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Cablegate: Russian Pharmaceuticals Market Takes Off (C-Tn7-00763,

DE RUEHMO #4043/01 2291114
R 171114Z AUG 07





E.O. 12958: N/A

REF: A. Moscow 976
B. 06 Moscow 12814

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1. (SBU) SUMMARY: Russia's pharmaceuticals market has grown by
leaps and bounds in the last three years, and experts predict
continued robust growth in the short term in almost all major market
segments. Foreign firms continue to dominate the market and account
for an estimated 75-80 percent of all sales. The GOR wants to
reorganize the domestic industry to compete more effectively,
because it views the dependence on foreign firms as a long-term
national security risk and as one factor that has led to the
development of a large counterfeit drugs market. International
firms argue that there is no link between foreign market dominance
and the counterfeit drugs market, noting that the bulk of
counterfeits are domestically produced. Even so, some foreign firms
are beginning to realize that an investment in domestic production
would not only be profitable, but also help ensure a continuing
long-term market share in Russia. However, it is likely that
European drug makers will be more interested than U.S. firms in
investing in existing Russian plants or in building production
facilities from scratch. END SUMMARY.

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Pharmaceuticals Market Growing Astronomically

2. (SBU) Russia's pharmaceutical market has seen some of the fastest
growth in the world over the last three years and is expected to
continue humming along in coming years. In 2006, the pharmaceutical
market was worth $10.7 billion, according to market analysts, up
27.4 percent from 2005, when sales grew by 35 percent compared to
2004. Over the counter (OTC) drug sales accounted for 53 percent of
total sales in 2006. The head of Russian operations at one U.S.
pharmaceutical company told us he expects sales growth of 25-30
percent in 2007 in the OTC segment and growth of 20-25 percent in
prescription drug sales. The Russian Government is the largest
single buyer, accounting for 47 percent of total sales through drug
tenders, subsidies to hospitals, and the federal drug benefits

3. (SBU) Despite the impressive growth prospects in almost all
segments of the market, the government's drugs benefit program for
social welfare beneficiaries has been a drag on growth in 2007. The
program, which is known as the Additional Drug Supply or "DLO," was
plagued by deficit spending and distribution problems in late 2006
and early 2007 (reftels). Some foreign firms tell us they are still
waiting to be fully paid for drugs they supplied under the program
in 2006. Market analysts estimate the DLO accounted for at least 10
percent of total sales in 2006.

4. (SBU) Sales of imported drugs have actually declined 17 percent
during the first five months of 2007 compared to the same period in
2006, according to the market analysis firm DSM Group. Most
observers believe the decline reflects continuing problems with the
DLO, which will act as a drag on sales growth throughout 2007. Full
year sales in 2007 are expected to increase by only 10-12 percent
over 2006. French drug-maker Servier's sales reportedly declined by
27 percent during the first five months of 2007, while British firm
GlaxoSmithKline's sales dropped by 33 percent, probably because a
greater portion of their sales were made through the DLO.

5. (SBU) Many industry contacts expect the DLO will continue to have
problems in 2008, because of the potential for chaos when the
federal government transfers procurement authority for part of the
program from the federal to the regional level in the fall of 2007.
Despite the program's difficulties, the DLO could account for as
much as 20-25 percent of total drug sales in 2008 as the government
expands the program to provide benefits both for chronic patients
who need expensive drugs or long term medication (primarily
hemophiliacs, leukemia patients, and diabetics), and for pensioners,
veterans, and the needy.

--------------------------------------------- -
Foreign Market Domination Worries the Russians
--------------------------------------------- -

6. (SBU) Foreign firms maintain a firm grip on the Russian market
and account for 75-80 percent of total sales, according to industry
contacts and market watchers. (NOTE: While President Putin stated
at a March Cabinet meeting his displeasure that foreign firms

MOSCOW 00004043 002.2 OF 003

control nearly "90 percent" of the Russian drugs market, Deputy
Health and Social Development Minister Starodubov has since stated
that foreign producers actually control slightly less than 80
percent of the market. END NOTE.) The current dominance of foreign
producers represents a gradual decline in the fortunes of domestic
producers, who controlled 60 percent of the market in 1991 as the
Soviet Union and Warsaw Pact began to disintegrate.

7. (SBU) With such a large percentage of sales going to foreign
firms, the Russian government is attempting to reform the portion of
the domestic market controlled by the state. The Kremlin sees
Russia's dependence on foreign drug suppliers as a long-term
national security threat and would like to establish a strong,
integrated domestic pharmaceutical production system. By the end of
2007, the Russian Agency for Industry (Rosprom) reportedly hopes to
establish a pharmaceuticals holding company, which would control
five state-owned production facilities and nine research institutes.
The government has been short on the specifics of how this
reorganization would work. However, up to half of the shares in the
new holding company could reportedly be sold to foreign drug
companies, probably to take advantage of their technical expertise
in good manufacturing practices.

8. (SBU) By increasing the competitiveness and capacity of domestic
drug companies, the GOR believes that Russia will achieve a more
stable and secure supply base, increase drug safety, and achieve
cheaper prices for consumers. Moscow Mayor Luzhkov has also long
wanted to promote the city of Moscow and the surrounding region as a
prime location for large-scale drug production. The most difficult
obstacle for Russian firms to overcome will likely be the poor
quality standards of domestic firms, few of which currently comply
with good manufacturing practices or other international norms for
drug production.

--------------------------------------------- --------
Will Foreign Firms Invest in Russian Drug Production?
--------------------------------------------- --------

9. (SBU) Historically, few international pharmaceutical firms were
interested in investing in domestic drug production in Russia.
According to our contacts, this was partly because of a generally
cautious approach among drug company boards towards investments in
Russia and the lack of a clear economic advantage to domestic
production versus importing. However, there are growing signs this
conservatism is beginning to change. One industry representative
told us that the recent tremendous growth in drug sales and the
concomitant strong growth in fast moving consumer goods (e.g.,
toiletries, soaps, cosmetics, toothpaste, shaving needs, and
detergents) are both persuasive signs that Russians in the coming
years will begin spending lots of money on OTC and prescription

10. (U) Servier, the second largest French pharmaceutical company,
became the first big drug company to establish domestic production
in Russia in early July with a 40 million Euro investment in the
construction of an 11,500 square meter full cycle pharmaceutical
plant near Podolsk in Moscow Oblast. Servier is the largest seller
of prescription drugs in Russia and the third biggest drug company
in Russia in terms of overall sales. Servier's Russian plant will
produce 20 drugs for the treatment of diabetes, cancer,
cardio-vascular and nervous system diseases. Production will start
by the end of 2007 with an annual capacity of 60 million pills and
will reach 4.5 billion pills per year by 2011.

11. (SBU) German drug-maker Stada purchased one Russian
pharmaceutical firm in 2005 and is now in the process of acquiring a
second, Makiz-Pharma, for a reported 135 million Euros, which would
be the largest-ever foreign acquisition of a Russian drug company.
Pfizer announced in late July it is also considering opening its own
plant in Russia, or acquiring and revamping an existing facility,
though the company has not made any final decision yet. Foreign
manufactures are likely thinking that a domestic presence will allow
them to increase both overall sales and sales to the government
through the DLO and other tenders. Other foreign firms, such as
Johnson and Johnson and GlaxoSmithKline, have established joint
ventures with local firms to manufacture HIV/AIDS drugs and some
seasonal flu and hepatitis vaccines. Industry contacts tell us the
GOR has not offered any concrete incentives like tax breaks for
establishing domestic production, but locally manufactured drugs do
enjoy a preference in government tenders.

12. (U) Some international banks have also been attracted by the
pharmaceutical market's impressive growth and have been willing to

MOSCOW 00004043 003.2 OF 003

back innovative financial mechanisms to support the industry.
Financing in the pharmaceuticals industry is generally on standard
commercial terms. However, 36.6, Russia's largest drug store chain,
has financed its expansion by selling for $85 million a nearly 25
percent stake in its pharmaceuticals manufacturing subsidiary,
Veropharm, to a consortium of international banks led by the South
African-based Standard Bank. Separately, 36.6 has been looking for
a buyer for Veropharm, and GlaxoSmithKline is reportedly the main
interested suitor. Whoever ultimately buys Veropharm will pay off
the international bank syndicate or retain them as a minority
partner. Later this year, 36.6 is also expected to become the first
Russian firm to issue short-term commercial paper (a novelty in
Russia) to fund its operations.

Fake Drugs Spark Controversy
13. (SBU) Experts estimate that sales of counterfeit drugs in Russia
are at least $200-$300 million per year, with some 70 percent of
fake drugs being produced domestically. Foreign pharmaceutical
companies have argued that more rigorous domestic enforcement and
stiffer penalties for "pharma-pirates" could help control the
problem. Government officials counter that establishing a stronger
domestic industry and eroding the dominant position of foreign firms
will allow the government to weed out counterfeit production,
claiming that the higher prices for imported drugs act as a profit
incentive for pirates to enter the counterfeit market. In a
February 2006 speech to prosecutors, President Putin stated that
"the trade in counterfeit medicines is a real threat to our nation's
health, and the distribution of counterfeit products without a doubt
discredits Russia as a reliable business partner."
14. (SBU) In a highly publicized counterfeiting case in 2006, a
Moscow court fined domestic drug company Bryntsalov-A 40,000 rubles
($1,500) for the improper storage of drugs at its facilities. This
was a lesser offense than counterfeiting, with which Brynstalov was
also charged. The court found there was insufficient evidence of
actual counterfeiting by Bryntsalov, and it also stopped short of
revoking the company's manufacturing license, as foreign
pharmaceutical firms had demanded. The decision was widely regarded
as a completely inadequate punishment for a company that Western
drug makers estimated had sold at least $30 million worth of
counterfeit drugs in the Russian market, including about $1.5
million in sales of fake bottles of Bayer aspirin. The company is
owned by Vladimir Bryntsalov, a former Duma Deputy and former
presidential candidate, and is still mired in other criminal
investigations. Tatyana Brynstalov (Vladimir's sister) and several
other company managers currently stand accused of illegally selling
alcoholic beverages as a medicine in order to avoid paying the
excise tax on spirits.
15. (SBU) COMMENT: Despite strong market growth in Russia, we
believe many American drug companies will take a conservative
approach in the near term and prefer investing in other BRIC
countries such as India and China. As the Russian office head of
one U.S. drug company told us, "The Americans are aggressive in
China, while the Europeans are aggressive in Russia."


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