16.06.23 Sanctions Review

Import Substitution: Most Russian companies will be unable to abandon foreign equipment or raw materials in the near future

According to a survey conducted by the Centre for Macroeconomic Analysis and Short-term Forecasting at the Higher School of Economics, nine out of ten Russian enterprises require high-quality domestic alternatives to foreign equipment. However, only a quarter of these enterprises have access to such alternatives. The Russian government has been advocating for a policy of import substitution since 2014 when the country faced its first international sanctions following the annexation of Crimea. Nevertheless, Russian industry was unprepared for the sanctions imposed after last year's full-scale invasion of Ukraine. Over the past five years, Russian industrial enterprises have been increasing their share of both domestic and imported equipment in roughly equal volumes. Looking ahead to the next three years, two thirds of enterprises are only partially ready to reduce their reliance on imported means of production, while 18% are not prepared at all. Moreover, parallel imports have become more costly due to logistical issues and the depreciation of the ruble.

According to a survey by the Centre for Macroeconomic Analysis and Short-term Forecasting at the Higher School of Economics, 87% of Russian enterprises require domestic alternatives to imported equipment, components, raw materials, and technologies that are of comparable quality. However, only a quarter of the enterprises surveyed reported no shortage of such alternatives. Accordingly, 65% of enterprises acknowledge their significant dependence on imported means of production. Of these, 47% are highly dependent on them, while an additional 18% depend on them to an extremely high degree.

Despite the fact that the Russian government has declared a policy of import substitution since 2014, many were caught off guard by the need to refrain from importing foreign products as a result of the new wave of sanctions. Over the past five years, only 22% of enterprises have increased their share of new domestic equipment, while a similar percentage has increased the share of foreign equipment they utilise. The extractive industries, particularly oil and gas production, have significantly increased the proportion of new domestic equipment they utilise, with 60% of enterprises favouring domestic equipment and only 10% relying on imports. However, the situation is worse in the manufacturing sector. Out of 20 sub-sectors, only 7 have seen an increase in the share of domestic equipment they use surpassing the quantity of foreign equipment. In sectors such as machinery and equipment manufacturing, pharmaceutical production, and rubber and plastic goods manufacturing, the number of enterprises increasing their share of imported equipment is two to three times higher than those increasing their share of domestic equipment.

Dependency of Russian Enterprises on imported equipment as of the end of 2022, % of enterprises surveyed

Only 25% of enterprises claim to have a high potential for the production of import-substituting goods, while 27% consider their potential to be average. However, it remains unclear what this potential means and under what conditions it might be realised. Nonetheless, looking ahead to the next three years, only 65% of companies are willing to partially give up imported products. 18% have said that such a phase-out would be impossible, and only 10% stated that they could do so easily, according to a survey conducted by the Higher School of Economics.

Prospects for reducing reliance on imported equipment within three years, as of the end of 2022, % of enterprises surveyed

In the absence of high-quality domestic alternatives, one in five enterprises is forced to procure the necessary means of production through parallel imports. Problems in this process arise for half of these businesses. The greatest difficulties are experienced by those in the printing and textile sector, computer and electronics manufacturers, automobile producers, as well as pharmaceutical companies. Unlike last year, this year the weak ruble has added an additional strain on procurement. Nearly a third of companies surveyed by the Gaidar Institute in April stated that it is the ‘weak ruble and, as a result, the increased cost of imported equipment and raw materials’ that is holding back production growth.

Thus, the survey reveals that Russia is only seeming to cope well with the sanctions on the surface. In reality, enterprises are facing stretched costs, and the consequences of the sanctions will be felt in industry for several years to come. Russia has so far failed to establish the supply of high-tech goods that have been directly targeted by sanctions, as revealed by recent research conducted by Russian and Western economists. By the end of 2022, imports of such products from the EU and other countries within the sanctions coalition had plummeted by 80%. At the same time, there was only a marginal increase in imports from countries that have not imposed sanctions (with the exception of chips and microchips).