- Government responded to crisis by promoting import substition
- Some industries failing to find replacements for goods at home
As the economic crisis deepened in Russia, Orthodox churches offered to hold prayers beseeching divine help for import substitution, a priority for President Vladimir Putin once his country found itself walled off from global markets.
In industries ranging from copper mining to pet foods, most entreaties have so far fallen on deaf ears. Companies such as GMK Norilsk Nickel PJSC and Nestle SA are struggling to source machinery and ingredients locally even as the mantra of “import substitution” pushed aside the previous buzzword, “modernization.” The latter was popularized during the presidency of Dmitry Medvedev in 2008-2012 and discarded without trace after the Ukrainian conflict, according to Sergey Tsukhlo, a department head at Gaidar Institute.
While heated rhetoric became the hallmark of Russia’s confrontation with the U.S. and Europe since the crisis in Ukraine erupted in 2014, a quieter struggle has played out on the domestic front, with authorities making import substitution their rallying cry. Banning French cheese and Polish apples was an easy first step. A much harder challenge is to upend supply chains and ease import reliance across a swathe of industries whose dependence of foreign components and materials has grown during Putin’s 16 years in power.
“It’s happening on a very modest scale, no match for the propagandist PR campaign that we see from the government,” said Tsukhlo, who studies import substitution at the Gaidar Institute in Moscow. “I have a feeling that manufactures don’t want to shift to Russian products, mainly because there are no substitutes or analogues or for another reason: quality.”
Policies aimed at making goods or services domestically that were previously produced abroad are again coming to prominence for economies trying to adjust to currency weakness and cheaper commodities. The strategy lost favor after its widespread adoption in Latin America in the 1950s ended with the debt crisis three decades later.
In Indonesia, President Joko Widodo has pushed an economic agenda that included some protectionist moves and measures to encourage import substitution. The Australian central bank has relied on a decline in the local currency to help replace imports and boost competitiveness.
The initiative carries an added ideological charge in Russia. While the crisis in Ukraine stoked the flames of patriotism and pushed relations with the West to a post-Cold War low, it also thrust Russian vulnerabilities to the forefront.
As part of the economic measures, U.S. companies shut down paid services in Crimea following Russia’s 2014 annexation of the peninsula and stopped providing software updates to Russian companies penalized by the U.S. over the Ukrainian conflict. Sanctions on the export of some drilling technology and equipment to the country threatened the energy industry.
With geopolitics and the upheaval on commodities and currency markets reshaping the economy of the world’s biggest energy exporter, a turn inward soon followed in government policy.
Also giving a fillip to farmers were restrictions on some food imports from countries that imposed sanctions against Russia in 2014, followed by similar measures against Turkey last year. A drop of more than 50 percent in the value of the ruble since early 2014 further undercut demand for foreign goods.
Russia’s currency, which touched a record low of 85.999 against the dollar on Jan. 21, has strengthened more than 21 percent since then, the world’s best performance over that period.
That’s propelled growth in agriculture to 3.1 percent last year even as the broader economy slipped into its first recession since 2009, shrinking 3.7 percent. Cheese output surged more than 17 percent from 2014 and meat added 13 percent.
How lasting the shift in will be is another matter. Evgeny Gontmakher, a board member at Moscow’s Institute of Contemporary Development -- whose chairman is Medvedev, now serving as prime minister -- says the effects will fade once the trade limits are lifted. After the gains, agriculture accounted for 3.5 percent of gross domestic product last year, close to its 3.2 percent share in 2011-2014, Alfa Bank estimates.
“As soon as foreign investors get back to the Russian agriculture market, they will force out domestic producers, because, clearly, they will again offer produce of a higher quality and, by the way, cheaper,” Gontmakher said. “There isn’t much sense even for Russian investors to invest in agriculture as they don’t know what will happen in a year.”
The central bank is more upbeat, saying that developments in import substitution and non-commodity exports provide evidence that the economy is adapting to outside challenges.
The latest survey, though, paints a different picture. The process is stalling, with 11 percent of industrial companies intending to boost import substitution, or half the share of those that plan the opposite, according to a December report by the Gaidar Institute and the Russian Presidential Academy of National Economy and Public Administration. The biggest laggard is the food industry, as the proportion of firms reducing purchases of foreign supplies fell to 16 percent in the third quarter, down from 36 percent in the prior three months.
“There is nothing to replace a German potato harvester, it simply doesn’t exist,” said Pavel Grudinin, director of an agricultural producer in the Moscow region. “We started purchasing some cheaper Russian seeds and they are worse than imports.”
There’s also little relief in sight for companies such as Norilsk Nickel. The country’s largest miner laments that no domestic substitutes exist for the type of machinery it needs in punishing places like the Arctic port of Dudinka. To run its far-flung operations in northern Russia, it’s spending millions to buy cranes from Liebherr Group, flotation equipment from Outotec Oyj, pumps from Weir Group Plc and grinding mills from Metso Corp.
Firms catering to consumers face similar challenges. The local chief for Nestle, the world’s biggest food company, says its dependence on imports for things as basic as the dry vegetables it uses in pet products or the materials needed to make packaging exposes it to swings in the exchange rate.
“There is political will in the country to push more to local manufacturing for raw materials and packaging, so we hope to benefit more from this trend in the future,” said Maurizio Patarnello, head of Nestle’s business in Russia and Eurasia.
Perhaps the biggest hurdle for any structural changes is Russia’s business climate, with the nation starved of capital amid sanctions. Fixed-capital investment shrank 8.4 percent in 2015, posting the longest stretch of declines since at least 1995, when Bloomberg started compiling the data.
“I will not be surprised if we do not see substantial changes, especially a recovery based on expansion of non-oil and non-commodity sectors in the near future due to a poor business and investment climate,” said Marek Dabrowski, a non-resident scholar at the Brussels-based Bruegel research group.