Industry Trend Analysis - Generic Drug Production To Accelerate In Eastern Europe - APR 2017

BMI View: P harmaceutical manufacturing growth in the CEE region has accelerated in recent years due to the combination of a rising demand for medicines and a need to reduce import reliance given weakening currencies. This theme will accelerate over the coming years due to the high growth potential of Eastern European markets. Revenue earning o pportunities will predominantly exist for generic drug manufacturers over patented medicine producers.

Investment into the domestic production of pharmaceuticals in the Central and Eastern Europe (CEE) region has accelerated considerably over recent years ( see 'A Recap On The Pharmaceuticals & Healthcare Outlook For 2016: Central & Eastern Europe', November 11 2016). We highlight this trend as a key theme that will be sustained in the region over the long term. Specifically, strong generic substitution rhetoric across the region as a whole, coupled with a lack of scientific expertise, will lead to an uptick in medicine manufacturers focussing on the generic medicine segment (at least over the medium term). We note that this will predominantly play out in Eastern European markets due to the different market dynamics and industry development between the Central Europe and Eastern European sub-regions.

Central Europe: Generic Medicine Production Presence, Convergence With Western Europe

Western European countries such as the UK, Germany and Switzerland are the historic powerhouses for innovative pharmaceutical research and development, and consequently patented medicine production. The Central Europe and Baltic sub-region has meanwhile developed a mature generic medicine manufacturing industry. Firms such as Lek (Slovenia), Krka (Slovenia), Grindeks (Latvia), Zentiva (Czech Republic), Polpharma (Poland) and Gedeon Richter (Hungary) manufacture significant volumes of generic medicines which are supplied not just to European markets but globally.

As a consequence of European Union accession in 2004 (or earlier), these markets have well developed and established regulatory environments. Consequently, demand for high-value innovative medicines is greater, reflected in the sub-region's elevated average per capita pharmaceutical expenditure. Given the development of these markets, the trends driving market growth reflect a closer alignment with Western European markets than those of less development CEE states of emerging market status ( see ' Central Europe And The Baltics Move Towards Western European Trends ' , December 20 2016).

Higher Demand For Advanced Medicines
Selected Central European Countries: Per Capita Pharmaceutical Spending, USD (2015)
Source: BMI

This expansion of domestic medicine production in the Eastern European sub-region has been driven by a number of reasons: rapidly expanding demand for medicines; weakening currencies increasing the cost of imports; and attempts to diversify economies.

Increasing Demand For Medicines

A theme we have highlighted previously is the expansion of healthcare access in emerging European markets. This will drive significant growth for both healthcare and medicine expenditure over the coming years. For many of these countries, healthcare provision is heavily concentrated in urban areas, is of poor quality and a significant proportion of the cost is placed on the consumer. We note that there has been a concerted effort from many governments in the region to reverse these trends, most clearly exemplified by the planned introduction of Mandatory Social Health Insurance Schemes in Kazakhstan and Azerbaijan in the coming years, whilst Georgia introduced a similar scheme in 2013. These initiatives will, going forward, greatly increase the affordability and therefore accessibility of healthcare treatments which will in turn drive demand for medicines.

In addition, poor dietary and lifestyle habits, as well as the region's ageing demographic profile will further increase demand for medicines. Alcohol and tobacco consumption is particularly high in CEE, leading to a disease burden of non-communicable diseases that is unparalleled on a global level. In addition, the region's ageing population will exacerbate the increasing demand for chronic disease medicines.

Ageing Population Drives Increased Medicine Demand
Pensionable Population By European Sub-Region, %
Source: BMI

Currency Weakness

This considerable increase in demand for medicines has been compounded in recent years by currency weakness which has dramatically increased the cost of pharmaceutical imports. The global depression in oil prices between 2014 and early 2016 had a significant impact on a number of CEE countries, many of whose economies are highly reliant on commodities. As a result, the values of their currencies have fallen considerably against the dollar since the start of 2014.

While the two key markets in the region of Turkey and Romania are not reliant on commodities, both have also seen their currency lose value against the dollar in recent years. According to BMI's Country Risk team, both have suffered from reduced sentiment towards emerging market currencies following rising yield expectations in the US around 2013. Both countries are highly exposed to this risk on account of a sizeable current account deficit, which is particularly critical for Turkey as it relies almost wholly on short-term capital inflows for external financing. Compounding matters further, deterioration in investor sentiment towards Turkey in recent years has resulted in growing levels of capital flight, placing additional pressure on the lira.

Weakening CEE Currencies
Key CEE-USD Exchange Rates*
Note: Exchange rates have been normalised from January 1 2014. Source: BMI

The widespread weakness in currencies across the region has made pharmaceutical imports extremely expensive. As such, to meet the growth in domestic demand, governments have attempted to incentivise investment towards domestic production. This effort is highly visible in Russia's Pharma 2020 plan, which aims for the domestic pharmaceutical industry to meet 90% of demand for medicines on its Vital and Essential Drugs List by 2020 ( see 'Status Quo To Remain For Pharmaceuticals Despite Elections', September 16 2016). Turkey too has outlined an ambitious vision (Vision 2023) for the growth of its pharmaceutical industry, aiming to reverse its medicine trade deficit by 2023 ( see 'Vision 2023 To Drive Domestic Pharmaceutical Investment', October 18 2016). Other governments have also introduced measures such as tax breaks and state financial support for investment into local manufacturing facilities.

Significant Export Opportunities

While a considerable proportion of this new medicine manufacturing is born out of a necessity to meet the aforementioned growth in domestic demand, investment in the region also represents strategic approaches by these countries to benefit from the high growth potential of their neighbouring markets. While pharmaceutical market growth is expected to be suppressed in Western Europe, and Central Europe to an extent, due to cost-containment measures, we forecast considerable growth within Eastern European markets. Indeed, this is highlighted by a number of pharmaceutical firms posting strong medicine sales growth in the region, with Latvian generic drugmaker Grindeks posting 18.4% y-o-y growth for 9M16 in Russia, Georgia and other CIS countries.

High Growth Prospects In Eastern Europe
CEE: Pharmaceutical Sales, 5-Year Forward CAGR, %, loccur
Source: BMI

In particular, we highlight that new production facilities built in the smaller countries, such as Georgia or Azerbaijan for example, will have a smaller domestic demand and will therefore be focussed on export opportunities. By contrast, investment into the Russian pharmaceutical market will principally seek to meet the demand of the domestic market. Indeed, with a population in excess of 140mn, Russia's own pharmaceutical market dwarfs those of its neighbours. Both approaches represent significant revenue generation potential for generic pharmaceutical firms. Meanwhile, Turkey's Vision 2023 aims to utilise growth in its pharmaceutical industry to diversify its economy. Therefore, despite Turkey presenting a large domestic market, firms based in the country will also be looking to benefit from export opportunities.

Risks To Multinationals

We note that although the high growth potential of medicine demand in the region represents an attractive proposition for drugmakers, multinational investment into the region by innovative pharmaceutical manufacturers will remain restrained. This is principally due to the high propensity of generic substitution, attributable to the widespread need to make medicines affordable for the population and healthcare providers. Moreover, large generic manufacturers will face challenges in the form of poor operating environments within these markets; many still struggle with weak regulation, opaque pricing legislation and high levels of corruption.

Russia will remain the exception to this given the Kremlin's strict domestically-biased regulations, making inward investment necessary for large multinational firms in order to prevent exclusion from the highly lucrative market. However, while investment into manufacturing facilities by these firms, such as Pfizer and Eli Lilly, has been accelerating in recent months, we note that much off this investment has come in the form of the localisation of their older, off-patent medicines ( see 'Domestic Pharmaceutical Industry To Continue To Expand', January 6 2017).