Import Substitution Woes: companies using Russian-made products report quality issues

According to a survey conducted by the Bank of Russia the results of which are presented in the report titled 'Regional Economy', the majority of Russian businesses have switched to domestically produced equipment and components in 2022. Prior to this, most had been using imported technology. The survey revealed that half of the companies surveyed voiced concerns about the quality of these domestic products. Nevertheless, experts from the central bank view the transition to domestic products as the primary goal of the ‘structural transformation’ of the Russian economy. The key ambition of this transformation is to maintain the technological capabilities that the country had achieved prior to its full-scale invasion of Ukraine. However, industries that require high-tech products that are difficult to replicate may struggle to achieve this goal.

The upcoming issue of the 'Regional Economy' report reveals that in 2022, two-thirds of the enterprises surveyed by the Bank of Russia experienced problems with imported equipment, components and materials. The mining, processing and agriculture sectors were hit particularly hard. In 2021, before the invasion of Ukraine, 46% of Russian imports consisted of investment goods; this figure dropped to 41% in 2022. This data indicates that imports have been ‘simplified’, and some domestic production that had been using imported components has now substituted these with imports of finished products.

Two-thirds of the businesses surveyed experienced import issues, with 75% citing problems due to the refusal of foreign counterparties to supply them, while 43% encountered problems during the transportation of the imported goods. Despite these problems, 40% of companies continued to purchase imported equipment and components, either directly or through intermediaries in third countries, such as Turkey. However, working with parallel imports through Asia has become increasingly difficult due to the limited transport capacity of the modernised Eastern range of Russian Railways (the railway’s capacity is set to increase by a mere 15% in 2024). Another issue is that the volume of traffic through Russia’s southern border crossings has grown fivefold, which has led to congestion issues. Additionally, nearly a third of the surveyed companies, which continue to use imported products, have experienced difficulties making payments for them.

The survey indicated that 13% of enterprises have experienced a decline in their output due to issues with the import of investment goods. However, the need for import substitution has resulted in an increase in output of 3% of the companies surveyed. 11% of those in the machine-building industry and 9% in the chemical industry increased their output due to import substitution. On the other hand, the machine-building industry had also experienced the most issues in terms of output, reporting a 25% reduction. Other industries that were negatively impacted by import substitution included wholesale trade (21%), construction (17%), manufacturing industries in general (15%), and transportation and storage (15%).

The transition to replace imported products with Russian-made counterparts has been challenging. 30% of companies that had made the switch to using these products reported an increase in the price of their finished goods, 12% had products break down more frequently, 12% had noticed a decline in product quality and 8% experienced a reduction in their production capacity. Some companies had been forced to simplify their product specifications in order to cope with these changes. In general, the Bank of Russia’s survey underscores what economist Branko Mladovich has referred to as an unprecedented 'experiment of technologically regressive import substitution.'

Nevertheless, the Bank of Russia views the expansion of domestic production, also known as 'replacement investment', as the primary means of adapting the economy to the conditions of large-scale international sanctions. To achieve this, the bank suggests using what is known as 'reverse engineering,' or the process of copying European technologies. This approach is favoured over using existing Asian analogues, as they are 'noticeably inferior in quality to their European counterparts.'

Generally speaking, this policy makes sense, given that the primary focus of the sanctions policy may ultimately be the enforcement of compliance with the restrictions currently in place (Re: Russia has previously discussed this here and here). Recent media reports indicate that Turkish customs have already begun blocking the parallel imports of sanctioned goods into Russia, following the visit of US Secretary of State Anthony Blinken to the country.

The Bank of Russia reiterates its position that the 'structural transformation of the economy' (a term first mentioned in the regulator's first 'wartime' issue of its 'What the Trends Say' review from April 2022) is crucial to the preservation of the country’s pre-war technological capacity. However, a number of its experts acknowledge that this objective will be difficult to achieve in certain industries, with microelectronics posing the biggest challenge.