Foreign Automakers are at the Forefront of Rapid Growth in Russia

Russia has started to appear on automakers' radar screens, as a market with enormous growth potential that can no longer be ignored, according to the latest Global Auto Report released today by Scotia Economics.

Russia is already one of the top ten global auto markets, with 2006 car sales of 1.5 million units, surpassing Spain to become Europe's fifth-largest car market. However, with only 31 million vehicles in operation in Russia, a country with a population of 142 million, the vehicle penetration rate only stands at 0.2 per capita, in line with Mexico, but still significantly lower than other Eastern European markets, such as Poland and Hungary. Russia's vehicle penetration is roughly one-third of the G7 average of 0.6 vehicles per capita.

"While many Russians still can't afford to purchase a new car, strong economic growth is boosting household income at a double-digit pace, leading to a rapidly expanding Russian middle class," says Carlos Gomes, Scotiabank's auto industry specialist. "In fact, estimates suggest that personal disposable income will more than double between 2005 and 2010, propelling Russia into Europe's second-largest auto market by early next decade, surpassing France, Italy and the United Kingdom."

Many middle-class households are increasingly shifting to more expensive foreign models, at the expense of domestic brands. Sales of imported cars surged by nearly 70 per cent in 2006. Ford has become the best-selling brand in Russia, largely due to the popularity of the Ford Focus, the best-selling model in Russia, with 2006 sales of nearly 80,000 units. Purchases of foreign cars have surged an additional 65 per cent year-over-year through April of 2007.

In contrast, volumes at Russian automakers, such as AvtoVAZ, the country's largest carmaker, fell by five per cent last year. Domestic vehicles are considered inferior to foreign models. To change this perception, and to fully participate in Russia's strong auto market, AvtoVAZ recently reached an agreement with Magna International Inc., Canada's largest auto parts supplier, to develop an US$8,000-US$10,000 compact car for the Russian market. The joint venture calls for an investment of US$2 billion, including new assembly facilities. A final decision on this plan is expected later this year.

Other foreign automakers, such as Volkswagen, General Motors, Toyota, Renault and Suzuki, also are rushing to set up new assembly facilities in Russia. The Russian Industry Minister indicated late last year that foreign automakers plan to invest US$1.8 billion in new assembly facilities, lifting Russia's vehicle assembly capacity to three million units by the end of the decade, up from the current 1.7 million. The addition of 1.3 million units of assembly capacity through decade-end means that Russia will experience the world's third-largest increase in new assembly capacity over the next several years, only behind China and India. @@page@@

North American Vehicle Sales Weaken

Turning to North America, vehicle sales slowed in the United States and Mexico last month, but revved up in Canada. In April, U.S. purchases fell eight per cent below a year ago to an annualized 16.3 million units, down from the 16.5 million pace registered in the first quarter. The slowdown was widespread and reflects weaker consumer purchases, partly linked to declining house prices as well as the recent increase in mortgage delinquencies, especially in sub-prime mortgages. Ford indicated that its retail sales fell by 17 per cent year-over-year in April.

"The increase in gasoline prices to more than US$3.00 per gallon, the highest level since September 2005 in the aftermath of Hurricane Katrina, was also a factor reducing U.S. purchases in April, and will dampen activity in the key spring selling season," says Mr. Gomes.

As a result, GM once again reduced its second-quarter North American production schedule. The company now plans to assemble 1.145 million vehicles in North America between April and June, 15,000 units less than last month's guidance. This latest cutback lowers second-quarter North American production schedules to an annualized 15.7 million units, down from 16.0 million in the opening months of 2007, and in line with the weak output registered in late 2006.

In contrast, Canadian passenger vehicle sales posted a nine per cent year-over-year gain in April, climbing above an annualized 1.7 million units for the first time since December, when automakers were offering year-end clearances. In particular, sales at the traditional Big Three climbed eight per cent year-over-year, reversing three consecutive months of decline.

Crossover utility vehicles led the advance, with sales surging 35 per cent above a year earlier. Subcompact cars also outperformed, with purchases of the Toyota Yaris buoyed by Ottawa's $1,000 rebate for fuel-efficient cars.

Scotia Economics provides clients with in-depth research into the factors shaping the outlook for Canada and the global economy, including macroeconomic developments, currency and capital market trends, commodity and industry performance, as well as monetary, fiscal and public policy issues.