
- Jon Hellevig
- July 26, 2017
- 5120
Russia’s Import Substituton: Impressive Results by Carrots and Sticks… and a Little Money (PART 2 TO AWARA STUDY ON RUSSIA’S ECONOMY 2014 – 2016, YEARS OF SANCTIONS WARFARE)
Данная статья также доступна на русском языке.
The most crucial outcome to date of Russia’s import substitution campaign is that it has insulated Russia against the effects of any further sanctions. Except for a few sectors, like agriculture, food processing and the automotive industry, the volume growth brought by import substitution is still modest. More importantly Russia has been able to cut its imports and launch a nascent and increasingly burgeoning domestic production of virtually everything that is produced in the world, quickly churning out technologies where it was most vulnerable, like arctic drilling technologies, engines for new ships for the navy and medicine. Therefore, Russia has been surprisingly successful in cutting the dependency on Western imports and by extension its need to appease the West. Import substitution has thus been a major factor in strengthening Russia’s national security and sovereignty.
The present report on Russia’s import substitution program comes as a sequel to our Awara report on how the Russian economy has fared under the years of the unilaterally imposed Western sanctions, 2014 – 2016. That report titled What Does Not Kill You Will Make You Stronger showed that Russia had survived the dual shock of sanctions and oil price plunge remarkably well. It was proven that Russia was running a much more resilient economy than its detractors would have us believe. GDP was only slightly down 2.3% in total for the three years, industrial production remained stable and unemployment remained at levels of 5% – something the European Union can only dream of. Similarly, all the other macroeconomic indicators lined up in the report remained strong, except for salaries, disposable income and consumer spending. We summarized the effect of the economic hardship of those years as “some belt-tightening, not much more.” At the same time we pointed out that all the indicators speak about a qualitative growth in the face of a slight quantitative drop.
This report on import substitution precisely aims at illustrating the qualitative growth by reviewing some of the grand reindustrialization programs underway in Russia.
CONTENTS
1. GENERAL ABOUT RUSSIA’S IMPORT SUBSTITUTION PROGRAMS AND EARLY SUCCESSES
2. SECTORAL ANALYSIS:
– Agriculture
– Automotive Industry
– Pharmaceuticals and Medical Equipment
– Aviation
– Shipbuilding
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Page 1
The Russian economy has indeed successfully modernized and diversified, Import Substitution programs will take it to a new level
In the face of the barrage of commentary claiming that Russia has failed to modernize and diversify its industry, we made in our report of June the bold and shocking statement that Russia in fact is the world’s most diversified economy. We motivated the statement by turning the question around, instead of staring blindly at the structure of Russia’s exports, we turned the attention to the country’s imports. The critics have obstinately wanted to prove that the economy as a whole is undiversified because oil and gas dominates Russia’s exports. However, they have totally ignored to analyze the figures for imports and domestic production.
We pointed out that the levels of Russia’s imports – measured as a share of GDP – are exceptionally low in a global comparison, as shown by Chart 17. The chart shows that Russia’s imports as a share of GDP was as low as 7.2%, while the corresponding level for Western European countries was between 30 to 40%. What this then means is that – as Russia imports so preciously little – it produces domestically most of what is consumed and invested in the country.
We also pointed out that – contrary to the Russia-bashing legends – the share of oil and gas make up only less than 10% of the GDP, and about 20% of the state budget revenue.
Industrial production remained strong and stable since the onset of sanctions
For the three years of sanctions industrial production was down merely 0.6%. Moreover, a handsome recovery is already on its way with an expected growth of 3 to 4% in 2017. In May, the industrial production already soared by a promising 5.3%. This was followed by another strong showing in June with 3.5% growth, bringing the half year growth to 2%. There is an abundance of projects that are due to produce significant industrial growth in the future. Such, for example, in aviation, shipbuilding, and pharmaceuticals. But there is naturally a long lead time before they mature to full production cycles. Therefore, we would expect them to start showing as an additional boost in production gradually over the coming years. Import substitution has been a trendy phrase very much on the lips of politicians and businessmen since the crisis that started with the Western organized coup in the Ukraine. But it would be misleading to think that the kind of reindustrialization and endeavor to cut down on dependence on imports contained in the concept of import substitution would have started only in reaction to the sanctions that the West imposed on Russia on the pretext of the chaos that followed in the wake of the coup. ‘Import substitution’ rather serves as a rallying call to intensify the efforts on reaching the goals – goals that for sure became more ambitious and pressing – that have already since 2009 (some going back to 2004) been set forth in the Government’s various strategic industrial development programs aiming at the development and modernization of virtually every sector of the economy. In total 17 industrial sectors – as well as several geographical regions, which have been singled out for accelerated development – benefitted from such programs prior to the onset of the Western assault on Russia’s economy. The sanctions did give a new impetus to the industrial development programs, and there is now an import substitution program for each of 20 industrial sectors (identifying 2,200 areas of technology), inter alia: light industry, aviation, automotive, machine-tools, chemical, forestry, electronics, pharmaceutical, medical equipment, ferrous and non-ferrous metallurgy, transport equipment, energy, oil and gas technology[1]. It is important to understand this distinction: Russia’s economy did not survive because of some heroic emergency measures undertaken in response to the sanctions and the fall of the oil price, but rather because Russia was able to take on the Western challenge thanks to its long-term measures to modernize and diversify the economy since at least year 2005. It’s is this that has enabled to achieve some in fact very impressive results during the last three years. Similarly, Russia did not become self-sufficient in food because of countering the Western sanctions with a food import embargo, on the contrary, Russia could enact that embargo as a countermeasure because it had already by then reached a virtual self-sufficiency. (Hereby, Russia continues to import food from friendly countries, but mainly for reasons of providing for variety and to ensure a competitive market). However, the counter-sanctions have enabled Russian producers to grow faster and become financially more viable. There are a multitude of success stories in Russia’s import substitution drive. First of all there is the already mentioned general success in that Russia’s industry is the most self-sufficient in the world, relying less on imports than any other major country. Below, we will review the success in agriculture and the food industry, and automotive industry, pharmaceuticals and medical equipment, aviation, and shipbuilding. These are the sectors that have shown the most significant improvement in addition to the chemical industry. In fact, the Russian government has in place development programs covering practically all spheres of industry and the economy at large[2]. Before we move on to the sectoral analysis, we want to share some tidbits of what have been achieved. April 2017, Putin in Rybinsk at NPO Saturn launching the production of import substitution gas turbines for the navy Russia proved (as we predicted) very apt at domestic substitution of the technologies that fell under the sanctions regime. The prime example here is of course its weapons industry, which has been able to continue its impressive developments (not at least as showcased in the defense of Syria) without interruptions even though the Western sanctions were designed to bring it to a standstill. A telling case in this connection is how the Russian engineers were able to develop and launch production of marine gas turbines needed for new ships being built for the Russian navy. The Ukrainian plant Zorya-Mashpoekt had supplied that class of engines for the Soviet and Russian fleets since the 1950, but following the coup, the new masters order it to stop all further supplies of the engines to Russia. In a coordinated move the EU also banned that kind of technology[3]. But already in April 2017, a victorious Putin could visit the NPO Saturn company and officially launch its production of the substituting and improved marine gas turbines. More in general, it can be concluded that the Russian defense industry has successfully completed its separation from the Ukraine not being anymore dependent of any of the spoiler country’s supplies. Writing the above, we are reminded about a new gas turbine scandal, this time with the German giant Siemens. The company is unhappy that Russian contractors have delivered for use in a two electrical power stations being built in Crimea gas turbines, which – according to Siemens’ account – have been produced by the company. The Russian side says that actually they were old and reconstructed turbines and therefore it should be of no concern. But that really is not the point. The point is that Siemens and the hapless EU leadership (it really is an oxymoron to speak about EU “leadership,” but just now I can’t think of another word) are now crying foul and accusing Russia of breaching the sanctions regime…yes, the pesky Russians are said to breach against the anti-Russian sanctions. Now Siemens has said it intends to sue its Russian contractors for “breach of a contractual obligation not to violate the international sanctions.” In particular the contractors are incriminated for trying to circumvent the sanctions and thus breaching international law. Now Siemens has said it intends to sue its Russian contractors for incriminated them in “trying to circumvent the sanctions and consequently the “breach of a contractual obligation not to violate the international sanctions”[4]. This really is funny or at least pathetic. Obviously, Russia is not bound by the sanctions that its enemies has imposed on it. Moreover, the Russian courts should declare any contractual stipulations aiming at restricting of business connected with Crimea or in any other ways serving to uphold the Western sanctions against Russia as null and void. Such provisions are to be considered as breaching ordre public, the public policy doctrine which states that any rule of international law or contractual provision which goes against the fundamental principles and underpinnings of a legal system, in this case the Russian legal system, and the moral and economic values inherent in it, as well as national security, should not be applicable. Contractual provisions where a Russian party would assume obligations to participate in international hostilities against Russia, like the contracts that Siemens refers to, are obviously of this category. Russian companies do produce gas turbines, but the existing production does not cover the high power turbines of the category that Siemens has produced. It does not mean that Russian plants could not produce them, rather there has been mutually beneficial arrangements whereby a joint venture between Siemens and Russia’s Silovie Mashini has produced them for the Russian market. But now that the gauntlet has been thrown, we’d expect that it won’t take more than a year, maximum two before the Russians have taken over this segment, too. And one more product market will be lost for the West. The US and EU sanctions specifically targeted Russia’s oil and gas industries by aiming to deprive them of capital and technology. The Western powers thought they would cripple Russia’s energy sector by especially banning the transfer of technologies for artic offshore drilling and shale projects to Russian energy companies, Gazprom, Lukoil, Surgutneftgas, Rosneft and others. But how did it go? Another Western failure. Russia’s energy sector has actually been thriving ever since. And what’s worse for Russia’s “Western partners,” Russia managed to develop its own technology for the arctic environment. Gazprom went on with new domestic state-of-the-art technology to develop the Yamala Peninsula arctic oil drilling and gas production center.[5] And then Russia’s state-owned Rosneft in a moment of triumph commenced upon televised orders of President Putin drilling at the Tsentralno – Olginskaya-1, Russia’s northernmost oil well on the edge of a peninsula so deep in the Arctic Circle that the equipment had to be shipped 3,600km through icy waters navigable only for two months of the year[6]. In April, 2017, President Putin gave orders to start drilling at the Tsentralno – Olginskaya-1 arctic oil wells Indeed, we said back in 2014 that it was a preposterous idea of the Western powers to think that Russia, a country that has been the leader in space technology for half a century and produces the most cutting edge nuclear arctic submarines, would not be able to make some arctic drilling machines (sic!). All in all, the behavior of the Western powers – and their Ukrainian puppet regime – reminds us of some cartoon villains that are desperately trying to harm the main hero in the story with all means possible, but to no avail. We can imagine that by now deep inside the anti-Russian containment laboratory, the CIA and NATO planners have resorted to sticking pins into Putin and Mother Russia voodoo dolls as a last resort. By way of example, will give a few more details on Russia’s import substitution. 85% of Russia’s household appliances are produced domestically[7]. The Russian Chelyabinsk Tractor Factory launched end of 2016 a state of the art conveyor assembly plant producing bulldozers that first time are of competitive high technical quality and affordable in ruble terms to challenge the global leaders that have dominated the Russian market[8]. The Uralmashplant recently started manufacturing the first Russian hydraulic excavator with a bucket of 16 cubic meters, and other cutting edge mining technology[9]. A Rosatom affiliated research center has in June 2017 announced that it has completed the development of a Thulium fiber laser for surgical application. The Thulium-doped fiber laser operating at 1.9–2.1 nanometers represents the latest revolution in high-power fiber laser technology. This comes as other modern medical equipment production is being launched (see below picture). The medical equipment plant in Krasnogorsk, Moscow Region, has developed a new laser surgery machine The incredible speed with which Russia has delivered Crimean energy and transport infrastructure and the speed by which the 19-kilometer long mega-bridge across the Kerch Strait from mainland Russia to the beleaguered Crimean peninsula stands as a testimony to Russia’s industrial prowess[10]. A rarely noted fact is Russia’s $1 billion investment into rare earth production to secure sufficiency in these crucial minerals[11]. This just goes to show that Russia is self-sufficient in every major aspect of the economy. Russia has also in record time developed a domestic system that serves as an alternative to the Western dominated international banking transaction system SWIFT. This became necessary when threats emerged in in 2014 that Russia would be shut out of the system as an additional sanctions measure. In a similar vein, Russia developed a new national banking card payment system called the Mir. The system was created to ensure the sovereignty of the national payment after Visa and MasterCard ceased to serve some Russian banks’ credit cards due to US sanctions imposed on Russia and the Western sanctions talk hinted at banning Visa and MasterCard altogether from Russia[12]. To conclude this list of examples we are pleased to tell that Russia has moved to essentially ban the Western credit rating organizations from Russia. A new law regulates their activities in Russia and most importantly, the Central Bank has decreed that for regulatory purposes the credit ratings by Standard & Poor’s, Fitch and Moody’s will no longer be used[13]. This is a very welcome move as these three sisters have increasingly evolved to essentially become a protection racket collecting money with the threat to ruin the reputation of the victim corporation. The final straw for Russia was when the racket joined the geopolitical scheming against Russia by way of crushing the ratings of Russian corporations and the state. Notably, the decision came after Fitch and Moody’s downgraded Russian sovereign debt to just above junk status. The one sector where the Russian success is unanimously acclaimed – albeit begrudgingly by Russia’s “Western partners” – is agriculture. Russia, which was in the beginning of 1990s receiving humanitarian food aid from the West (albeit mostly in form of propaganda stints) has now become a major food exporter and the biggest wheat exporter. It’s not only a question of Russia’s traditional exports of grain and vegetable oil exports, but it also will enter global markets with new products such as pork, poultry, potatoes, sugar. In 2Q, 2017 agricultural exports look to overtake imports, making Russia a net exporter for the first time. Now the plow’s before the sword as the agriculture has overtaken arms as Russia’s second largest exports. At the same time Russia has become self-sufficient in food with increased domestic production and a sharp decline in imports. A major economic feat but also crucial for its national security. From the food shortages and misery in 1990s, Russia has gone to become a self-sufficient food superpower. Left: A look at meat in the beginning of 1990s somewhere in Moscow. Right: A new look at meat in 2016 in Volshky, Volgograd region. (BTW, should be interesting to those who claim that all the development has happened only in Moscow within the MKAD). Chart Agriculture and Food Processing The agriculture sector grew a combined 11.1% in 2014 to 2016. In the years of sanctions, Russia has grown to become an agricultural superpower with the world’s largest wheat exports. Already in the time of the Czars Russia was a big grain exporter, but that was often accompanied with domestic famine. Stalin financed Russia’s industrialization to a large extent by grain exports, but hereby also creating domestic shortages and famine. It is then the first time in Russia’s history when it is under Putin a major grain exporter while ensuring domestic abundance. Russia has made an overall remarkable turnaround in food production and is now virtually self-sufficient. In looking at food production, it is often forgotten that it consist of two components, agriculture (farming and breeding) and food processing. Russia’s food processing industry has also greatly developed and grown in recent years, reaching a cumulated growth of 6.8% in the three years of sanctions. The food processing industry has continued strongly in 2017, with 3.9% growth year-on-year in May. The revival of the Russian automotive industry represents an extraordinary successful early import substitution program. The program involved a restructuring of the domestic carmakers and the enticement of foreign producers to set up plants in Russia. This included subsidies to domestic producers, the creation of joint ventures with foreign manufacturers and, state sponsored investment contracts with import duty and tax exemptions, among other measures. Foreign carmakers responded by setting up car assembly lines in Russia using imported components but with obligations to gradually bring up the share of locally produced components. There was the usual ridicule, as the “experts” said that nothing would come out of it, they would remain mere assembly lines, and that’s it, they claimed. But again they were proven wrong. The share of localized content has steadily been going up. Following the car manufacturers, the global leaders in components have set up production in Russia, among them Magna, Valeo, Faurecia, Lear, Bosal. What was unthinkable merely 10 years ago has also happened, some foreign manufacturers have even started producing engines locally. A quick check returns that at least these foreign car makers have engine production in Russia: Volkswagen, Ford, and Mazda. Contrary to the received wisdom, the share of locally produced components is as high as 60 – 70% of the total in the Russian automotive industry on a whole. Hereby local content make up about 50% of the foreign brands produced in Russia. The total value of imports of automobile parts and accessories in 2016 was $5.7 billion (including those for the secondary market). This figure may be juxtaposed with the total value of Russia’s passenger car industry, which is estimated at approximately $20 billion (2016, value of domestic manufacturing of passenger cars). Following a 35% growth in the first 4 months of 2017, the total production value of the automotive industry is expected to reach $30 billion in 2017. Today nine out of 10 leading new cars, in terms of sales, are produced in Russia. The leading brand was Russia’s Lada. About 20 foreign brands have production in Russia. In 2016, 1,311,000 passenger cars were sold in Russia, of these 79% or 1,038,000 were produced in Russia (Chart 36). Of the domestic production, Russian domestic brands amounted to 284 thousand cars while foreign brands produced in Russia totaled 754 thousand[14]. The number of imported cars was a mere 273 thousand, which compares very favorably with the situation a decade ago: in 2007, Russia imported 1.2 million cars[15]. Chart #36. Passenger car sales and production in Russia Car imports to Russia fell by 23.7% in 2016 and by a further 15% in the first half of 2017, this while domestic production grew by 20% in the same time in 2017. In addition to passenger cars, 93 thousand light commercial vehicles and 53 thousand trucks were sold in Russia; both categories with domestic production over 80%. Also 43 thousand buses were produced, of which almost all domestically in Russia. The value of imported passenger cars was approximately $20 billion in 2007, while it was down to $6 billion in 2016 (partially the decrease in imported ready cars has been compensated by increase in automotive parts for domestic production). Exports of Russian cars are still subdued, although even several foreign brands have announced intentions to grow exports of Russian made cars, mainly to the other Eurasian Union countries. The Russian Lada brand is still the leading exporter. In 2016, Russia exported merely 68 thousand cars to a value of $1.1 billion. However, exports are up about 20% for the year, and as imports have further declined by 15%, the gap between imports and exports of cars is narrowing, although slowly. The domestic Russian automotive industry is set to continue its development and growth as the Chinese carmakers are now about to seriously enter the market. The Western manufacturers cannot afford to yield the Russian market to the Chinese and will therefore need to reply with investments to investments. It’s not only a question of the Russian market but the entire Eurasian Union market plus also other neighboring countries (Uzbekistan, Tajikistan, Azerbaijan) and potentially even Iran and other Middle East countries. Presently, 11 Chinese brands are represented on the Russian market, 4 of which make up the overwhelming part of their volumes. The market shares of the Chinese producers are still very small; Lifan, which is the leader among them only reached a 1.3% market share in 2016. This is, however about to change as the Chinese have set their eyes on penetrating the Russian market. The carmaker Great Wall is presently building a huge car plant in Russia’s Tula region to the cost of half a billion dollars. The full-cycle production plant is due to open in 2018 and projected to reach a 75% level of localization. Among several other new investments, Daimler announced in June 2016, that it will do a $250 million investment to build in the Moscow Region a factory for the production of Mercedes-Benz sedans and SUVs. The drive to kick start the Russian pharmaceutical and the accompanying biotechnology and medical equipment industries provides an excellent example of Russia’s import substitution and reindustrialization strategy. As part of this strategy, the Government is running a special development and import substitution program for the pharmaceutical and medical technology industries covering the years 2012 to 2020. The ambitious program takes aim at rapidly increasing the share of domestically produced medicines and equipment. The pharmaceutical and medical equipment industries were in a particularly dire state still going into the 2000s. In a global comparison, the volumes of Russia’s domestic production were insignificant and what there was basically only concerned the lower-value added segments of the market in form of generic drugs. Exports of medicines and equipment were negligible. These industries had also been identified as sectors that would be especially suitable for Russia’s efforts to create a modern innovative economy. Not of the least importance, was the concern of Russia’s national security. The overwhelming dependence of imported medicines and medical technology had rightly been deemed to constitute a grave threat to the national security. The program was initiated in 2011, which shows that at least by then the threat that (so far) has culminated in the sanctions of 2014 had already been identified. As President Putin has said, the events in Crimea and Donbass were only pretexts for enacting the sanctions. Here we have one more piece of evidence showing that Russia had correctly assessed the threat. Actually, Russia never had a developed pharmaceutical industry, even in the Soviet times the industry was relatively insignificant. Within the Soviet led Eastern Economic Bloc, Russia had been assigned the role of acting mainly as a supplier of raw materials to producers in the other Comecon, Eastern bloc countries[16]. AO Pharmasynthes will open this fall a new medicine plant for the production of antibiotics, its fifth, in Bratsk, Irkutsk region. The company’s turnover grew by 50% to 10 billion rubles ($170 million) Thus coming into the Putin era, the total annual value of Russia’s pharma production barely reached $1 billion. Thanks to the stabilization of the country and some government development initiatives, the value of Russia’s domestic pharma production reached 286 billion rubles in 2016. In years 2010 – 2016, the growth was nearly 200% in nominal terms; deducting the cumulative inflation for that period (73.5%), the so-called real growth would have been 124%. However, this method of arithmetically deducting the inflation, might not give the real picture of the development, as there has been a clear qualitative improvement and near total renewal of production. (Tellingly, the Ministry Industry and Trade expects the production growth for 2017 to be 20% in terms of volume but only 8% in monetary value, logically meaning that the Russian producers would produce more drugs for a cheaper price, and therefore there would not be any justification in deducting the inflation from the nominal price to show “real growth”). The value of 286 billion rubles would correspond to approximately $4.5 billion. Considering the sharp depreciation of the ruble and ensuing volatility of the currency exchange rate, the nominal dollar value is not either a good indicator for the volumes. The general level of prices in Russia are three times less than in the United States, as expressed by the purchasing power parity (PPP) calculations of the IMF and the World Bank. Therefore, one would get a better idea of the size of Russia’s domestic pharma production by multiplying the said $4.5 billion by three, yielding a value of approximately $13 billion. So far, in 2017 growth has continued robust, with 12.6% (real) growth for January – May. The primary strategic goal of the pharma development program was defined as producing domestically by 2020 90% of all those drugs, which were deemed as vital and essential medicines as per a catalog adopted by the Government. After a revision of the catalog in 2016, it contained 646 items. By end of 2016, already 77% of these drugs were readied for production. This does not, however, yet mean that those drugs are produced in significant volumes, more time will be needed for the necessary production volumes to be reached. Hereby the 90% production target does not either mean that 90% of the total volumes sold on the Russian market of those drugs must be produced in Russia, but that that those types of drugs must be in production in Russia and widely distributed to compete with imports. The aim is that domestic production would cover 50% of the value of the pharma market by 2020 (up from 20% in 2008?) and with domestically patented newly developed drugs covering the lion’s share of that. By end of 2016, 44 import substitution (generic) drugs had been brought to the market, as well as 2 brand new Russian developed drugs. The total value of the pharma market (drugs sold, domestic and imported) was 1.2 trillion rubles ($20 billion) in 2016. By 2016, Russian made drugs covered 30%of the market (24% in 2014) in terms of sales value, but made up 58% of the material volume of all drugs sold. The difference in the share of the monetary value and material volume is explained by two facts: that the Russian made drugs are less expensive than the imported equivalents, and that the Russian drugs presently occupy the lower value market segments. The difference is even more markedly pronounced in state procurements of medicine, where domestically produced drugs made up 69% of the total volume but only 25% of the monetary value. So, 1/3 of the money went to domestic producers and they delivered 2/3 of the drugs, and 2/3 went to foreign producers and they delivered 1/3 of the drugs. Obviously, this is going to change, very soon. One strong indicator of the success of the pharma import substitution program comes precisely with significantly decreased values of imported drugs. In 2014, the Russia imported drugs for a value of $12.8 billion, but in 2016 only for $9.1 billion, this also in the face of the growth of the general market of drug sales. From 2009 to 2016, 28 new pharmaceutical factories were opened in Russia, 8 of them owned by major international corporations. Hereby, many of the foreign pharma corporations have preferred to outsource and localize the production with Russian producers The Government’s development strategy is based on a two-pronged carrot and stick approach. From one side it is creating the infrastructure for the industry, participating in financing, enticing domestic and foreign producers to set up production in Russia, and from the other side it gives preferences to the domestic producers (including foreign owned) in state procurement. Concerning the list of vital and essential medicines, the state must in procurement choose from the drugs produced by domestic companies (or other countries of the Eurasian Economic Union), if at least two non-affiliated domestic companies have tendered their bids. The relevant ministry also signs guaranteed state procurement orders with plants that invest in the production of designated drugs. The production of medical equipment (technology, health aids, prosthesis) has also seriously lagged behind the global leaders. The overall market in trade of medical equipment reached levels of $4 billion by 2011, while the value of domestic production was only about $0.5 billion. Notwithstanding the relatively insignificant value of the production, the Government had identified[17] 1,800 companies working in this sector, of which it deemed 200 to 300 to have a good potential for growth. Globally the medical equipment industry is a high-tech innovative growth industry, which Russia now wants to tap into. Given the size of its population and present levels of consumption of the imported equipment, there is indeed a huge potential for growth. By 2016, the domestic production had doubled to a level of $1 billion, reaching a 20% share of the market. The sharp drop in the RUR/USD exchange rate in 2014/2015 hides a yet bigger growth in the volumes of equipment produced. Nevertheless, the volumes are still very small; the potential must be a 10-fold growth within the next ten years. There is naturally a lag time between the decisions and initial efforts and the resulting production and market penetration, therefore we see this goal as realistic. Concerning the medical equipment industry, the Government uses a similar two-pronged carrot and stick approach, as was the case with pharmaceuticals. In addition, certain imported equipment according to a Government list have been totally banned from state procurement. By end of 2016, 65 new pieces of import substituting medical equipment had been brought to the market, of which 10 based on Russian innovation (other ones being imitative). Russia’s exports of medical equipment was still a misery $75 million in 2016, but there was a much bigger improvement in the decrease of imports, down to $2.9 billion. And what’s the cost of all this fun for Russia? In a televised call-in back in April 2015, President Putin announced that the entire development program (through 2020) would cost 180 billion rubles. We are unsure about the applicable currency rates over the periods of this investment, but it is fair to estimate the dollar value to be around $4 billion, on average $450 million per year. These are not big amounts, considering the dramatic impact it has on the Russian market, the country’s industrial capacity, development of high-tech industries and R&D – and on the national security. In fact, a quick glance on the above reported figures would show that the entire investment has been more or less paid back for the national economy already by the savings on one year’s imports. The Government has largely invested in the general national infrastructure of the pharma and medical industries, investing in science, specialized universities, education and R&D. For the actual investments in the production entities, the Government has largely relied on the private sector, domestic and foreign (some state owned corporations are also among the investors, notably Rostec, Rusnano, and Rosatom). Between 2011 and 2015, these investments amounted to 120 billion rubles, while the state put in 35 billion rubles. These results fly in the face of the teachings of liberal market theories as the revival of Russia’s pharmaceutical industry is driven by the state. But as mentioned above, so far the Government has largely relied on private corporations, domestic and foreign to stand for the investments. This will not be enough, if Russia wants to achieve more ambitious goals and become a serious player on the global export markets. For that it will be required for Russia to create state-owned pharma corporations that it will grow to become national champions in the sector and take on the Western multinationals at home and globally. (It will be better to create a couple of such corporations, than just one, in order to allow for more competition). Since 2015, the Government has been operating a newly established state investment fund, the Fund for Industrial Development. It had by 2016 signed contracts for financing new production facilities in these industries to the tune of 4.5 billion rubles ($75 million). This is a cute start, but much bigger volumes of state investments will be required. CHART #37 Source: www.worldstopexports.com The Government’s development program has as one of the stated aims to increase exports of drugs and medical equipment. Hereby, the Government has set itself a very modest target of reaching export volumes worth a couple of billion dollars in these sectors by 2020 ($0.6 billion in 2016). Maybe that was an optimistic target way back in 2012 when the program was being devised, but looking at the situation today and from point of view of Russia’s real capabilities and requirements, that is peanuts. Russia must set its sights on a level of at least $10 billion, which could be achieved by 2030, with the right marketing mix, geopolitical trade strategy and investments in state corporations. For comparison, Germany – the world’s biggest pharma exporter – shipped $76.8 billion worth of drugs in 2016. Chart #37 lists the 15 biggest pharmaceuticals exporting countries and their export volumes in 2016. For each of the listed countries, pharmaceuticals were among the countries top 10 export goods, for the majority of them they ranked among top 4. The listed 15 countries shipped 86.5% of all of the world’s drugs and medicine exports in 2016. This is the competition, and Russia must set it goals to reach the top ten within a foreseeable future. But that will never happen by relying on wishful thinking that by creating the right liberal market conditions the Russian fledgling pharma industry could take on the global competition. Perhaps that kind of a strategy would have worked 60 years ago, but it certainly will not on today’s global markets dominated by deeply entrenched global multinationals. Russia, needs its own state-owned multinationals if it wishes to participate in the global markets of export of pharmaceuticals. Russia has increasingly during the last decade or so been investing in development, modernization and growth of its aviation industry with very promising payback prospects. Presently it runs a development program spanning the years 2013 to 2025[18] Russia retained its leading position in military aircraft, missile and space industry throughout the years of otherwise general neglect in the 90s. Now, Russia is about to resurrect its positions in civilian aviation as well. The program allows for a tenfold increase in the value of Russia’s aviation industry from annual levels of $15 billion to $50billion by 2025, of which half could be generated by exports. (For comparison, the value of the whole automotive industry is about $30 billion, 2017). However, considering the significant differences in the purchasing power parity in Russia’s favor with that compared of the Western countries, the monetary value of the production might not be an accurate and proper comparative indicator. The more objective indicator would be that of the number of aircraft produced. The program foresees by 2025 the annual production of 300 airplanes, military and civilian (3-times increase); 465 helicopters (2-times increase); and 3,000 aircraft engines. For comparison, Airbus and Boeing delivered 635 and 762 aircraft, respectively, in 2015. In 2016, Russia domestically produced 30 units of civilian and 109 military airplanes, as well as 22 civilian and 186 military helicopters. According to PM Medvedev, reporting on the results of the national economy in 2016, Russia’s aviation industry increased military production by 3.5% while its civilian output grew by about 20%. Key product developments of the recent years have been: the Sukhoi Superjet, the twin-engine regional passenger jet with a capacity of up to 108 seats; the Irkut MC-21, twin-engine short- to mid-range jet airliner with a capacity of 150–230 passengers; the PD-14 next generation turbofan engine, developed primarily for the Irkut MC-21, but forming part of a greater family of engine concepts for various uses; the helicopters MI-38 and Ka-62; the modification and upgrading of the four-engine Ilyushin Il-76, under the name Il-76MD-90A, a dual use military airlifter and civilian cargo plane; complete modernization of the Ilyushin Il-114 twin-engine turboprop airline designed for local routes; complete modernization of the Ilyushin Il-96 four-engined long-haul wide-body airliner with a capacity of 250 to 312 passengers. In addition to the listed product developments, Russian and China have agreed to jointly build a wide-body passenger jet to challenge the remaining monopoly of Boeing’s and Airbus in the long-haul flights. The planned maiden flight of this plane is due in 2022 with deliveries starting 2025. The MC-21, will have a capacity to carry up to 211 passengers and is designed to take up the competition with the Boeing 737 and Airbus A320. The Irkutsk MC-21 made its maiden test flight in late May, 2017. The manufacturer, the state owned Irkut Corporation (part of the United Aircraft Corporation), has received 285 orders for the plane, of which 185 are characterized as firm with advance payments received. The first delivery to a customer is expected by end of 2018. The corporation expects to deliver 1,000 planes within the next 20 years. The initial production rate is planned at 20 planes per year, with a boost to an annual rate of 70 by 2023. The anchor client, Russia’s Aeroflot, plans to initially have 50 MC-21 in its fleet. This goes to show how extremely important it is for Russia to have strong state-owned corporations, here both as the developer of the plane and a significant customer, ensuring the viability of the project. One must understand, that the oligarchs would never have bet their private capital on producing a plane to compete with the Western powers, nor would they buy it. Russia’s brand new Irkut MC-21 medium-haul passenger jet made its first test flight in May 2017 The MC-21 debuted with its test flight only 6 years since Russia’s short-haul Sukhoi Superjet aircraft went into service. The Irkut MC-21 is a single-aisle medium-haul passenger jet (flight range of 6,400 kilometers, 3,400 miles) and the Sukhoi Superjet is a short/medium-haul jet (4,500 kilometers, 2,400 miles). The wide-body passenger jet to be jointly produced by China and Russia will cover the long-haul segment with a range of 12,000 kilometers (7,400 miles) and carry 280 passengers. The MC-21 will be fitted at the customer’s choice with a Pratt & Whitney engine or the Russian developed PD-14 by Aviadvigatel. The Russia-Chinese plane will come with a Rolls-Royce or GE engine or alternatively with a future Russian engine PD-35, developed on the same platform as PD-14. The development cost of the Russian-Chinese plane is estimated at $15 billon, with each side contributing the half. The cost of the development of the Sukhoi Superjet has been estimated at around 1 to 1.5 billion USD, of which less than the half from the federal budget and the rest from other sources, mainly from state corporations. To illustrate how comparatively insignificant this budget assignation was, it suffices to say that it was significantly less than the recently completed renovation of the Moscow Bolshoi Theater, and about the same amount that was spent on the renovation of the St. Petersburg Marinsky Theater. More than 100 of these aircraft have been delivered at a total price of about 4 billion USD. It’s nice to watch song and dance and have a cognac at the breaks at these venerable venues, but somehow we would consider that the production of world class competitive ships and aircraft anyway takes the prize. The development of the MC-21 has been valued at $3 to $4 billion, of which less than half has come from the federal budget while the rest has come mainly from state banks and other state owned corporations (including, in form of advance payments for future deliveries). The state will also support the marketing efforts for the MC-21 with a financing package of 200 billion rubles (approx. $3 billion) planned to cover the needs up to year 2025. This funding will go towards subsidizing future lease purchases and development of maintenance and post-sales guarantee services. The PD-14 engine has reportedly cost $1.1 billion to develop. The development costs of the Russian aircraft have been very modest by any global standards. The established global aviation leaders would spend some 7 billion dollars just to launch a new model based on their existing aircraft. Like it is the case with the shipbuilding industry (discussed below), relatively low amounts of investments will make a decisive contributions in Russia’s push to revive its industries in their push to retake their positions among global leaders. Hereby it is of crucial importance to note, that the investments have almost exclusively come from the Russian state and the state owned corporations. The investment opportunities have been there for decades, one may only ask why the cash-flush oligarchs never wanted to go for them. The answer to that question will also explain why the liberal economists and the Russian Central Banks pipe dream of private investments coming to the rescue will never materialize (until at least before there is a new world order, a post-Western hegemony new world order.) Russia is also running a long-term state program covering the years 2012 and 2030 aimed at the total overhaul of the shipbuilding industry. The program addresses all aspects of shipbuilding: investments in modern technology and science, research and education, universities and institutions, research and development (R&D), investments in shipyards and shipbuilding clusters in the North-West, Far East and South Russia, and financing of customer orders, including by way of leasing. According to the plan, as it stood at end of 2013, the amount of required financing for the whole program was less than half a trillion rubles, or approximate $15 billion at the prevailing exchange rate. Most likely the required amounts in dollar terms are today even less considering that the devaluation of the ruble has been far greater than the ruble inflation. This would mean an annual financing on average for the years of the program of only $800 million. Rosneftflot has ordered 5 tankers from its affiliated Zvezda shipyard. These amounts are modest by any standards, however, the reasonably expected effects are massive. According to the program, by the target year of 2030, production of civilian vessels should increase fivefold compared with the starting year 2012. Hereby Russia would retake its place among world leaders in civilian shipbuilding with a market share of 10% (2012 – 2%). In military shipbuilding Russia already has a 12% world market share, being, after the USA, the second biggest producers. Considering that Russia presently is a major client for global shipyards, it is easy to believe that the orders will come home to Russia after the capacity overhaul. A marvelous example of this development is the Zvezda shipyard in Bolshoi Kamen by Vladivostok. From 2009, the state directly and through state owned corporations started to develop the formerly military shipyard and repair facility into a world class facility for civil production as part of the Far East shipbuilding and marine equipment cluster. The complex will have Russia’s first shipyard for building large capacity vessels such as oil and gas tankers. Zvezda will also have the capacity to produce ships of up to 350,000 dwt, elements of offshore platforms, ice-class vessels, special vessels and other marine equipment. Originally the investment was started by the state owned United Shipbuilding Corporation and in 2013 a consortium comprised of three other state corporations – Rosneftegas, Rosneft and Gazprombank – acquired the majority of the shipyard. Rosneft invested 111 billion rubles ($1.7 billion) in 2013 to modernize Zvezda for civilian shipbuilding. By 2016, the Rosneft consortium is said to have invested 150 billion rubles ($2 to 2.5 billion). The Zvezda shipyard started with the production of the first vessels in 2016, with the first delivery scheduled for 2019[19]. In 2016, the combine turnover of the Russian shipbuilding industry was $141 billion, or about $2.5 billion); civilian production accounted for 25% of that turnover.
2014
+1.7%
2015
– 3.4%
2016
+1.1%
Total
– 0.6%
Import Substitution did not start with the sanctions
Page 2
Import Substitution results across the board
Russia produced crucial domestic technology in record time
Page 3
Contractual provisions stipulating restrictions to trade with Crimea must be seen as null and void, immoral and fundamentally against the principles of Russian law
After sanctions, Russia developed its own arctic drilling technology
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And much more
Page 5
SECTORAL ANALYSIS
AGRICULTURE – Russia is now an agricultural superpower
Agriculture
Food Processing
2014
+3.7%
+2.4%
2015
+2.6%
+2.0%
2016
+4.8%
+2.4%
Total
+11.1%
+6.8%
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AUTOMOTIVE INDUSTRY
Auto components also produced in Russia
79% of all sold cars were produced in Russia
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2007
2016
Cars sold
2,414,000
1,311,000
Domestic production
49%
79%
Incl. % of total sales
Russian brands
30%
22%
Foreign brands
19%
57%
Imported cars
51%
21%
The Chinese are coming
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PHARMACEUTICAL AND MEDICAL EQUIPMENT
Initial growth 2010 – 2016
Page 9
Strategic goals to produce vital and essential medicines domestically
Carrots and sticks for investors
Production of medical equipment
Page 10
Cost of the pharma import substitution program
But this is not enough
Page 11
Think Big – if you want to become an exporter
1. Germany
$76.8 billion
2. Switzerland
$67.1 billion
3. United States
$47.1 billion
4. Belgium
$41.8 billion
5. United Kingdom
$32.6 billion
6. Ireland
$31.8 billion
7. France
$30.1 billion
8. Netherlands
$29.5 billion
9. Italy
$21.2 billion
10. India
$13 billion
11. Spain
$11 billion
12. Austria
$8.7 billion
13. Canada
$8.4 billion
14. Sweden
$7.2 billion
15. Israel
$5.94 billion
AVIATION
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A range of new cutting edge aircraft
State corporations behind the surge in Russia’s aviation industry
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Results have been achieved with very modest investments
SHIPBUILDING
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Rosneft and other state corporations invest in massive Zvezda shipyard
[2] https://programs.gov.ru/Portal/
[3] http://theduran.com/russia-sanctions-fail-gas-turbines/
[4] https://shepwedd.com/knowledge/violation-eu-sanctions-russia-siemens-sues-over-unauthorised-shipment-power-turbines
[5] https://thebarentsobserver.com/en/industry-and-energy/2017/05/gazprom-prepares-arctic-drilling-new-yamal-projects,
http://www.gazprom.com/about/production/projects/mega-yamal/,
https://thebarentsobserver.com/en/industry/2016/05/start-pumps-putin-tells-yamal-oilmen
[6] https://www.ft.com/content/cca94692-2061-11e7-a454-ab04428977f9
[7] http://www.rbc.ru/economics/28/06/2017/5953aed69a79472c880d9ae1
[8] http://russia-insider.com/en/business/ri18828
[9] https://www.uralmash.ru/
[10] https://www.awaragroup.com/blog/the-hidden-story-of-crimeas-economic-success/
[11] http://www.reuters.com/article/us-russia-rareearth-china-idUSBRE9890EI20130910
[12] https://sputniknews.com/russia/201703221051851682-russia-swift-bank-head/
[13] http://www.zerohedge.com/news/2015-01-19/russian-central-bank-bans-western-ratings-agencies
[14] http://www.pwc.ru/en/automotive/publications/assets/auto-report-eng.pdf
[15] http://www.autonewseurope.com/assets/jpg/ads/pdf/RussiaAutomotiveMarketandtheCIS2010.pdf
[16] https://cyberleninka.ru/article/n/farmatsevticheskiy-rynok-proizvodstvo-lekarstvennyh-sredstv-v-rossii
[17] http://government.ru/programs/219/events/
[18] http://government.ru/programs/220/events/
[19] http://worldmaritimenews.com/archives/200981/zvezda-shipyard-secures-first-orders/Page 15