The Russian government has developed an ambitious import substitution plan to modernize Russia’s industry, which aims to produce 800 products from 19 industry sectors by 2020. This will be accomplished by implementing more than 2,000 localization projects. The government has recently tried 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 just a big country but also a great market for local and foreign companies and businessmen in various sectors. Many western European companies are already in the Russian market and profiting from the development of the Russian economy, even during economic crisis.
Despite political and economic sanctions, the share of foreign investments are quite high. The latest government regulations and change of localization laws should support modernizing Russian industry and foreign trade, adapting new technologies on the Russian market, fostering local production, and reducing 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 most attractive markets in many industry sectors in the world. The decline of oil prices and the subsequent fall of the Russian ruble in 2014 showed the dependence of Russia on oil prices. The Russian Government identified this problem and took countermeasures to increase domestic production. Russian industrial policy is aimed at two things: developing the manufacturing of Russian products that will replace imports (import substitution program) and increasing in domestic production (localization).
The import substitution program was initially aimed at establishing restrictions on the access of foreign goods to the public procurement system in Russia. Then the Russian government developed a specific action plan for import substitution aimed at reducing the amount of foreign goods being consumed in Russia by 2020 in more than 20 sectors of the economy, such as machine manufacturing, light industry, oil refining industries, and medical and pharmaceutical industries.
A whole legal framework was created to implement the import substitution program and to provide a more detailed legal regulation of import substitution and localization. Each industry covered by the import substitution program contains specific requirements for products to be considered “made in Russia”.
2. How attractive are Russia, Ukraine, Belarus, and Kazakhstan for production set up?
Setting up production in these countries has different motivations. Russia, Belarus, Kazakhstan, Armenia, and Kyrgyzstan form the Eurasian Economic Union (EAEU), with a population of 183 million and an interesting market. Several years ago, localization 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 became less important. However, due to the import substitution program, many 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, production set up in Russia makes sense, but as localized products from other EAEU member states are treated like Russian goods, localization in Belarus is an attractive option. The costs for production setup in Belarus are lower than in Russia and Belarus is closer to Western Europe, a logistics advantage. Production setup in Kazakhstan is usually driven by the needs of the local Kazakh market and investment incentives in the special economic zones. The motivation for setting up production in Ukraine is different. Production in Ukraine is often set up not only for the local market, but especially for export. You can find several suppliers for the European automotive industry making 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 effect on 1 October, 2015 and regulates the industries in which products need to be produced in Russia.
This decree regulates the following industries:
- machine manufacturing
- automotive industry
- special machine manufacturing
- photonics and lighting engineering
- power engineering, electric, and cable
- heavy engineering
- medical products
- construction materials
- furniture and wood
- railway machinery
The Government Decree No. 719 stipulates criteria for localization in Russia. The concrete criteria depend on the type of product and includes these requirements, among others:
- certain technological operations on products are carried out in Russia
- the manufacturer will have rights to the product’s design and technical documentation
- the existence of a service center in one of the Eurasian Economic Union member states.
For example, certain technical operations localize the manufacturing of registered drugs when conducted in the EAEU since 1 January, 2017:
- production of the finished pharmaceutical form (granules, pills, drops, solutions, etc.)
- final quality control
Coming into effect on 1 January, 2017, Government Decree No. 925 stipulates the priority of Russian goods, works, and services in government procurement. This priority is established in light of the General Agreement on Tariffs and Trade (GATT) of 1994 and the Eurasian Economic Union Treaty of 29 May, 2014. This means that the priority is not applicable to EAEU members and is established only for specific spheres: defense, security, and military; protection of human life and health; gold and silver distribution; protection of artistic, historical, and archaeological objects.
4. What to consider when choosing a production location?
The key drivers of a localization project depend on the function of the prospective production. Therefore, the following points vary in terms of importance and priority from project to project:
Location of final customer: The location of the final customer(s) can be the single key driver in choosing the future location, or not be important at all. Within the automobile industry, it is mandatory that car component suppliers be near the OEM factory, in accordance with standard OEM requirements. Otherwise, suppliers will not 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. Since cars from the OEM are distributed directly to the whole country or internationally, other factors play a much more significant role.
Amount of state incentives and reputation of regional state bodies: After the location of the final customer, the next crucial point is government support. The implementation of many state incentives start only after the location decision has been made, so it is important to check the reputation of the respective regional authorities. It can be beneficial to contact investors in the region to discuss their experience with the local governmental bodies.
Supplier infrastructure: Most types of production rely on basic components or parts which are sourced on the domestic market. Therefore, an appropriate and stable supplier network with the necessary quality and quantity is important.
Access to ports and airports: The importance of this factor depends on whether the produced goods require many imports and/or will be exported extensively. If a company is able to source most of the components on the domestic market, it does not need to add many imported parts to deliver the goods directly to the nearby OEM plant, so having an airport or sea port is not very important. Port access can be necessary with high product turnover or high volume goods to avoid road transport. Airport access can be important for small cargo that needs to be transported quickly.
Access to public transport: Often the production location is several kilometers away from the nearest city. The connection and access to the public transport system is crucial to move the labour force to and from the production plant. When there is no connection to the public transport system, a company solution is necessary and creates additional cost.
Educational infrastructure: This factor reflects the amount and types of universities located in the chosen area. Especially when the production setup is long-term oriented, this factor plays a crucial role. Having a 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 carries additional risks and can lead to an over budget project or production output deficit.
Living space / Real estate environment: The quality and quantity of affordable living space in the chosen region for employees is important. A low quantity of good quality living space can lead to additional costs for employee and employer.
Access to healthcare: Quick and sufficient access to medical infrastructure such hospitals, doctor’s offices, and pharmacies need to be considered.
Entertainment opportunities: It is important to consider entertainment options like restaurants, cinemas, swimming pools, etc., to maintain the satisfaction of your labor force.
5. What incentives are provided for investment in industrial parks or special economic zones?
In general, industrial parks, managed privately or by the state, are subject to the specific regulations in the region’s investment policy. The validity period depends on the investment agreement concluded with the regional authorities responsible for investment projects, whereas the incentives for special economic zones (SEZ) are regulated on a federal level and guaranteed until 2054 by law in the Russian Federation. Due to this, it is necessary to look into the regional investment policy or the specific SEZ incentive offering for a more complete evaluation. Relief from or significant decrease of the following is the most popular way to attract new investors, among others:
- Profit Tax
- Land Tax
- Transport Tax
- Property Tax
- Customs duties
- Import VAT
- Purchase Price of land plot(s)
- Social contributions
- Requirements for HQS employment
6. What are the options for production setup?
There are several options for production setup in Russia, including a contract manufacturing agreement with a local partner, lease of production facilities, or establishment of your own production via the construction of a plant.
A foreign manufacturer is entitled to enter into a contract manufacturing agreement (CMA) with a local partner that owns manufacturing facilities where the end products, to be sold and distributed in Russia or 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 to perform the agreed work or service. The result is a final local product or service performed by the CMA partner.
The obvious advantages of the contract manufacturing option are the quick start of the project and that a manufacturing license/certificate is unnessecary. The downsides are risks associated with know-how transfer, sometimes high contributions required by providers, and lack of 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 localizing manufacturing in Russia is leasing existing manufacturing facilities, equipment, or personnel by a local legal entity. With this option, the local entity will receive all necessary licenses (if applicable) and permits/certificates for the manufacturing processes itself. This grants more control over quality and use of know-how.
Self setup of local production
Self setup of local production, and later comprehensive localization, provides full control over the production process and benefits from concluding special investment contracts. The downside is that the setup of such production requires high initial investments and is time-consuming. The preliminary phase (construction, approval, etc.) can be rather long in practice. There are many successful examples of self production across different industry sectors: Volkswagen, Ford, Hyundai, Claas, Astron, Bosch, Novartis, Teva, Takeda, Berlin-Chemie, and Stada
7. How to secure my know-how when producing in Russia, Ukraine, Belarus, Poland, or Kazakhstan?
Although infringements of IP rights are not as big of a problem in Russia as in some Asian countries, 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, and know-how are essential.
8. How to import machinery and assembly lines for production?
Customs procedures have become much faster and more transparent in the last few years, especially in Russia, but customs clearance and certification are still a major consideration when setting up production and organizing the delivery of an assembly line. Due to the large distances, logistics might also a challenge. Regarding 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 can save on customs duties. After obtaining a classification decision, machinery or assembly lines can be delivered piecemeal and still be regarded as one single unit with one customs tariff number and one certificate. After all parts are imported, a summarized customs declaration is done. Obtaining a classification decision takes time and requires proper preparation, so the key for successfully bringing machinery and assembly lines into the country is thinking and planning ahead.
Localization with SCHNEIDER GROUP – Our services:
We provide you with overall support in searching for the right partnerships, constructing production, and finding the right Contract Manufacturing Operator (CMO) in Russia.
We provide the following services:
- Searching for partnerships in production
- Risk assessment of partners
- Contract and legal consulting
- Business setup
We support you in building your own production
Mistakes in localization and production building can jeopardize the entire project. Our experts support you from beginning to end of your localization project. We provide the following services, among others:
- Consulting on location choice
- Company registration
- Interim Management
- Tax consulting
- Accounting and reporting
- IT infrastructure setup
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.
Opportunities and risks of localization
Since the beginning of 2015, the Russian government has increasingly used import substitutions. The independence of the domestic economy from foreign imports and export of fossil fuels is being reduced and the necessary requirements for improving the quality and quantity of locally produced products are being set 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 substitutions and restriction for the 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
- Opportunities and risks of localization
- Motivation of investors
- Our services