Made (badly) in Russia

By bne IntelliNews May 23, 2012

Ben Aris in Moscow -

What does Russia actually produce? Vodka and caviar spring immediately to mind. More recently, it has spawned a range of beer brands and a few dairy products that are unique to Eastern Europe like kefir, the sour yoghurt-like drink. At the other end of the scale there is of course oil, metals, minerals and diamonds. Oh and weapons - the AK-47 remains the world's most popular assault rifle. But that is pretty much it.

The government desperately needs to diversify the economy, but despite investing several billion dollars into the effort there has been little progress. Talk to the Russia Venture Company or the Direct Investment Fund and they will invest in any project that has the word "Russia" in the prospectus, because of the dearth of viable projects at home.

And things just got worse. In the middle of May, one of the very few Kremlin-sponsored programmes to have actually produced a new product ended in tragedy.

A newly minter Sukhoi Superjet 100 passenger aircraft strayed off course during a demonstration flight during the Indonesian air show and crashed into a mountainside killing all 45 people on board, including the deputy transport minister, who was presumably a possible buyer of the plane. At the time of writing, it was not clear if the disaster was due to pilot error or a technical problem with the plane, but the latter would deal a body blow to Russia's already poor image for aviation safety.

Planes, trains and automobiles

The Superjet is the culmination of five years of work to re-create the Russian aviation industry and establish a third player in the international plane-making industry after Boeing and Airbus. The government has sunk hundreds of millions of dollars into creating the Superjet passenger plane and nominally Russia is still good at making planes - the parent company Sukhoi also makes the world's only fifth-generation fighter jet, the T-50. "If [the Superjet crash] was pilot error, then it is not a huge blow to the Russian aerospace industry. However, if it was a technical problem with the aircraft, then it could really affect customer perception of the aircraft and order capability," says Tom Chruszcz, a director at the ratings agency Fitch Ratings.

Not that the Superjet programme was a roaring success even before the crash. A personal project of Vladimir Putin, the Superjet factory was opened in 2007 with a target to sell $250bn worth of the aircraft by 2025. However, sales have been slow. The first plane sold abroad was to Armavir, Armenia's national airline, which has four. Aeroflot also took delivery of four planes earlier this year, but immediately sent them back, officially because the interior decorations were wrong. In all, the company claims it has 170 orders so far (bne counts only 10 actual deliveries), but even this is well off the 1,000 the company needs to sell to be viable. Indonesia was going to buy 30 planes. Despite its foreign engines, avionics and a price that is a two-thirds of its rivals, the plane seems to underwhelm buyers. The biggest potential deal announced so far was from Irish budget carrier Ryanair, which said it was interested in buying 70 planes last year, but there has been no follow up.

The story is similar with cars. The state has lent the struggling Russian automotive industry, aka Lada-maker Avtovaz, $1.56bn in the last few years. And in a recent interview with bne, Avtovaz CEO Igor Komarov boasted that the company had already caught up with its peers in places like Romania in terms of productivity and was still aiming higher.

However, the Kremlin has given up what was obviously the hopeless task of catching up with the international carmakers, many of whom now have factories in Russia. The production of the iconic Lada 2107 was halted in April and then in May the government signed off on a deal to give control of the company to the French-Japanese Renault-Nissan alliance.

Truck-maker Kamaz is now the only truly Russian automotive producer left and even that is already working with Daimler and likely to be merged with Belarus' maker of giant mining trucks MAZ.

Call to arms

Russia is even having problems with the handful of products that it's famous for. In April, the Izhmash gun plant went bust, the maker of the world famous Kalashnikov AK-47 assault rifle. The problem is that although the AK-47 remains the most widely used rifle in the world, it is increasingly becoming out dated compared with modern weapons. Izhmash attempted to keep up with a new model, the AK-12, but the gun flopped and the company finally filled for bankruptcy after making an $80m of loss in 2011.

Likewise, the Russian Ministry of Defence abruptly cancelled a multi-million order for Tiger battle tanks this time last year because they were not good enough. Increasingly, the defence ministry is shopping overseas for arms and has purchased Mistral helicopter carriers from France, unmanned aerial vehicles from Israel, and Iveco armoured vehicles from Italy. It specifically criticised Russian-made tanks, reportedly saying "it is better to spend the money on German Leopards." Indeed, the Kremlin just announced that it was withdrawing its modernised version of the T-90 full order battle tank - the flagship of the fleet - at the Defexpo India 2012 that is about to open, without explaining why.

Still, Putin has made it explicit that while he may have given up on the Russian carmakers, he is not prepared to do the same with the Russian defence sector - just yet. In his sixth newspaper article in Rossiiskaya Gazeta published in February ahead of the presidential elections, he committed Russia to spending a "non-negotiable" RUB20 trillion ($655bn) on modernising the defence sector.

Putin rejected as "deeply untrue" the notion that developing the defence industry is an unnecessary burden and that militarisation bankrupted the USSR. He believes the planned spending "will modernise the entire economy", as a revived military industry will act "as a locomotive" that can pull the national economy into the future, creating new jobs and technologies.

That is a huge (or at least very expensive) gamble. It already brought him into direct conflict with his capable finance minister Alexei Kudrin at the end of last year, which ended with Kudrin's resignation. And given the defence sectors track record so far, it looks like relying on the military-industrial complex to stimulate modernisation is a poor plan.

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