China, Russia: the big shift

Kindly translated by Anne-Marie de Grazia

The recession striking Europe since 2011 has had, of course, a considerable impact on Russia’s economic activity. It has affected the activity of exporters, be they exporters of fossil fuels or exporters of semi-finished products (steel, non-ferrous metals, basic chemical products). These exports, less spectacular than those of fossil fuels, have in reality a much greater impact on economic activity by means of the chains of sub-contracting. From this point of view, the impact on industrial employment of the crisis in Europe has been noticeable, but all in all it has been rather well digested. The unemployment rate is presently inferior to 5% of the active population. Still, it is clear that Russia, whose first trading partner is Europe, has “imported” in part the recession or stagnation, which the European continent has been undergoing. This phenomenon has triggered among the Russian elites, political as well as economic, a deepened reflexion on the future of economic relations with Europe, but also with other partners, Asian partners foremost.

 I. The reasons of a shift.

As early as the end of 2012, economic growth started slowing down in Russia. Confronted with the economic situation in Europe, it was clear that there was a risk that the situation would endure for several more years. One is talking more and more about the perspective of a « lost decade » in Europe, and in any case for the countries of the Eurozone. It is obvious that such a perspective has been perceived only progressively among the Russian political and economic elites. Seen as a potential risk in October 2012, but one that the Europeans were able to reduce and set limits to, this perspective became an objective fact in the Fall of 2013. During this period, the Russian leaders have by and by taken notice of the incapacity of European leaders to measure the gravity of the economic situation. This was certainly not easy for them, as they generally held these leaders to be competent and rational, as a rule, in matters of economic policy. The recognition of the powerlessness of European leaders in a field in which they were reputed to be the masters, has deeply shaken the image of these European leaders in the eyes of the Russian elite. It has brought about, in reaction, an important change in the strategy of the Russian government. This change translated in the choice of Asia, which was made in reality between the end of 2012 and the end of spring 2013. From this point of view, one may speak of a pragmatic readjustment of the economic policy of Russia. [1].

The Russian government has deployed much effort in order to re-orient Russian international trade towards Asia, and towards China in particular. It has also sought to develop a free-trade zone with some of the countries of the former Soviet-Union. On this terrain, it is clear that economic objectives combine and tie in with political objectives. The aim is at once to find new sources of growth for the Russian economy and to constitute a geopolitical block capable of resisting destabilizing attempts by America. On the economic plane, the principle of a diversification of trading partners is certainly judicious. But the implementation of these aims should have been spread over time. On the other hand, even if the share of Europe in Russia’s exterior trade were to decrease due to the economic context, it certainly would have to remain at a high level initially. In fact, it appears that the solution doesn’t reside so much in a reorientation of the external trade fluxes (even if such a reorientation appeared necessary as early as in 2012) [2].

Table 1

Russian Exports and imports by geographic zone

A. Exports

	Rest of the world	CIS	BRICS	Other Asia	Iran and Turkey	Switzerland and Norway	USA and Canada	EU
2000	12,0%	15,5%	6,9%	4,2%	3,6%	3,9%	4,6%	49,2%
2005	7,7%	15,6%	7,4%	3,0%	5,3%	4,7%	2,7%	53,6%
2010	6,0%	17,7%	7,8%	6,7%	6,0%	2,4%	3,4%	50,0%
2011	7,6%	18,2%	9,0%	6,1%	5,6%	2,4%	3,3%	47,8%
2012	7,2%	17,6%	9,7%	6,2%	5,6%	2,2%	2,5%	49,0%

B. Imports

	Rest of the world	CIS	BRICS	Other Asia	Iran and Turkey	Switzerland and Norway	USA and Canada	EU
2000	7,8%	34,2%	5,9%	3,0%	1,2%	1,3%	8,5%	38,2%
2005	7,8%	19,2%	11,0%	10,5%	1,9%	1,6%	5,1%	42,8%
2010	8,1%	13,9%	20,4%	8,3%	2,2%	1,7%	5,5%	39,9%
2011	7,9%	14,7%	18,8%	9,4%	2,2%	1,6%	5,4%	40,1%
2012	9,4%	12,7%	19,3%	9,4%	2,3%	1,5%	5,7%	39,6%

BRICS : Brazil, China, India and South Africa. Other Asia : Japan, Korea, Singapore and Vietnam. Source : Central Bank of Russia

 II.   The development of privileged relations with China

The development of trade relations between China and Russia was in the order of things, considering the size of the Chinese economy and its strong potential for growth. But the economic dimension was not the sole consideration in this rapprochement. Progressively, both countries found that they had common interests in the face of the United States. This lead Moscow and Beijing to take various initiatives about the reciprocal convertibility of the Ruble and the Yuan[3], but also about a parallel use of the Ruble and the Renminbi in exchanges[4]. This is in keeping with the Chinese strategy of a progressive reinforcement of the Yuan/Renminbi. In fact, since 2010, a certain number of important measures have been announced:

1. At the end of 2010, the yuan can be exchanged for the first time against Rubles on the trading place of Moscow (with an electronic quotation).
2. At the end of 2011, China and Japan announce having signed an accord to use their respective currencies instead of the dollar in their trading exchanges.
3. In September 2012, China and Russia hit again, historically putting an end to the reign of the petrodollar, by signing an accord allowing the Chinese to buy as much oil as they wish in yuan. This accord is confirmed by the presidents of both countries in September 2013.
4. In March 2013, Brazil signs an accord allowing it to pay for its imported goods in reals, whereas China will pay for its imported goods directly in yuan.

It is clear that the role of the Renminbi as a transaction currency is now rapidly increasing. According to SWIFT[5], the use of the Chinese currency as a currency for international payments took a leap of 24% , propulsing it to the 13th rank of the currencies for the payment of transactions in the world, against the 20^th rank in 2012. This situation underwent a drastic shift in 2013 and 2014. Direct Asian investments, particularly those Chinese, have sharply increased. This corresponds to the creation of a joined Sino-Russian investment Fund which was actually put into place in June 2012, but which started operating at the end of 2012. This Fund was jointly created by the Russian Fund for direct investments and the Chinese Corporation of investments. The company managing the Fund is owned at 60% by Russia and at 40% by the Chinese party. The aim concerning the volume of investments of the fund was set at 4 billion dollars. It seems to have been achieved as early as the end of 2013[6]. Japanese and Korean investments have also increased, if to a smaller extent as the Chinese DFIs. These investments are broadly concentrated in the domain of transport infrastructures (oil and gas pipelines [7], but also rail and air transport), in the industrial and in the agricultural domain.

In the middle term, this should be tantamount to a new deal in the area of fossil fuel exports et put an end to the pre-eminence of Europe as the principal client of Russia. In the accord signed in June 2014, at the  Economic Forum of Saint-Petersburg, the public Russian oil company Rosneft plans to provide 365 million tons of oil to China until 2038, for an amount of 270 billion dollars. The first deliveries were carried out in July 2013 (800,000 tons), but have remained at a symbolic level. On the other hand, the volume of deliveries should reach 2 million tons in 2014 and 15 million tons in 2015. These figures remain still far behind those delivered to the European countries, Russian exports reaching 208 million tons for the countries outside the CIS in 2013. But the perspective of seeing the flux with China reaching 15% of the exports outside the CIS by 2017 is by no means unrealistic. For this project, Rosneft has presently two Chinese partners: CNPC and Sinopec. Projects just as important have generated accords which are in the process of negotiation with Japan, where the energy question looms particularly acute since the accident at Fukushima, as well as with South Korea. These accords are broadly linked with the development of the gas field of Sakhaline (in the Russian Far-East) and of Kovytka.

III. Dynamics of sanctions and the reality of the Russian economy.

It is clear therefore that long before the dynamic of sanctions kicked into action following the events in Ukraine, Russia had engaged in a process of shifting its trade fluxes as well as its investments towards Asia. But the logic of sanctions, and of the counter-sanctions taken by Russia, quite certainly pushed towards an acceleration in the process. The elements are presently in place for a strong re-launching of the economy, partly linked to the substitution to imports. It is presently possible to return to high growth rates, such as Russia has known from 2002 to 2008, particularly through the mechanism of substitutions. But this implies considerable investments. This is presently the central question of economic development. It is evident that the goal is to relocate to Russia part of the production for, until now, large Russian companies considered the world market as a “supermarket” where they were used to do their shopping. The present situation brought home the fact that this was not a healthy situation. And this doesn’t only concern the countries having applied the sanctions. It is a general choice.

Macroeconomic indicators reveal a measure of disconnection between the evolution of the exchange rate, which is certainly the point on which the sanctions have had the most effect, and the one of the real economy. This disconnection translates into an acceleration of industrial production, which should in time show up in the results of the GDP. A similar tendency is noticeable in households-consumption, after a sharp decrease from January to June 2014. The evolution of industrial production is linked to several combining factors. Among the most important of these, we’ll note:

• (a)   The effect of the increase in military spending, following the decisions taken in 2012 and early 2013, the industrial effects of which are beginning to show.
• (b)  The impact of the mechanism of substitution to imports, at first the imports coming from Ukraine and, for the past few weeks, agro-alimentary imports from the EU and the United-States.

But this movement of industrial activity picking up is also propped up by consumption. If, in volume, the consumption of food stuffs and alcohol has remained stable over the past three months, the consumption of manufactured goods has increased by 3.5% (as against the same months of 2013).

Chart 1

Evolution of industrial production and of household-consumption

If the levels of increase of the consumption as well as of the real income of households have decreased in relation to 2013, the main part of this decrease occurred during the first semester of 2014. The situation has therefore stabilized during the Summer, and shows signs of strength for the end of the year.

We shall finally note that the « run » on Russian banks which some were expecting following the sanctions did not occur. On the other hand, after a strong take-off towards the end of 2013 and the beginning of 2014, purchases in real-estate have broadly softened. This seems to have been caused by the rise in interest rates.

 IV.  The Eurasia integration project.

In such a framework, the constitution of a common space on the Eurasian continent which was proposed by President Vladimir Putin at the occasion of the « Valdaï » talks which were held on October 22-24 2014 in Sotchi appears at once as a geopolitical project AS WELL AS an economic project.

In geopolitics, it is essential to avoid a new divide in this continental mass, by avoiding the reconstitution of the Cold War blocks, but also by forestalling a possible return of the conflict between Russia and China. This is an essential point for the Russian leaders. We in Europe tend to ignore that in the Far-East, contrarily to what has happened in Europe, there did not occur a retraction of Russia at the end of the Cold War. The dissolving of the Soviet Union was in no way accompanied by a retracing of borders. The present borders are those of 1945, such as they have been fixed at the exit of World War Two. However, these borders have been historically contested, be it during the sino-soviet conflicts (at the beginning of the 1930s, at the time of the reactionary turn of the Kuomintang) or in the 1960s, at the time of the politico-ideological conflict between Moscow and Peking. These borders have also been contested by Japan, and if one remembers the war of 1904-1905, the reason of which was the Russian presence in Korea, one tends to forget the fightings at Lake Khasan (1938) and especially of Khalkhin-Ghôl in 1939, then in Mandchuria in 1945[8]. The idea of being able, by means of this accord, to tie in China into such a continental project is an important dimension in the strategic thinking of Vladimir Putin.

In economy, he also sees the interest, for Russia, in being a bridge between Western Europe and China. Dmitry B. Kuvalin, one of the most remarkable researchers at the Institute of Economic Previsions of Moscow, carried out a study which had been impulsed by the counsel of the Eurasian Union, on the advantages of a common transport system between Belarus, Kazakhstan, Russia and China[9]. This study was carried out by the Institute of Prevision of the National Economy (IPNE-ASR). IPNE-ASR rapidly demonstrated that the pertinent horizon was in fact the one of 2030. In the case of the Eurasian Union (EurAsU), and in contrast with the European Union, integration proceeds by the way of multilateral cooperation, and not by the constitution of supranational decisional instances. So that the national ministries of transport are keeping their hold on the transportation system. The role of the Commission of the Eurasian Union will be foremost one of consulting. In fact, this strategy of an integrated development does not replace the national rail strategy. Considering the territory of the EurAsU, it is clear that rail and air transportations play an important role. They make up 8% of GDP and they employ a total of 15 million people. The volume transported is superior to 150 million tons by railroad. This study made it possible to point out two things:

1. By 2020, for Belarus, there will be an increase of 5% solely linked to integration. Inside the EurAsU, transport will increase by 7%. The gains in GDP for Belarus will be of 0.4% per year. An increase in the same order is expected (0.5% per year) for Kazakhstan. The volume of transport should increase by 8.5% in 2025 (and by 12% by 2030). The increase is weaker for Russia, being expected to reach on average 0.1% per year until  2030. This is understandable, given the general size of the economy. The first result is therefore that EurAsU will benefit foremost to Belarus and Kazakhstan and little to Russia.
2. But, and this is a very important point, the volume of freight in transit will increase steeply. The integration of transport systems will make out of Russia a « bridge » between Europe and Asia (China). Which is where the maximal positive effect for Russia would reside, which would therefore be an indirect effect, instead of a direct one. Part of the now maritime traffic should then be made by railroad. This effect is estimated to bring between 0.4% and 0.6% of growth of GDP per year.

In the framework of this study, the creation of new lines have been examined, so-called “high-speed” lines, particularly serving China from the Sinkiang and connecting either with the Baltic ports, or with the Black Sea ports. This programme corresponds to the integration of the national “High Speed” plans, which will be extended to freight.

This “High Speed” line would at first connect Yekaterinburg to Astana and Almaty. Three logistics centres would then be constructed, one between China and Kazakhstan (between Almaty and Urachi), the other at Yekaterinburg and the third in Moscow. These logistics centres would be doubled with aero-portuary centres (the one at Moscow having to be delocalized to Kazan, for the platforms at Moscow are presently saturated). The idea is to have a line Helsinki – Moscow – Beijing and Brest-Litovsk – Moscow – Beijing. The Moscow – Brest-Litovsk derivation has been studied on the account of Belarus. We know that an accord of principle has been signed recently, foreseeing 230 billion in investment in the next 15 years[10].

The government of North Korea rallied itself in October to the idea of a Eurasian initiative joining Korea with Russia for energetic and transport questions. We can see that these initiatives pre-date the sanctions. In reality, Russia has decided for several years to study the question of the development of transports in Eastern Siberia and in the Far-East. The goal being to increase the volume of transported freight but also to enhance the living standard in these regions. This project includes the modernisation of the Baikal-Amur-Magistral (??) (which is to be upgraded to two rail-lanes, being presently a single railer), the development of the harbor of Magadan and of the harbors of the oriental coast. The costs of investment will be high, probably around 4 billion Euros for the railway connection to the harbors.

We note that the idea of a Eurasian integration is a coherent project, from the geopolitical point of view as well as from the economic point of view. It is, from all evidence, a major project for the Russian government and for Vladimir Putin.

 

[1] Clément-Pitiot H., «La stratégie de l’économie russe en perspective: le choix du pragmatisme?», Note de l’Observatoire franco-russe, Moscou, 2014, n°6, 26 p

[2] What transpires from the discussions of the Club Valdaï d’octobre 2012. Voir Sapir J., « La diplomatie russe, entre Asie et Euro(pe) », note posted on RussEurope, le 27/10/2012, http://russeurope.hypotheses.org/390

[3] La Voix de la Russie, « Moscow and Beijing take on the dollar », 26 juillet 2013, http://french.ruvr.ru/2013_07_26/Moscou-et-Pekin-s-attaquent-au-dollar-0076/

[4] C. Luo, « Russian roubles flow freely in Heilongjiang border city », South China Morning Post,  URL : http://www.scmp.com/news/china-insider/article/1376913/russian-roubles-flow-freely-heilongjiang-border-city

[5] Or Society for Worldwide Interbank Financial Telecommunication.

[6] http://www.asie21.com/asie/index.php/russie/741-investissements-asiatiques-en-extreme-orient-russe-remi-perelman-asie21-fevrier-2014

[7] http://french.peopledaily.com.cn/Chine/n/2014/1009/c31354-8791878.html

[8] Sapir J., La Mandchourie Oubliée – Grandeur et démesure de l’Art de la Guerre soviétique, Éditions du Rocher, Paris-Monaco, mai 1996.

[9] Il a présenté les résultats de cette étude au séminaire franco-russe sur le développement régional, qui s’est tenu à l’EHESS les 6 et 7 octobre dernier.

[10] http://french.peopledaily.com.cn/Economie/n/2014/1013/c31355-8794099.html

 

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