April 28, 2017

China–Russia Economic Ties: Strengthening but Strained

Sino-Russian relations have been improving in many dimensions, including in economic terms. In the last few years, the People’s Republic of China (PRC) has become the Russian Federation’s largest trading partner, while Russia has become a main source of China’s imported oil and has attracted more Chinese investment. The PRC has also been acquiring advanced weapons from Russian arms exporters, filling critical gaps in Chinese military power. Overall, Russia’s foreign economic ties have rebalanced away from Europe and towards China in recent years.

However, Russian hopes of China filling the gap created by Western sanctions have not panned out. The devaluation of the rouble, the economic slowdown in China and Russia, and the fall of global oil and gas prices have sparked a major decline in Sino-Russian trade volumes and quelled hoped-for PRC direct investment in and loans to Russian industry. Notwithstanding Russian aspirations for greater Chinese investment and technology, PRC investors are as reluctant as other foreign firms to expose themselves to the lukewarm and unpredictable Russian market. Sino-Russian economic ties remain risibly small compared with China’s US and European trade and investment links. The economic relationship between Russia and China remains small in size and scope, and Moscow has become more economically dependent on China. Among other consequences, Moscow’s bargaining position has greatly weakened, making it harder to resist Chinese demands to buy shares in Russia’s upstream market or Arctic hydrocarbon projects.
For many joint projects, China generally contributes cheaper labour, extensive manufacturing capability and most financial capital, while Russians typically offer access to their domestic market as well as superior technology and R&D insights. Moscow has sought to exchange exports and access to Russian infrastructure for Chinese loans, investment and other aid in modernising Russia’s economy. More recently, Russia’s immediate focus has been to evade Western sanctions through the pursuit of other partners, especially China, combined with import substitution and other domestic measures.
Russia’s desire for energy sales to China is unsurprising, given that hydrocarbon exports fund about one-third of the government’s budget. Meanwhile, China wants to diversify its sources of imported energy, especially from neighbouring countries like Russia, whence energy can come via pipelines or other land transport less exposed to Western interdiction than maritime imports from Africa and the Persian Gulf. Fundamentally, Russia is energy-rich but capital-poor, while China needs more oil and gas and opportunities for foreign investment.

New Deals and Directions

The last few years have seen a raft of energy and other Sino-Russian commercial agreements. For example, during Putin’s June 2016 visit to Beijing, the two governments signed dozens of deals that included accords on agriculture, energy, finance, infrastructure, technology and trade. In 2013, the Russian energy giant Rosneft signed a 270-billion-dollar deal with the China National Petroleum Corporation to supply the PRC with 360 million tonnes of crude oil until 2038. Moreover, the Russian Transneft energy corporation has been building a new pipeline that could send 30 million tonnes of oil per year to China. Until recently, Russian policymakers were hesitant to grant China access to Russia’s natural resources and investment opportunities in the country’s Far East. However, Moscow relaxed these barriers after Western sanctions battered Russia’s economy. For instance, the Beijing Enterprises Group Company has acquired 20% of Rosneft’s East Siberian subsidiary, Verkhnechonskneftegaz, giving China access to the East Siberia–Pacific Ocean oil pipeline and Rosneft the opportunity, through gas swap deals, to sell gas directly to Chinese consumers.
Several projects being considered extend beyond oil and gas, including coal, solar energy and hydroelectricity. Russia is striving to retain its position as a major source of technology, equipment and services for China’s civil nuclear energy sector, which is undergoing a major expansion. Sino-Russian cooperation at the Tianwan nuclear plant dates to 1997, and 10 years later the plant began regular commercial operations. China has also worked with Russia on the development of fast neutron reactors. The China Atomic Energy Authority also signed an agreement with Rosatom to cooperate on the construction of floating nuclear power plants for China’s offshore islands.
Beyond energy, China Railway and Russian Railways have signed a “comprehensive strategic cooperation agreement” and several concrete deals. The PRC plans to give Russia a large loan to build a high-speed rail line between Moscow and Kazan. Moreover, China and Russia have signed protocols on phytosanitary regulations for imports of Russian agricultural products to China, allowing imports of wheat grown in four specific regions of Russia. The two countries are launching a two-billion-dollar joint investment fund to support Sino-Russian agricultural projects and are establishing a free-trade zone between their key farming belts. Chinese firms have invested in a variety of border development projects encompassing the Russian Far East.
The two countries have created new international financial institutions to support joint projects and present alternatives to the Western-led World Bank and the International Monetary Fund. They have sought to develop financial structures within the Beijing-led Asian Infrastructure Investment Bank, the BRICS-sponsored New Development Bank and the Shanghai Cooperation Organization (SCO) to offer their businesses substitutes for Western-dominated financial resources, including the US dollar.
China and Russia have been increasing payments in their national currencies in bilateral exchanges and want to see the dollar and euro replaced by a “basket of currencies” for global trade. The countries’ central banks signed a memorandum of understanding on setting up a clearing mechanism for the renminbi in Russia, while Russia’s second-largest financial institution, VTB Bank, signed an agreement with the Bank of China to bypass the dollar and pay each other in domestic currencies. Russia’s central bank is buying renminbi-denominated assets to diversify its foreign-currency reserves and reduce the rouble’s vulnerability to Western sanctions.
For years, Moscow has been pushing to broaden Sino-Russian economic projects beyond hydrocarbons, stressing the need to prioritize high-tech cooperation in industries such as biotechnology, nanotechnology and aircraft manufacturing. With the strong support of their respective governments, Chinese and Russian companies have recently signed deals aimed at jointly developing and co-producing a wide-body passenger plane and a heavy-lift helicopter. Both countries are aiming to reduce their aviation industries’ dependence on Western companies such as Airbus and Boeing. Despite years of effort, PRC firms still have trouble making the most advanced aircraft engines and with system integration of all the many contractors and sub-contractors. Meanwhile, China can offer Russian firms cheaper means for large-scale production.
China and Russia also share interests in developing Central Asian energy supplies. The PRC uses them directly, while Russian companies earn valuable revenue by reselling Central Asian hydrocarbons in third-party markets, especially in Europe. While Moscow would probably prefer to be an intermediary between Central Asian energy suppliers and Chinese markets, PRC purchases of Central Asian energy keep these resources from European markets that are most crucial to Russia.

Problems, Old and New

Sino-Russian trade, which amounted to almost 100 billion dollars in 2014, dropped 28% in 2015 due to the decreasing value of Russian commodity exports, slowing Russian and Chinese economic growth, and a massive devaluation of the rouble. Since then, reaching the goal of increasing bilateral trade to 200 billion dollars by 2020 has looked increasingly unlikely. The trade that does occur between them remains very imbalanced, drawing regular Russian criticism. Chinese purchases from Russia consist overwhelmingly of oil, gas, timber and other commodities rather than high-tech and other high-value products, except for some advanced weapons and Russian nuclear power plants. Meanwhile, the PRC’s exports to Russia are much more varied: intermediate goods, finished goods, capital goods and mixed end-use goods.
In terms of transport, only a few railways cross the Sino-Russian border, the focus of Beijing’s Eurasian land bridge remains Central Asia, and PRC and Russian representatives have disagreed over proposed pipeline routes. Chinese negotiators have prioritized the eastern route via the Power of Siberia pipeline since it will deliver gas to where it is needed in north-east China. But Russia favours the western Altai route, since that pipeline would be fed from existing fields in West Siberia and, by relying on already-built infrastructure, cheaper. However, from Beijing’s perspective, the Altai route delivers gas to the wrong part of China—the more sparsely populated west, which has easy access to Central Asian pipelines.
Moscow has repeatedly touted many flashy, large-scale infrastructural projects that it has undertaken with Chinese financing since the start of the Ukraine crisis in 2014. This has been used as a means to minimize Western confidence that efforts to isolate Russia are succeeding, but actual monetary allocation and the execution of concrete projects has been a slow and arduous process. The two primary energy pipeline projects China and Russia are constructing have stalled. The West Siberia pipeline was postponed by two years in 2015, and Altai seems to have been delayed indefinitely due to wrangling over prices. Many non-energy projects have also stalled, such as efforts to build new joint economic institutions or binational currency reserves.
Beijing has refused to accept the legitimacy of Western sanctions. However, most large PRC commercial entities wisely avoid actions that might antagonize Western governments and bankers and deprive them of access to the more valuable US and EU markets. In 2015, only 560 million dollars in Chinese foreign direct investment (FDI) went to Russia—less than 0.5% of China’s total FDI for that year and a much lower figure than the four billion dollars in 2013. Indeed, China’s total investment in Russia has fallen in the last few years, from already low levels. Western sanctions, the rouble’s instability and the collapse of global commodity prices have all reduced the expected returns to Chinese and other potential foreign investors of Russian-based projects.
Plans to open oil and gas fields in Siberia have not gone beyond the planning stage due to general Russian economic challenges and expected reduced export earnings due to lower global energy prices. The only large Chinese lenders to Russia have been the state-run China Development Bank and Export-Import Bank of China, which often make decisions on political rather than commercial considerations. They are also less exposed to Western financial systems and are more easily manipulated by the PRC authorities. In any case, Chinese technologies cannot yet substitute for the most advanced Western energy technologies that Russia needs to exploit the challenging geophysical conditions found in its offshore Arctic fields. Meanwhile, the 25-billion-dollar Sino-Russian currency swap deal remains underused due to currency instability. Fundamentally, the increasing Sino-Russian economic ties have had much less impact in diminishing the impact of Western sanctions than individual efforts by China and Russia; in particular, government policies decreasing the use of Western financial institutions and mechanisms have made the two national economies less vulnerable to Western restrictions.
For major joint projects, Chinese and Russian entrepreneurs are forced to overcome multiple bureaucratic obstacles. For example, they must work with at least three Sino-Russian intergovernmental commissions, whose powers are not always defined. The SCO and other shared institutions are much weaker than other regional economic bodies—thus we are unlikely to see the kind of deep economic integration that has occurred within the EU, North America or ASEAN any time soon. Russian policymakers are eager to reduce their dependence on volatile raw material exports by reviving China’s purchase of high-value industrial goods and services—such as high-tech weaponry and other products. In public, PRC policymakers commit to do this. But in practice, China no longer needs most Russian high-technology or industrial products, so Chinese companies continue to obtain most advanced technology from Western and Asian countries. Another reason for lagging high-tech ties is that Russians, citing past instances of Chinese intellectual property theft from Russian designers, are wary of in-depth R&D cooperation for fear of Chinese reverse engineering.
Barring major changes, China’s commerce with Russia will keep looking like the PRC’s trade relationships with African, Latin American and Middle Eastern countries and other states that sell raw materials to China and receive manufactured goods in return. The US, European and Asian countries remain considerably more important to China’s economic health than Russia. Even if existing obstacles were, implausibly, overcome, Moscow’s leaning on China’s economy would not provide a quick resolution for Russia’s economic troubles since Russia’s rebalancing towards Asia is a long-term process that will take years.

Silk Road Visions

One way that China and Russia are seeking to change these fundamentals is by harmonizing their regional economic integration plans—the Moscow-led Eurasian Economic Union (EEU), which comprises Russia, Kazakhstan, Belarus, Kyrgyzstan and Armenia, with Beijing’s “One Belt, One Road” (OBOR) initiative. The Chinese “Silk Road Economic Belt”—the westward, land-based prong of the OBOR that Xi highlighted during his September 2013 trip through Central Asia—aims to strengthen economic and transport ties between that region and China. In public, Russian policymakers say they will work with China to integrate Beijing’s belt with the Moscow-backed regional economic initiatives centred on the EEU; Putin has explicitly stated that he wants to expand the EEU to include China. Russian experts see this OBOR-EEU integration as a new mechanism for promoting mutual trust and ties among the member countries of the SCO. They also note that the OBOR provides Moscow with one of its few sources of leverage over China, in that Beijing would rely on Russia to use its influence in former Soviet republics and the Balkans to secure support for Beijing’s plans and to ensure security in regions where China cannot extend military power. The recent US decision to abandon the Trans-Pacific Partnership removes a major potential rival to the OBOR, increasing its attractiveness to Russia and other potential participants.
Nevertheless, their joint Eurasian integration project is still at an early stage of development. While there has been agreement on some issues, and experts are developing more concrete implementation concepts, other critical issues—such as the division of responsibilities among the players or the role of the SCO and other regional institutions—have yet to be resolved. In addition, the proposed combining of the OBOR and the EEU must sustain high-level political support and attention in both Moscow and Beijing to overcome the inevitable financial and bureaucratic obstacles that have thwarted past Eurasian integration programmes. Since the EEU’s formation, levels of trade within it have fallen due to Western sanctions, falling commodity prices, decreased industrial trade, declining two-way investment and Russia’s economic slowdown—making the EEU a less attractive economic partner for China. As an alternative to transiting Russian territory, Chinese planners are exploring transit routes through Georgia, Kazakhstan, Turkey and Azerbaijan for the Silk Road Economic Belt’s branches to Europe. Meanwhile, Russia is trying to build new Arctic maritime transport routes that would halve shipping times from Asia to Europe compared to the current route through the Suez or Panama canals or the Strait of Malacca. Some Russians resist including China in the EEU trade zone since this could deprive Moscow of the ability to use the institution to constrain Chinese economic penetration of Russia and the other EEU members. PRC experts are debating the risks of rendering aid to or investing in Russia, “citing the questionable state of Russia’s ability to pay back debts and good faith in pursuing such cooperation”1, though others warn of the danger to China of having a weaker neighbour as well as the desirability of having some low-cost, if low-gain, cooperation to limit Russian opposition to China’s economic penetration of Central Asia through the OBOR.

Implications for the West

Even if the EEU-OBOR integration is modest, each initiative could independently displace or constrain some EU and US commercial ties with the countries covered by the two zones. However, the West lacks a well-developed policy toward the OBOR, which weakens the West’s standing in Central Asia. That region’s governments pursue multi-vector foreign policies based on diverse foreign partnerships, including with the United States. For example, Central Asian countries want Western diplomatic backing, security support and private investment. However, Western countries’ engagement in the region has been episodic, Afghan-focused and decreasing. Their own high-profile Silk Road projects have had little impact on the ground.
The West has an opportunity to craft a new policy toward the OBOR as part of a revised Russia-China-Eurasia strategy that gives Western countries more influence at lower cost. For example, while Russia and, especially, China are funding the long-term infrastructure projects that private Western companies avoid, EU and US experts are better trained to promote free-market institutions and minimize disruptive rent-seeking behaviour. Meanwhile, the United States should strive to make Chinese and Russian economic activities in Eurasia more transparent in order to reduce duplication with other projects and to address local concerns about their opacity. Western governments should also coordinate more effectively their regional development projects with one another. Pooling assets and enhancing policy coordination can build synergies and collective leverage.
To foster public–private and business-to-business ties, Western governments should consider: creating a pre-qualification programme that would offer enhanced support to Western and Central Asian companies that meet certain criteria; forming public–private working groups to identify commercial synergies between Western and Central Asian companies; aligning Western and local export-promotion strategies to advance mutual investment and trade goals; helping Western companies identify local partners and markets; improving human capital by promoting Western training of Central Asian workers and managers; supporting understanding of EU and US commercial law; and otherwise facilitating Central Asian companies’ access to Western services, experts and strategic partnerships, with leading Western companies as anchor investors.
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1 Zheng Yu, “Feeling Squeezed by the U.S., China Leans on Russia in Push for Strategic Balance”. China-US Focus, 7 July 2016. www.chinausfocus.com/foreign-policy/why-president-…

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