization required of it by purchasing interior carpeting, glass, plastic parts and similar secondary components from Russian suppliers while continuing to import engines and transmissions for the Ford Focus.

Deputy executive director of the United Auto Producers of Russia Alexey Serezhenkin, who was directly involved in the development of the new industrial assembly procedure, agreed that “the industrial assembly procedure is rather reserved in its description of localization requirements.” He said that, when the three ministries involved were developing the procedure, officials thought about requiring foreign carmakers to open engine production plants in Russia as well as assembly plants. That requirement would have been included in the order, but they were forced to abandon it. “It was explained to us that, since Russia is trying to accede to the WTO soon, the assembly production agreement should meet at least the minimum requirements of that organization. Therefore, we couldn't just take and require foreign carmakers to buy engines from Russian producers or organize production themselves,” Serezhenkin said. The formula of 30-percent reduction within seven years was a compromise option.

Now Serezhenkin says that he is “not sure that Western producers will build engine plants in Russia unless there is an assembly plant next to them that produces 250,000-300,000 cars per year… Smaller volumes are senseless.” None of the foreign auto plants in Russia will have a capacity of 250,000 cars and a single plant cannot build engines or transmissions for different automakers (for example, Nissan, Toyota and Ford-Vsevolozhsk) at one time because of technical limitations, Serezhenkin added.

Body Parts

Analysts note that the auto body is no less important for localization. According to Alexey Ipatov, director of the state Research Institute of Automobiles and Automobile Engines, a car's body accounts for 15-20 percent of its final cost. United Auto Producers of Russia data indicate that the motor accounts for 15-18 percent of a car's cost and the transmission 15 percent. Thus localization of auto body production also means establishing production of high-value components in Russia. While the Economic Development and Trade Ministry and Industry and Energy Ministry could not force foreign carmakers to produce engines in Russia, they did make creating capacity for the welding and painting of at least 25,000 vehicles per year a condition of the industrial assembly procedure. The Economics Ministry notes that the localization of painting and welding, combined with a 30-percent reduction in component imports, effectively brings the level of localization for foreign carmakers to 50 percent.

A consequence of the requirement to localize welding and painting has been the development of the production of pressed metal parts in Russia. At the beginning of October, the German Kirchhoff concern announced plans to build an auto-body parts plant in St. Petersburg to supply the assembly lines of Ford-Vsevolozhsk and GM. It did not mention when that plant would be completed. A week after that, Severstal-avto announced the creation of a joint venture with the British Stadco to produce body parts. That joint venture will be registered by the end of the year and begin producing Fiat body parts for the Severstal-avto project in Tatarstan in 2008.

Kirchhoff and Stadco will not take advantage of the industrial assembly procedure because they have nothing to import. Three Russian metal producers, Severstal, Novolipetsk Steel and Magnitogorsk Metals, offer steel automobile sheets. Therefore, it can be said that Kirchhoff and Stadco are opening in Russia not for the sake of benefits but because of economic expediency. As they note at Severstal-avto, importing bulky car body parts is expensive and inconvenient.

The investment needed to open a body parts production facility is exponentially lower than that required for engine production. Kirchhoff estimates its investment at $35 million, and Severtsal and Stadco at no more than $35-40 million. The Severstal-avto/Stadco enterprise will nonetheless be the largest in that sector with capacity to produce the body parts for 150,000 cars. The founders of the venture see a possibility that they will supply individual parts to foreign automakers' Russian plants.

The question is what demand there will be for pressed metal. Of course, the industrial assembly procedure stipulates the welding and painting of 25,000 pieces a year. But, notes Serezhenkin, the order does not articulate the investor's responsibility for failing to meet that requirement. Under the procedure, the automaker has two and a half years to implement the minimum painting and welding requirement. During that time, the carmaker has the right to assemble cars by importing the body and all the components of the automobile, practically without any localization. If the investor does not create the painting and welding capacity within two and a half years, under the procedure, it “must pay all customs fees owed and bear responsibility for under the Customs Code and Administrative Violations Code.”

Serezhenkin notes that “those are streamlined formulations that could end in endless court procedures with unprincipled investors… It would follow to write out in detail the investors' responsibility for violating conditions, for instance, specific fines. Until that is done, the risk remains that a number of investors will simply want to take advantage of the more than two-year customs window for usual car assembly.” Kommersant has learned that the Economics Ministry chose that wording so as not to frighten away foreign carmakers. Some of them refuse to submit to excessively harsh requirements.

Serezhenkin notes that the most likely violator of the conditions will not be Western automakers, but “investors who estimate setting up welding and painting for $5 million in their preliminary documentation.” The actual cost of such a facility is about $100 million. The Economics Ministry confirms that it is receiving applications of that type from little-known firms. Large foreign automakers are likely to meet the requirement for body part localization. Levchenkov notes that the Russian car market will be worth $30-40 billion by 2010 ad the large Western automakers are highly interested in that market.

Dmitry Belikov