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The following article is from a past issue of the CENTRAL EUROPE AUTOMOTIVE REPORT™. If you would like to receive our most current information and all the articles included in our information packed monthly and weekly reports, subscribe today.
Article title: Developing Production & Improving The Quality of Autos & Parts in Russia
Subhead: Russia and CIS Watch
Central Europe Automotive Report, Volume III, Issue 2, February 1998
The following are edited excerpts from a paper prepared by Victor I. Pashkov, Head of Economic Analysis at ASM Holding in Russia. The paper was delivered last October at a supplier conference organized by IBC UK Conferences in Warsaw.
ASM-Holding is a company created by more than 160 automobile and agriculture machinery construction enterprises from Russia, CIS, and Baltic countries. The company's principal tasks are to represent and protect the interests of its shareholding enterprises, to assist with the development and consolidation of international cooperation, to facilitate scientific and technical studies, and to provide technical, economic, organizational, and other services to support the financial and economic activities of the enterprises.
The company was established in 1991 and has set up more than 60 enterprises and organizations either independently or jointly with partners, including manufacturing companies, banks, insurance companies, and leasing companies.
In 1997, the majority of automobile construction enterprises shall pass through the lowest critical point and shall begin to increase production volume and restructure themselves while taking into account consumer requirements, their solvency, and the overall economic situation. Thus, in the first six months of 1997 there was a substantial increase in the volume of production compared to the corresponding period in 1996: 8.0% for trucks, 11.3% for passenger cars, and 17.9% for buses.
The data on the relationship between volume of sales and volume of production in the first six months of 1997 provide evidence of the achievement of a process of production reconstruction in response to consumer demand. Thus, Zil sold 93.6% of trucks manufactured; GAZ sold 100% of trucks, 99.8% of passenger cars, and 98.7% of buses manufactured; KamAZ sold 100% of trucks and 100% of passenger cars; UAZ sold 105% of trucks, 99.6% of passenger cars, and 104.5% of buses; VAZ sold 100% of passenger cars; Krasny Aksai sold 108.7% of passenger cars; and the Kurgansk Bus Plant sold 86.1% of its production.
Unfortunately, sales of the Moskvich plant remain low: 30.3% of production for the first six months of 1997. But on the whole, enterprises have learned to operate in the market and, in our opinion, it can be expected that the tendency for automobile production growth shall continue for the near future.
However, the stability of this tendency shall depend on how quickly plants can improve the quality of automobile equipment produced and maintain their competitiveness.
Measures to Increase Production & Improve Quality
Traditionally, the inadequate quality of domestic automobile parts resulted from their production not being an independent sub-sector but being concentrated in the production of large automobile plants. In the 1980's, only 15 of 146 automobile parts plants were independent, with the remainder being part of large enterprises. Internal production relations in such enterprises did not aid the resolution of quality problems.
Today, the domestic auto industry's most important task is to set up the production of parts that meet international quality standards. In our opinion, this should be achieved through the implementation of a number of key measures.
Organizational Restructuring
The organizational restructuring of active plants must take place, making provision for the allocation of parts production to legally independent enterprises and facilitating the creation of a competitive environment. The restructuring of such enterprises may be initiated by changing the taxation system -- primarily through regulating VAT rates -- and by creating other economic conditions to ensure that restructuring is attractive.
Presently, there is an unfortunate predominance of large associations of enterprises with narrow specializations that are not capable of reacting quickly to market demands, including the demand for constant improvement of quality.
Joint Ventures Must Be Encouraged
The creation of joint ventures with foreign companies should be an effective method for improving the quality of parts production.
Investment Incentives For Domestic & Foreign Investors
A system of privileges should certainly be employed, providing state support to enterprises cooperating as part of joint ventures or independently developing high quality auto parts.
Russia is closely monitoring the experience of Uzbekistan, Belarus, and other countries that are utilizing taxation and other privileges to develop automobile construction.
Daewoo's Demands
By building automobile plants in consumer countries, the Koreans are procuring extraordinary taxation and customs privileges from country governments.
For example, during the discussion of issues related to the creation of a joint venture between AvtoZAZ and Daewoo, Daewoo's demands formed a long list:
exemption of the joint venture from payment of VAT and profit tax;
an amnesty for the plant with regard to debts to the budget;
a three-year exemption from payment of all taxes and import duties on approximately 100,000 Korean-assembled cars;
exemption from social welfare payments and extra-budgetary fund payments; and
the adoption of severe restrictive measure against imports of other manufacturers' automobiles to Ukraine
These demands do not appear excessive if one takes into consideration that success can come only where there is speedy concentration of huge resources, and that the project itself shall be implemented in an extremely compressed time period.
Belarus Entices Ford
The Belarus government, giving priority to extricating the country from a severe investment crisis, granted the US/Belarus joint venture ("Ford-Union") considerable privileges:
from the registration date, the joint venture was exempted from payment of customs duties, value added tax, and excise duties on machines, equipment, tools, raw materials, parts, overland transport facilities, and spare parts and accessories for these facilities imported into the territory of Belarus and intended for the production of Ford automobiles; and
exemption from payment of tax on profit from the sale of services and its own production for five years from the time a profit is declared, including the first year of profit.
In 1997, the joint venture intends to assemble 6,000 Escorts and Transits and expects to develop the capacity to produce 20,000 vehicles a year.
Kaliningrad Attracts Automakers With Incentives
Certain state support measures have been adopted to create assembly-line production of modern passenger cars in Kaliningrad Oblast. An order of the Russian Federation Government has granted enterprises engaged in implementing the project an investment tax credit of 120 billion rubles, and the introduction of $30 million of investment credit from foreign banks has also been permitted under state guarantees.
Substantial privileges have been granted by decisions of the Kaliningrad Oblast Duma and the Kaliningrad City Duma. For legal entities taking part in this project, incentives included:
exemption from payment of local profit taxes for three years;
profit taxes reduced by 75% in the fourth year and by 50% from the prescribed rate in the fifth year;
property tax exemptions for the first two years, and a 50% reduction from the prescribed rate in the following years;
reduction of the lease payment (land tax) rate by 50%;
cancellation of the advertising duty and retail trading right fee for the first three years, with partial reductions in the fourth and fifth year.
Uzbek/Daewoo Joint Venture
The Uzbek/Daewoo joint venture involved establishment of a plant with a designed capacity of 200,000 automobiles per year. In 1996, 24,878 automobiles were produced (of which 96.3% were sold), and the plan for 1997 was 125,000 cars.
A significant part of the funds earned by the joint venture are earmarked for a new plant in Taskent for production of some 300,000 1.5-1.8 liter engines. To a large extent, such positive results have been achieved through the support given to the joint venture by the state, which introduced tax privileges for five years.
Decisions to Grant Privilege Come Slowly
There is a particular need for rationalization of taxation and customs policies in order to support enterprises producing automobile components. Unfortunately, implementation of decisions to grant taxation privileges proceeds with great difficulty. For example, it would appear that there are no obstacles to implementation of the "Statute on the Procedure for Applying VAT and Excise Duties on Supplies of Goods/Services in Relation to Industrial Cooperation when Payments are Made Between Economic Subjects of CIS Member States" (the "Statute").
Introduced by the CIS Inter-State Economic Committee, the Statute was approved by the Council of CIS governments in January 1997. It provides that payments for goods (work, services) supplied by the economic subjects of CIS member states in accordance with agreements concluded on the basis of inter-state industry and inter-industry production cooperation and production specialization agreements shall be made at market prices and tariffs without value added tax or excise duties.
Implementation of this Statute would have substantially influenced the reduction of prices of manufactured products, increased the ability of consumers to pay, and would have provided an incentive to inter-state parts suppliers and increased production in CIS country enterprises. But on various pretexts, the CIS member states avoided this agreement. Evidently, interested parties -- automobile manufacturers and their unions -- need to show greater persistence in working with state administrative bodies and demonstrate the necessity for introducing privileges.
Russia and Belarus Use Tied Credit
The following companies are taking part in a well known project for the development of diesel engine production: AO "Yaroslavl Engine Plant," AO "Tutaev Engine Plant," Yaroslavl Fuel Equipment Plant, Yaroslavl Diesel Equipment Plant, Minsk Automobile Plant, Minsk Wheeled Tractor Plant, BelAZ, and Mogilev Automobile Plant.
The relationships between these enterprises are defined by the conditions of tied state credit of 500 billion rubles, which is granted by the Russian Federation Government to the Government of Belarus. Belarus shall use these funds to acquire engines from the "Russian Motors Company." The first tranche of credit (50 billion rubles) has already been paid, signifying the commencement of the project's implementation.
Tied credit as a means for stimulating the foreign consumer's ability to pay has had very restricted use in Russia. The success of the above project is extremely important since it shall open up new opportunities to develop automobile construction in both countries, providing new Belarus automobiles with new Russian diesel engines.
Adoption of International Accounting Standards Essential To Attract Investment
Serious hopes of reviving the investment process -- especially foreign investment -- are tied to the introduction in 1997-1998 of accounting practices complying with international standards. This permits the balance sheets of domestic enterprises to be rendered comprehensible for foreign investors.
Presently, a great volume of documents have been published regulating the activities of foreign investors in Russia. The efficiency of this regulatory base, however, is extremely low. First, because privileges granted are insubstantial, and second, because enterprises remain non-transparent to foreign investors due to the special accounting systems used by the companies.
OAO ASM-Holding has approached state administrative bodies with a request to entrust it with the organizational work of converting Russia's automobile enterprises to meet international accounting standards, especially component manufacturers.
Preferential Credits Can Speed Up Promising Investments
Automobile manufacturers are looking to state administrative bodies for more precise definition and speedy implementation of a procedure for state support of the most promising investment projects on a quota basis by granting preferential credits out of budgetary funds. Up to the present time, a large number of such projects have undergone expert examination by Russia's Ministry of Economics and have been deemed efficient. Auto parts projects under this program include:
Organization of the production of 16-valve engines at the Zavolzhskiy Engine Plant;
Creation of new types of electrical equipment (AO "Tarasov Plant," Samara);
Creation of facilities to produce a multi-functional compact generator (AO "ATE-1," Moscow);
Organization of production of fuel injection electric petrol pumps (Tyumen Plant ATE);
Creation of compact generators and electronic locking systems for car doors (AO "ATE-2," Moscow);
Development and organization of fuel equipment with increased injection power for bus and auto diesel engines ("YAZTA," Yaroslavl);
Organization of production of a series of 2-3 liter diesel engines jointly with the company "Shtaier" (AO "GAZ," Nizhny Novgorod);
Development of lighting equipment production for automobiles (AO "OSVAR," Vyaznki);
Creation and production of fuel injection systems (AO "PEKAR," St. Petersburg)
However, decisions on the actual allocation of preferential credit funds from the budget to implement these projects have been deferred for the time being due to a severe deficit in these funds.
More Solutions Still Needed For Some Problems
Problems which have not yet found a solution in Russia and other CIS countries include:
Development and organization of production of modern petrol and diesel engines and anti-locking units for pneumatic and hydraulic braking systems;
Creation of highly efficient ignition systems for vehicles that use natural gas as a fuel;
Creation of exhaust gas neutralizers without using precious metals;
Development and organization of production of driving wheel hydraulic servo-control units for passenger cars, automatic gearboxes for trucks and cars, control systems micro-processors
Summary
The information presented here provides evidence that enterprises in the automotive sectors in Russia and other CIS countries are conducting serious research efforts to improve the quality of autos produced. There is adequate potential, which, with a certain amount of state support, is capable of bringing the quality of auto equipment closer to market requirements.
There are, however, problems which need to be tackled from scratch. Without attracting foreign investment and cooperation with foreign partners, marked improvement of the situation is hardly possible within a short period of time.
Today, it is becoming evident that governmental administration bodies in Russia and other CIS countries are paying more attention to direct producers. State support is being recognized as necessary and enterprises are prepared for efficient cooperation with foreign investors.
The specialists at OAO ASM-Holding are prepared to consider proposals from foreign investors interested in the above-mentioned projects to develop auto components, and to organize negotiations with the representatives of the relevant companies.
OAO ASM-Holding, jointly with a range of scientific organizations and by commission of the Russian government, is preparing a strategy for developing Russian automobile construction, which involves interaction of state administrative bodies, direct producers of auto equipment, and investors (including foreign investors), for the purpose of ensuring a sharp rise in the standard of domestic automobile construction over the next few years.