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Can China prop up Russia’s failing economy?

Posted By on March 23, 2022 @ 06:00

The Russian economy will contract by 35% [1] in the second quarter of 2022, and by 7% overall this year, according to JP Morgan. That’s probably an extremely conservative estimate that doesn’t take into account the cascading effects of sanctions and supply-chain issues. Other economists are predicting a 15% GDP drop [2] in 2022.

If China was to decide to help Russia stabilise its economy, it would have to help Russia pay for imports, boost its currency, and increase support for its oil and gas sector. But how could China do this?

Beijing could direct China’s banks to increase bilateral loans and export credits to Russia to help it pay for goods and sell its commodities. However, so far two of China’s largest state-owned banks have restricted US-dollar-denominated financing [3] for Russian commodities. The China Development Bank and the Export–Import Bank of China have provided billions of dollars in credit to Russia related to projects under China’s Belt and Road Initiative, and it’s unclear what their sanctions exposure is.

China could attempt to lessen Russia’s dependence on imports of critical technology from the EU, US and East Asia through import substitution, but it probably can’t provide Russia with many of the high-end technical and machining products that it requires. And there are some indications that Chinese exporters fear secondary sanctions and doubt Russia’s capacity to pay for imports.

China apparently refused to supply Russian airlines with parts [4] when Boeing and Airbus blocked sales. There are also reports of Chinese smartphone companies [5] being unable to take advantage of the departure of Apple, Google and Samsung from the Russian market because of payment difficulties caused by sanctions.

China’s central bank could speed up Moscow’s access [6] to the US$77 billion of Russian foreign exchange reserves held in yuan, to allow it to pay import and debt bills.

It could also agree to a fixed renminbi–rouble exchange rate to help Russia pay for imports, but that would mean large-scale subsidising of Russian consumers given the actual value of the rouble. Instead, China is allowing the rouble to depreciate [7] against the yuan, making it cheaper for China to purchase Russian commodities.

Beijing could also allow Russia to buy goods through China’s CIPS financial messaging system [8] in yuan to try to circumvent SWIFT sanctions. But CIPS uses the SWIFT system and since CIPS makes up only 3% of payments globally, it’s not big enough to handle Russia’s needs.

There’s speculation that Beijing could start buying Russia’s gold reserves, [9] valued at about US$140 billion. But the US is moving to impose secondary sanctions on trading in Russian gold.

China could try to replace Western divestment in Russia’s major oil and gas projects and companies, and there are reports that Chinese energy majors [10] are considering buying or increasing their stakes in Russian energy giants like Gazprom. But talks are in early stages and are being couched as a hedge by China against global inflation, rather than support for Russia, indicating continued caution from Beijing.

And China might also be wary of stranded-asset exposure over the longer term from overinvestment in fossil fuels as the global economy transitions to renewables. It might prefer to put more capital into Russian metals, agricultural assets and water infrastructure.

Russia might seek to increase its oil and gas sales to China, but Chinese pipelines and storage facilities may not be engineered to cope with extra supply, and it’s unlikely that demand in China would grow enough to replace the loss of income from the EU in the event of an embargo.

Some analysts argue [11] that Moscow’s previous energy deals with Beijing, such as the 2019 Power of Siberia natural gas pipeline agreement, are unprofitable for Russia anyway due to internal corruption that has inflated construction costs, and the low prices that China negotiated. This dynamic will worsen for Russia as its economy weakens further and China seeks even cheaper gas as a buffer against global inflation.

Beijing may bargain that the West would be reluctant to extend secondary sanctions to China, which may be more damaging to the global economy, or that it may not be able to enforce them if it did. But the US has warned that it will sanction Chinese companies [12] that supply products to Russia, saying a critical technology embargo against China would be considered in that eventuality.

However, to make a real difference, these measures would need to be part of a highly coordinated and very public whole-of-government effort by Beijing, and they would take time to implement. Ad hoc assistance that keeps China under the radar of secondary sanctions is unlikely to help Russia much in the short term.

And none of these potential actions by China are likely constitute a lifeline to a commodities-based economy so highly exposed to Western markets. Although Russia’s trade with China has surged in recent years, a lot of that growth is probably due to inflation of fossil fuel prices rather than volume. Taken together, Russia’s trade with the EU, US, Japan and South Korea is more than double its trade with China [13] and the EU remains Russia’s largest single investor.

The damage to Russia’s economy is likely to be permanent, even with China’s help, and even if Putin earns some sanctions relief [14] by withdrawing from Ukraine. The combination of sanctions, Russian countermeasures, and the diversification of major markets from Russian energy are undoing decades of economic progress and integration into the global economy in ways that will be difficult to reverse.

Russia’s economy will face further shocks in the next decade; it’s completely unprepared for the global energy transition, climate change and a likely leadership succession crisis.

Some analysts have argued that China wants a weak Russia [15] so that it can exert more influence over its leadership and buy up distressed Russian resources on the cheap and Russian military technology that Moscow so far has been reluctant to sell. This may well be the case, and Chinese companies certainly will seek opportunities where they can in the wreck of the Russian economy.

But the costs of underwriting the economy of a malevolent nuclear-weapon power in rapid decay could outweigh any gains. Russia may be too big, too nativist and too chaotic to become a useful, quiescent client state for China in the long term.

In Beijing and Moscow’s shared neighborhood, Russia’s economic combustion is already having a knock-on effect on financially dependent strategic buffer zones and client states, including Belarus, Chechnya, Abkhazia, South Ossetia, Kazakhstan and Transnistria.

And other Central Asian BRI states are starting to worry about a drying up of remittances from Russia [16], which in Tajikistan’s case make up 30% of its GDP, along with their trade exposure to Russia [17]. The political fragility of these nations will make China’s central Asian neighborhood much more unpredictable, possibly requiring more expensive economic intervention to stabilise them.

Sharp increases in energy, metal and food prices driven by the war and sanctions will hurt China as much as they will hurt its major export markets, even though securing cheap Russian imports and increasing exports to Russia (if it can pay for them) might help Beijing soften the impacts of inflation somewhat.

At the crux of China’s dilemmas is a deeper issue. Russia and Beijing have enjoyed the benefits of the global political and economic order while undermining it under the cover of the grey zone, believing that the status quo powers would be reactive, risk-averse and divided and would continue to focus on damage minimisation rather than coordinated deterrence.

This arrangement may have worked as long as actions fell short of war. But Russia’s invasion of Ukraine and it’s continued escalation of the war have likely changed that dynamic for good.



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URLs in this post:

[1] contract by 35%: https://www.reuters.com/article/ukraine-crisis-russia-jpmorgan-idUSKBN2KX0LH

[2] economists are predicting a 15% GDP drop: https://twitter.com/RobinBrooksIIF/status/1500469489573498884

[3] restricted US-dollar-denominated financing: https://www.bloombergquint.com/global-economics/chinese-state-banks-restrict-financing-for-russian-commodities

[4] refused to supply Russian airlines with parts: https://www.reuters.com/business/aerospace-defense/russia-says-china-refuses-supply-aircraft-parts-after-sanctions-2022-03-10/

[5] Chinese smartphone companies: https://twitter.com/ftchina/status/150150393216996557

[6] could speed up Moscow’s access: https://www.bloomberg.com/news/newsletters/2022-03-01/what-s-happening-in-the-world-economy-could-china-come-to-russia-s-aid

[7] allowing the rouble to depreciate: https://abcnews.go.com/International/wireStory/china-eases-control-ruble-fall-faster-yuan-83360995

[8] CIPS financial messaging system: https://www.marketplace.org/2022/03/01/could-chinas-payments-system-be-a-swift-workaround-for-russia/

[9] start buying Russia’s gold reserves,: https://www.bloomberg.com/news/articles/2022-03-16/the-140-billion-question-can-russia-sell-its-huge-gold-pile

[10] Chinese energy majors: https://twitter.com/business/status/1501176335108091908z

[11] Some analysts argue: https://twitter.com/kamilkazani/status/1499875219376386051

[12] will sanction Chinese companies: https://www.washingtonpost.com/world/2022/03/02/russia-economy-sanctions-china-support-ukraine/

[13] double its trade with China: https://ec.europa.eu/trade/policy/countries-and-regions/countries/russia/

[14] some sanctions relief: https://www.politico.com/news/2022/03/16/blinken-withdrawal-necessary-russian-sanctions-00017671

[15] China wants a weak Russia: https://octavian.substack.com/p/inside-the-bear-alexander-gabuev?s=r

[16] worry about a drying up of remittances from Russia: https://www.rferl.org/a/central-asia-migrants-ruble-impact/31730968.html

[17] trade exposure to Russia: https://eurasianet.org/kazakhstan-redirecting-import-export-from-russia-to-latvia

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