Rachel Morarjee in Moscow -

Foreign drug manufacturers are racing to bolster their positions on the Russian market in order to circumvent the Kremlin's tough new rules on imported medicines, and the domestic market is set for a new growth spurt.

Late last year, Prime Minister Vladimir Putin unveiled a new two-decade long plan to modernise the country's pharmaceutical industry and to give local firms a greater presence in international markets through $3.9bn in government funding.

Putin said he wants 90% of Russia's vital medicines and 50% of its medical equipment to be produced domestically by 2020, and wants to increase exports eight-fold.

Foreign pharmaceutical companies and medical equipment manufacturers will face restrictions on selling their goods in Russia if they do not bring their technology and manufacturing facilities into the country, he warned. "We will have restrictions for them on our market if there are no imports of manufacturing facilities and technologies," Putin said, saying the trade barriers would be implemented in a gradual way.

Dmitry Genkin, CEO of Russia's Pharmasynthez, which raised $17.6m in a November IPO, says Russia has struggled with the Soviet legacy of building most of the pharmaceutical industry elsewhere in Eastern Europe. "It left us with a huge gap between fundamental sciences and applied science like medicine when the Soviet Union collapsed," he explains.

Russian firms have long waited for government support, but current spending levels in the country fall far short of the money spent to support research and development in Europe, Genkin notes. "The money being spent by the Russian government is still peanuts compared to spending by the European Commission or the US National Institute of Health," he says

Nevertheless, Russia's pharmaceutical market is growing twice as fast as in the US and European markets, and has already become a key battleground for pharmaceutical companies whose sales have stalled in western markets as patents expire. "The pharmaceutical market, boosted by consumer and government spending is set to outperform Russian GDP, while the fragmented regional pharmacy segment offers big consolidation potential to leading chains," say analysts at Russian brokerage Uralsib.

Arrival of the giants

Western drug giants are determined that they won't be caught out by the import barriers and so are setting up domestic manufacturing bases in Russia to cash in on the market's growth potential.

Just before Christmas, Swiss giant Novartis said it would invest $500m in Russia over the next five years, building a manufacturing plant in St Petersburg to focus on local manufacturing and R&D partnerships with local companies. Switzerland's Nycomed and Denmark's Novo Nordisk have also announced plans to start producing in Russia, while Britain's GlaxoSmithKline struck a vaccine deal in November with Moscow-based Binnopharm. French firm Sanofi-Aventis in January appointed a new emerging markets management team to boost their market share in Russia, which it considers as one of its key markets.

Meanwhile, Russian companies are also looking at markets overseas. Pharmasynthez has said it will use part of its IPO funds to purchase pharmaceutical producers in Europe, as well as in the US and Israel. Pharmasynthez is looking for small, growing and profitable

companies that own production facilities, Genkin says.

With the push to promote the domestic pharmaceuticals industry, the Kremlin has opened up a new front in the war to diversify the Russian economy. Analysts are excited by the government's initiative, as it gives them a new sector to invest into. In the last week of January, Russian investment bank Uralsib launched a re-initiation of research into the pharmaceutical sector with a report entitled, "Just what the doctor ordered."

"Russian pharma producers offer an excellent domestic story and access to defensive market niches and strong cash flows. The relative underperformance of Russia's pharmaceutical market by comparison to other Bric markets is compensated for by the market leaders' higher margins and consolidation potential," Uralsib's analyst Tigran Hovhannisyan wrote in the report.