Belts tighten as Russian car buyers turn to budget vehicles

General Motors shut its factory in Saint Petersburg as car sales in Russia plunged early this year, saying the local market, which not long ago had promised to become the biggest in Europe, was too challenging to merit more investment.

The Detroit-based company was the first western carmaker building vehicles in Russia to retreat — but it may not be the last. Behind the scenes “there’s a constant review of business strategies going on”, says Tim Urquhart, a principal analyst at IHS Automotive, an industry consultancy. “The situation is so bad.”

Russia’s automobile industry has been among the sectors worst hit by the economic contraction caused by low world oil prices and western sanctions imposed because of the Ukraine crisis.

The rouble has shed more than a third of its value against the US dollar over the past 12 months, driving a surge in inflation that has slammed the brakes on consumer spending.

Demand for new cars that soared throughout the past decade — except for a short lull during the 2008-09 global financial crisis — has evaporated as Russians have pared back their budgets to focus on essentials.

After falling 10.3 per cent in 2014, sales of new passengers cars are expected to drop by 37 per cent this year to 1.57m units , according to the Association of European Businesses, a lobby group that tracks the Russian car market. Western auto groups that flocked to establish assembly ventures in Russia when the market was booming had agreed gradually to increase production and the amount of local parts used at their factories in exchange for immediate tax breaks.

But, with the weakening rouble hammering sales and pushing up the cost of imported parts and components, these deals no longer look attractive.

GM decided to cut its losses in March, saying that Russian market conditions did not justify further large investments in localisation. Writing off $600m, the company mothballed its vast St Petersburg assembly venture and began withdrawing the Opel and several Chevrolet models from Russian dealerships.

GM’s exit sent shockwaves through the market although other western carmakers have yet to follow suit.

Indeed, Ford Sollers, the Ford Motor Company’s Russian venture, is moving in the opposite direction. It opened a $275m engine manufacturing plant in the Volga region last month, its biggest investment yet.

Sitting next to the company’s assembly plant in the town of Elabuga, the factory will equip at least 30 per cent of Ford’s Russian-built cars, says Elizaveta Novikova, vice-president of communications and public affairs at Ford Sollers. She adds: “Localising production helps cut costs and reduces exposure to currency fluctuations. It’s the best way to beat the crisis.”

Volkswagen and Renault have also commissioned engine plants in Russia this year to honour their commitments to the government.

Localising production helps cut costs and reduces exposure to currency fluctuations

While investing in a falling market may be risky, carmakers with a high level of localisation are better able to offer competitively priced products, according to Oleg Malyshev, head of the corporate finance practice at PwC in Russia.

“Others may experience difficulties and consider restructuring their Russian businesses, cutting model ranges or significantly increasing prices,” Mr Malyshev says.

Imported vehicles have been disappearing from the Russian market, driven away by high customs duties and the weak rouble, reinforcing the case for local production.

Seat, VW’s Spanish subsidiary, and South Korea’s Ssangyong Motors have both halted vehicle supplies to Russia this year. Honda is also on the way out. Its plans to shut its Russian distribution network next year amount to a “soft exit”, according to Azat Timerkhanov, an analyst at Autostat, a Russian car consultancy.

One bright spot is the luxury market, which is still too good for even GM to forsake. The US company has pledged to continue deliveries of US-made Corvette and Camaro sports cars to wealthy Russian clients, as well as its Chevrolet Tahoe sport utility vehicle.

UK luxury carmaker Bentley, owned by VW, added a third outlet this year to its dealership network in Moscow, where it is seeing strong interest in its Bentayga SUV.

Porsche, meanwhile, boosted Russian sales by more than 30 per cent in the first three quarters of this year, and sales of Toyota’s Lexus models are also up.

Aside from the wealthy, however, Russians have been trading down as real incomes fall, favouring budget cars over mid-priced ones, says Mr Timerkhanov.

Avtovaz, a Russian automaker controlled by Renault-Nissan, is still by far the biggest force, dominating a third of the total new car market, but it is facing strong competition from cut-price, locally made South Korean brands in the budget segment. For the first time in September the Hyundai Solaris sedan overtook Avtovaz’s Lada Granta as the best-selling car in Russia.

The Russian government forecasts the economy will stage a mild recovery in 2016 after contracting by 3.9 per cent this year.

But real incomes, weighed down by wage arrears and double-digit inflation, are unlikely to rise. That bodes badly for car sales, which could reach fresh lows, says Mr Timerkhanov. The Autostat consultancy warns that a return to the giddy peaks of 2012, when Russia for a few brief months overtook Germany to become the biggest car market in Europe, is unlikely in the near future.

For western carmakers trying to tough out the crisis, the road to recovery could be as rough as Russia’s potholed streets.