Russia's Pivot to China Is Real

By Leonid Bershidsky

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JUN 25, 2015 

The search for alternative investors and markets has been a political priority for President Vladimir Putin and his government since Western countries imposed economic sanctions on Russia last year. The resulting pivot to China may seem merely cosmetic, but it is happening.

Admittedly, most of the vague and extremely long-term mega-deals signed by the two countries' governments over the last year will have no immediate effect. Even so, China has become one of the two biggest sources of funding and investment for the Russian economy. The other is the money Russian businesses have stashed in tax havens and bring home as needed. The Chinese share of Russian trade is growing, too.

Russia received only $21 billion in net foreign direct investment last year, compared with $69.2 billion in 2013. Most of the money came from offshore havens such as Cyprus, the Bahamas and the British Virgin Islands. Among non-offshore source countries, China, with its $1.3 billion in direct investment, was second only to France. That's a tiny amount, but a sign of change: In previous years, Chinese investment never exceeded $450 million.

At the same time, Chinese loans became by far the biggest source of foreign financing for the Russian economy last year. According to Central Bank data, Russia's non-financial sector and households received $11.6 billion in net new loans from China. Cyprus -- or rather Russian businesses operating in Cyprus -- was the second-biggest lender, with $3.4 billion.

This presents a radically different picture compared with just two years ago. In 2013, the U.K. dominated lending to Russia with $23 billion in net new loans; China contributed $7.5 billion. But the increase from China wasn't sufficient: last year, those funds failed to cover the net outflow of money to European countries and in aggregate, net loans fell by $6.3 billion. Still, without the boost from China, that outflow would have been 65 percent higher. 

This year, there will probably be another jump in Chinese loans, thanks to a recent deal that allows Russian companies to raise $25 billion from Chinese banks against Russian government guarantees.

Much of the Chinese lending is going to Russian oil companies, especially to state-controlled Rosneft, which has been forced by Western sanctions to tap the government's reserve funds. Rosneft has also increased sales to China, where it can get access to the long-term trade financing that's no longer available in Europe. 

In May, Russia sent 930,000 barrels of oil per day to China, overtaking Saudi Arabia in that market for the first time. Although the groundwork for this market share gain was laid before the Western attempt to isolate Russia, Rosneft might have been less willing to send as much oil to China if it weren't for the shift in financing opportunities.

Russia's trade with China has fallen as the economy has stagnated, but the drop has been smaller than with other major trading partners, in part due to the boost in oil exports. In the first quarter of 2015, the sum of Russia's trade with the European Union shrank by 37.5 percent, but China saw a smaller 29.4 percent drop, increasing its market share.

European companies have recognized the trend. This month, BP bet on the growth of Russia's energy trade with China by paying $750 million for a 20 percent stake in Taas-Yuriakh Neftegazodobycha, a Rosneft subsidiary licensed to work a large oil field next to China's northern border. 

Another area in which Russia needs Chinese funding and technology is infrastructure. This month, the state-controlled China Railway Group signed a contract with the Russian railroad monopoly to design a high-speed rail link between Moscow and Kazan. Russia then wants to extend the network to Beijing, reducing the length of the trip between the two capitals to 48 hours, from seven days. In previous years, the contract probably would have gone to Putin's billionaire friends. Now, though, the need for funding -- which China will provide to the contractors -- takes precedence even over their interests.

The Russian government has become willing to contemplate deals with China that would have been unthinkable before the sanctions. One of the regions in Russia's Far East recently signed a tentative agreement to lease 284,000 acres of unused agricultural land to a Chinese company. This has generated outrage in the Russian press and on social networks: Russians have always been wary of giving China access to the vast Siberian spaces, suspecting that if Chinese workers arrive, they will never leave and Siberia and the Far East will end up as colonies.

It would be wrong to discount Russia's swing toward China as just a PR campaign to convince Russians their country can do without the West. Russia is a big ship and turning it around is not a quick exercise, but the trend toward closer economic ties with China is real. In that respect, sanctions have done Russia a favor. They have forced the regime to accelerate much-needed market diversification and to pay more attention to the country's huge, underdeveloped eastern regions.