Testing times for China as its Russian ally looks for help

China moved closer to Russia when its officials amplified Vladamir Putin’s disinformation, including his bizarre claim that the US and Ukraine were planning to target Russia with Slav-specific biological weapons carried by migratory birds. The US warned that those claims could be a cover for Moscow to use chemical or biological weapons.

Beijing also reaffirmed that it’s seeking more strategic and economic integration with Russia.

Russia and China share world views. Xi Jinping is personally invested in building the relationship, and Russia is seen in Beijing as the only other power capable of challenging US hegemony. The perception of Russia and China working in lockstep has generated much anxious attention in Western capitals. Despite the whiplashing events of recent weeks, it would be hard for China to give up on this prized ‘no limits’ relationship and return to a more isolated position.

But the relationship is being tested by the harsh sanctions leveled against Russia by the world’s biggest economies in an effort to halt Putin’s war in Ukraine. Central bank and SWIFT sanctions appear to have crippled Russia’s financial system and are unraveling its economy in chaotic ways. Russia is facing steep currency devaluation, divestment, debt default, supply-chain and credit-access problems, a looming unemployment crisis and a decline in state revenues, despite higher fossil fuel prices.

Russia urgently needs economic assistance from China and, according to the US, Putin has asked for it. Thus far, Beijing and other actors in China’s economy seem reluctant to step in, fearing secondary sanctions and irrevocable damage to major markets. And there are real limits to what China can do.

But an economically collapsed Russia is a big strategic negative for China. And given that Putin would be unlikely to forgive Xi for turning his back on Russia in its self-inflicted hour of need, there are strong incentives for Beijing to consider how it might help stabilise Russia’s economy.

This is a complex dilemma and uneven signals from China suggest that Xi hasn’t yet given a clear directive about how he wants to proceed, and that the broader system is still figuring out its options.

China was as unprepared as Russia for the first-ever coordinated central bank sanctions against a G20 country. Some Russian journalists say the country’s financial institutions were anticipating SWIFT sanctions and some level of currency depreciation.

But Moscow and Russia’s major companies weren’t prepared for being barred from dollar- and euro-denominated international trade, or for losing roughly half of Russia’s US$630 billion of foreign currency reserves held in Western banks combined with a 40% decline in the rouble. Russia’s credit rating now ranks with that of Angola.

Russia is also heavily dependent on imports for machine parts and digital technologies, which is why some analysts argue that choking tech supply chains to the oil and gas industry would be more effective than sanctioning the industry outright.

Russian agriculture depends on EU and US imports for about 40% of its seed stock.

There’s been a mass exodus of companies that have effective global monopolies on critical technology supply chains. Russian aviation has only a few weeks to live, according industry experts. Boeing, which provided parts and repairs to Russia’s military and civilian aviation sectors, and Cisco, Intel and Microsoft, which provide the software, hardware and services on which Russian computing networks depend, have gone. Internet isolation may soon become a reality. Data-routing entities Cogent and LINX have suspended Russia from their services, and Putin appears to be taking steps to isolate Russia’s internet from the rest of the world.

Russia’s fossil fuel industry—the backbone of the economy and of the political power of Putin and his circle—is also affected, even though the sector has so far been exempted from sanctions because of fears about driving up energy prices in developed economies even further, as well as the fact of the EU’s gas dependence on Russia.

But BP, Exxon, Shell and others are divesting from the sector and Russia is finding it hard to sell its oil due to overcompliance with sanctions by global oil markets. In addition, the US unilaterally sanctioned Russian oil and there’s now a live debate in Germany on blocking both oil and gas from Russia. And given that the EU has developed a plan to cut Russian fossil fuel imports by two-thirds in the next year, Russia is likely to permanently lose its most valuable market.

Russia’s financial institutions are trying to figure out ways of surviving, but central bank sanctions mean options are limited. There was no inventory build-up before the war. Measures taken by the Russian central bank to prop up the rouble—the imposition of capital controls, restricted currency trading and raising interest rates to 20%—may have stabilised its slide in the short term but could have a disastrous effect on the economy given Russia’s extremely high levels of consumer debt. The central bank has reportedly requested that banks keep pre-war rates for existing mortgages, but it may not have spare liquidity to compensate them for the losses this would create.

As yet, the Russian government hasn’t announced any large-scale stimulus measures to prevent mass layoffs. But it seems keen to ensure Russia’s long-term isolation from the global economy by passing legislation permitting seizure of foreign company assets, including leased aircraft, and software pirating. The government is also trying to stem a brain drain in critical technology skills by issuing flexible visas for tech workers, though this is unlikely to be effective.

JP Morgan estimates that the Russian economy will contract by 35% in the second quarter of 2022, and by 7% overall this year. 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 in 2022.

To assist significantly, China would have to help Russia pay for imports and boost its currency and increase support for its critical oil and gas sector. My next post will look at how China could help Russia’s failing economy.