The Russian government has developed an ambitious import substitution plan for modernizing Russia’s Industry aiming to produce 800 products from 19 industry sectors in 2020 by implementing more than 2,000 localization projects. Furthermore, the government has tried recently to address this problem with the “carrot and stick” method: It excludes foreign suppliers from state tenders and offers incentives for companies that localize their production.
Localization – Your Chance to profit from Russia
Russia is not even a big country but also a great market for interior and foreign companies and businessmen in various sectors. Many western European companies are already in the Russian market and profit from the positive development of the Russian economy, even when there is an economic crisis.
Despite political and economic sanctions, the shares of foreign investments are quite high. The latest governmental regulations as well as the changing of laws for localization should support the modernization of Russian industry and foreign trade to adapt new technologies on the Russian market as well as foster local production and reduce Russia’s reliance on imported products.
Your questions – Our answers.
1. What exactly is the import substitution program of the Russian government?
Although the Russian economy is still suffering from a severe economic crisis, the Russian market remains one of the largest and attractive markets in many industry sectors in the world. The Decline of oil prices and the subsequent fall of the Russian ruble in 2014 proved a high dependency of Russia on oil prices. The Russian Government has identified this problem and took counter-measures to increase domestic production. Therefore, the Russian industrial policy is aimed at developing the manufacturing of Russian products that shall replace imports (import substitution program) and an increase in domestic production (localization).
The import substitution program of the Russian government was initially aimed at establishing restrictions on access of goods of foreign origin to the public procurement system in Russia. Then the Russian government developed specific action plans for import substitution aimed at a reduction of foreign goods being consumed in Russia by 2020 in more than 20 sectors of the economy, .e.g. machine manufacturing, light industry, oil refining industries, as well as medical and pharmaceutical industries.
A whole legal framework was created to implement the import substitution program in Russia as well as to provide more detailed legal regulation in the sphere of import substitution and localization. Each industry branch covered by the import substitution program contains specific requirements on products corresponding to “made in Russia”.
2. How attractive are the countries Russia, Ukraine, Belarus and Kazakhstan for production set up?
Setting up production in these countries has quite different motivations: Russia, Belarus, Kazakhstan, Armenia and Kirgizstan form the Eurasian Economic Union (EAEU), a union with a population of 183 million and a quite interesting market. Some years ago localization for example in Russia was mostly driven by high import duties and the respective customs duty advantage when producing locally. After the accession to the WTO this aspect faded. But due to the import substitution program of the Russian government, quite a lot of companies, especially those who sell to the public sector, are forced to localize to avoid losing the Russian market.
When localizing for the Russian market, of course a production set up in Russia makes sense. But as localized products from other EAEU member states are equally treated like Russian goods, to consider a localization in Belarus might also be interesting, especially as the costs for production set up in Belarus are still lower than usually in Russia and as Belarus is closer to the Western Europe, what might be an advantage from a logistic perspective. Production set up in Kazakhstan is usually driven by the needs of the local Kazakhstani marked and quite some interesting investment incentives in the special economic zones in Kazakhstan. The motivation for setting up production in Ukraine is different. Production in Ukraine is quite often set up not only for the local market, but especially for export. So you can find in the western part of Ukraine several suppliers for the European automotive industry that make use of the cheap labor force in western Ukraine.
3. What products need to be produced in Russia and to what extent?
The Russian Government adopted Decree No. 719 “On the criteria for the classification of industrial products as industrial products with no substitutes produced in the Russian Federation” which came into force on 1 October 2015 and regulates the industry sectors in which products need to be produced in Russia and to what extent.
This Decree regulates the following industry sectors:
- machine manufacturing
- automotive industry
- special machine manufacturing
- photonics and lighting engineering
- power engineering, electric and cable industry
- heavy engineering
- medical products
- construction materials industry
- furniture and wood industry
- railway machinery
The Government Decree No. 719 stipulates criteria for localization in Russia. The concrete criteria depend on the specific type of product and may include, among others, the requirement that:
- certain technological operations on products are carried out in Russia;
- a manufacturer shall have rights to the product’s design and technical documentation; and
- existence of a service center in one of the member states of the Eurasian Economic Union.
For example certain technical operations shall be conducted in the EAEU to localize the manufacturing of registered drugs since 1st January 2017:
- production of the finished pharmaceutical form (f.e granules, pills, drops, solutions);
- final quality control.
Coming into force on the 1st January 2017 the Government Decree No. 925 stipulates with the priority for Russian goods, works and services in the field of government procurement provisions. This priority is established in light of the provisions of the General Agreement on Tariffs and Trade (GATT) as of 1994 and the Eurasian Economic Union Treaty as of 29 May 2014. It means that the priority is not applicable to the EAEU members and is established only for specific spheres, including defense and security, military, protection of human life and health, gold and silver distribution, protection of artistic, historical and archaeological objects.
4. What needs to be considered when choosing the location for production?
The key drivers of a localization project depend strongly on the function which the prospective production will perform, for instance supplier or final producer. Therefore the following points vary in terms of importance and priority from project to project.
Location of final customer: Depending on the amount, the location of the final customers can be either the single key driver for the choice of the future land plot or even being not important at all. For instance, within the automobile industry, it is mandatory in accordance with standard OEM requirements that suppliers of car components need to be near the OEM factory. Otherwise suppliers will not or hardly be considered as official suppliers. In terms of an automobile OEM facility the location of final customers doesn’t play a significant role at all. While cars from the ORM are distributed directly to the whole country or internationally, other key factors play a much more significant role.
Amount of state incentives and reputation of regional state bodies: After the factor “location of final customer” the next crucial point is of course the quality of governmental support. But it is important to mention that the amount and type of incentives shall not blend the potential investor from the reality. The implementation of many state incentives start only after the decision of the location has been made. Therefore it is important to check on the quality of the reputation of the respective regional authority. It can even be beneficial to contact investors in the region in terms of their experience in cooperation with the local governmental body.
Supplier infrastructure: Most types of production projects rely on basic components or parts which are sourced on the domestic market. Therefore an appropriate stable supplier network with a respective output level on quality and quantity is important.
Logistic access to ship port and airport: The importance of this key factor depends on whether the produced goods require many imports and/ or will be subject to extensive export. In case a company is able to source most of the components on the domestic market, it only partially has the need to add imported parts and deliver the goods directly to the nearby located OEM plant, and so having an airport or ship port is not necessarily important. The access to a port can be necessary in case of high product turnover or voluminous goods to avoid logistics via highway. In terms of an airport, for cargo this might be necessary for smaller charges but with a necessity to be moved fast.
Logistical access to public transport: Often the location of the production is several kilometers away from the next city away. The connection and access to the public transport system is crucial to move the labour force, for example from the nearest located metro station to the production plant. In case there is no connection to the public transport system available, a company solution is necessary to implement and creates additional costs.
Educational infrastructure: This factor reflects the amounts and types of universities located in the chosen area. Especially whereas the set-up of a production is mostly long-term oriented, this factor plays a crucial role. Having sufficient and sustainable supply of young experts is a big advantage. Inviting specialists and experts from afar and convincing them to settle in the chosen area is connected with additional costs and can lead to a project result totally over budget or a deficit in production output.
Living space / Real estate environment: The quality and quantity of affordable living space in the chosen region for employees, which have to change their place of living, is important. A low quantity of good quality living space can lead to additional costs for employee and employer.
Access to healthcare: A quick access to medical infrastructures (e.g. hospital, rehabilitation centers) and a sufficient amount of doctor offices as well as pharmacies need to be taken into consideration.
Opportunities of Entertainment: In regard to the satisfaction level of your labor force it is also important to consider the options of going out and being entertained, for instance in restaurants, cinemas, swimming pools, etc.
5. What incentives are provided by regional investment policies for investments in industry parks or special economic zones?
In general incentives for industrial parks, even managed privately or by the state, are subject to the specific regulations stated in the investment policy of the respective region. The duration of validity depends on the investment agreement concluded with the regional authority responsible for investment projects Whereas the incentives for the special economic zones (SEZ) are regulated on federal level of the Russian Federation and guaranteed until 2054 by law. In this regard it is necessary to have a closer look into the regional investment policy or the specific SEZ incentive offering to do a better evaluation. A relief or significant decrease of the following factors (additional factors possible) is the most popular tool to attract new investors:
- Profit Tax
- Land Tax
- Transport Tax
- Property Tax
- No customs duties
- Import VAT
- Purchase Price of land plot(s)
- Social contributions
- Requirements for HQS employment
6. What are the options for a production set up? (Contract Manufacturing, Leasing, Self set up)
There are several options for a production set up in Russia, including the conclusion of a contract manufacturing agreement with a local partner, lease of production facilities or by the establishment of your own production via the construction of a plant (Greenfield vs. Brownfield).
A Foreign manufacturer is entitled to conclude a contract manufacturing agreement (CMA) with a local partner owning manufacturing areas, where the end products to be sold and distributed in Russia (and possibly elsewhere) will be produced. Usually, the local legal entity of the foreign manufacturer delivers raw materials and provides the CMA partner with all technological documentation required for
performance of works or services agreed. The scope of this cooperation is to receive a final local product or services performed by the CMA partner.
The obvious advantages of the contract manufacturing option are a quick-start of the project and no need to require a manufacturing license/certificate. The downsides of such cooperation are risks associated with know-how-transfer, e.g. in case of contract termination. Moreover, sometimes high contributions are required by providers while there is no complete control over quality.
Some samples for CMA in the pharma industry:
- Merck Senoro (Pharmstandard)
- Eli Lilly (R-Pharm)
- Pfizer (Petrovax)
- Teva (Biotec)
Another option for localization of your manufacturing process in Russia is the lease of existing manufacturing facilities, equipment or personnel by a local legal entity. Choosing this option, the local entity shall receive all necessary licenses (if applicable) and permits/certificates for the manufacturing processes itself. In this case you will have more control over quality and use of know-how.
Self set up of local production
The self set up of a local production (eventually comprehensive localization) provides full control on the production process and benefits from conclusion of so-called special investment contracts. The downside is that the set-up of such production requires high investments and is quite time-consuming. The preliminary phase (construction stage, approval stage etc.) can last rather long in practice. There are, however, several successful examples of self productions in different industry sectors, e.g. Volkswagen, Ford, Hyundai, Claas, Astron, Bosch, Novartis, Teva, Takeda, Berlin-Chemie, Stada etc.
7. How to secure my know how when producing in Russia, Ukraine, Belarus, Poland or Kazakhstan?
Although infringements of IP rights are in these countries not such a big problem like in some Asian countries, especially in case of contract manufacturing or joint ventures securing know how and other IP rights is an important issue to consider. Proper registration of patents and clear contractual agreements on licensing trademarks, patents, know how etc. are a must and the key to be on the save side.
8. How to bring machinery and assembly lines for the production into the country?
Although within the last few years customs procedures became much more transparent and faster, especially in Russia, customs clearance and certification are still a major aspect to be considered when setting up production and organizing the delivery of an assembly line to these countries. Due to the large distances logistics might also a challenge. But with regard to customs clearance and certification some tools exist that can make life much easier when importing machinery and assembly lines to Russia or other EAEU countries. If the machinery or assembly line cannot be delivered by one truck or convoy, a classification decision might be an interesting option that often also saves quite some money on customs duties. After having obtained a classification decision, machinery or assembly lines can be delivered in smaller parts/several trucks and still being regarded as one single unit with one customs tariff number and one single certificate. After all parts are imported a summarized customs declaration is done. It should be taken into account that obtaining such classification decision takes some time and requires proper preparation. So the key for successfully bringing machinery and assembly lines for production into the country is thinking ahead, good preparation and well planning.
Localization with SCHNEIDER GROUP – Our services:
Localization in Russia – We provide you with overall support in all questions about searching for the right partnerships and construction of production in Russia. For you we will find the right CMO partner.
Therefore we provide you with the following services:
- Searching for partnerships (affiliate partner) in production
- Risk assessment of partners
- Issue of contracts for further legal consulting
- Set up business
We support you in building up you own production
Mistakes in localization and building up of production could be more expensive than you thought. Our experts support you from the beginning of your localization project. We provide you as well with the following services:
- consulting for choice of location
- company registrations
- Interim Management
- Tax consulting
- Accounting and reporting
- Set up an IT infrastructure
- Many more.
Localization in Russia
Read our publication about Localization in Russia. Simply click on the picture and upload the PDF issue of the brochure.
Read our publication about Localization in Russia. Simply click on the picture and upload the PDF issue of the brochure.
Chances and risks of localization
Since beginning of 2015 the Russian government increasingly uses import substitutions. The reliability of the domestic economy from foreign imports and export of fossil fuel should be reduced. The setup of a comprehensive industry should be forwarded during the next time. The necessary requirements for improving the quality and quantity of local produced products are made via laws and regulations.
Read our brochure “localization in Russia” and get to know more about the following
- Localization in Russia
- Pharma strategy 2020
- Automotive industry
- Legal framework for localization in Russia
- Import substitution, restriction of state
- Special contracts for investments
- Tax privileges
- Requirements for localization
- Certificate for “made in Russia”
- Where to localize? Overview of special economic zones and industry parks
- Special economic zones
- Regional industry parks
- Chances and risks of localization
- Motivation of investors
- Our services