Thu, Mar 24, 2022

China Unlikely to be Russia’s Economic White Knight

  • China could help soften the blow of recent sanctions to Russia’s economy by supporting Russian trade, financial transactions and central bank reserves.
  • However, China is unlikely to offset the impact of the sanctions in any of these areas.
  • Over time, China may play a greater role in boosting Russia’s economy. But this could ultimately benefit China more than Russia, with the latter economically and financially reliant on the former.

China has so far adopted a decidedly neutral stance as Russia continues to fight in Ukraine, abstaining from condemnations of Moscow, opting out of joining in international sanctions, and even offering to moderate talks between Russia and Ukraine. But China could end up getting off the fence and picking sides. After all, just before Russia's invasion of Ukraine, Russia and China declared that their friendship had “no forbidden zones.” Furthermore, the U.S. government revealed intelligence suggesting that Russia requested military support from China last month. A lot of ink has been spilled on whether China will come to Russia’s rescue with military weaponry. But China could also step in to bolster Russia economically—in theory, at least. Yet in reality, it is very unlikely that China could succeed in being Russia’s economic white knight.

Trade Ties Could Rise

There are three ways that China could step in and alleviate Russia’s economic pain from the sanctions: it could support Russian trade, financial transactions and/or the Russian Central Bank.

Trade ties between the two countries are significant, with commodities playing a major role: China accounts for around 15% of Russia’s total exports and 23% of its imports. And recently there have been some indications China could ramp up trade ties with Russia. On February 4, both countries announced a joint cooperation agreement that involved China lifting limits on wheat imports from Russia. It also included commitments to build two pipelines in Russia for natural gas exports to China.

As of 2020, roughly 30% of Russia’s oil, and 10% of its natural gas, went to China. Both figures have risen rapidly in recent years, though the latter is hindered by a lack of pipeline infrastructure going to China (the new agreed pipelines won’t be operational for years). Overall, the EU’s energy imports from Russia are four times larger than China’s. Should the EU follow the U.S.’s lead and ban energy imports from Russia or should Russia itself decide to ban energy exports to the EU, China could not step in to replace the demand quickly.

The ban on exporting semiconductors to Russia also cannot be cushioned by China. Russia mostly imports low-end semiconductor chips from China, used in cars and home appliances. Both Russia and China rely on the U.S. for the more sophisticated chips used by high-tech companies and for advanced weapons systems. Even if China wanted to branch out into these kinds of chips, it would near impossible. One of China’s largest semiconductor companies, does not have access to many parts needed to build sophisticated semiconductors, in part because the U.S. banned technology exports to this company.

China Could Help Financial Services and Payments Systems

With the U.S. and its allies preventing banks from transacting with the Central Bank of Russia (CBR), sovereign wealth fund or finance ministry, Chinese banks could continue to transact with them. However, there are indications Chinese banks are wary of the potential repercussions of doing so, even though China hasn’t joined in these sanctions officially. Chinese state-owned banks have been instructed by the central government to uphold Western sanctions. The Beijing-based Asian Infrastructure Investment Bank (AIIB) and Shanghai-based New Development Bank suspended business with Russia. A 2017 law allowing the U.S. to penalize foreign entities trading with sanctioned companies, countries or individuals (so-called secondary sanctions) could be a major impediment to doing business with Russia for any bank that wants to be able to transact in U.S. dollars.

China could also ride to Russia’s financial rescue by allowing Russian banks expelled from SWIFT (the messaging system used for interbank transactions) to use the Chinese payment system, Cross-Border Interbank Payment System (CIPS). There are two major problems with this. First, CIPS still relies on SWIFT for messaging. This won’t always be the case, but for now there is no immediate alternative, particularly for cross-border transactions. Second, CIPS has neither the liquidity nor the scale to serve as a realistic alternative for Russian banks to engage with the global financial system. Alternatively, Russia could use the People’s Bank of China (PBoC)’s digital currency, the E-CNY, for cross-border payments with China that bypass SWIFT. As of now, the CBR has not signed a memorandum of understanding with the PBoC for E-CNY cross-border use. And even if the CBR did so, the E-CNY has a negligible role in domestic payments, let alone international transactions.

China could also help Russia financially by setting up smaller, single-purpose banks that serve as vehicles to circumvent sanctions. This could happen over the medium- to long-term, but such operations tend to ultimately get discovered and shut down. This was the case with the Bank of Kunlun after the U.S. Treasury sanctioned it in 2012 for doing business with Iranian banks.

Rescuing the Central Bank

Finally, China could support the CBR, which has been sanctioned by the U.S. and its allies. The CBR undertook a concerted effort from 2014 to de-dollarize the country’s foreign exchange reserves. By mid-2021, the biggest share of the CBR’s $643bn FX reserves (22%) were in gold—sitting in vaults in Russia—followed by renminbi (17%). Still, nearly half of the CBR’s foreign reserves are still held in euros and dollars, which have been effectively rendered useless by the sanctions. Russia can use its renminbi reserves for imports from China, but the non-convertibility of the renminbi makes it difficult for Russia to ramp up its renminbi reserves to exchange them and transact in U.S. dollars or euros. The CBR has a swap line with PBoC, giving it access to roughly 150 billion renminbi, but this also cannot be converted into hard currency.

The CBR also holds around $24bn in IMF special drawing rights (SDRs). The PBoC could help Russia exchange its SDRs into liquid currency, but this could be interpreted as a breach of sanctions and therefore it’s unlikely the PBoC would do this.

Conclusion

Even if China decided to step in and save Russia from the economic impact of the sanctions imposed by the U.S. and its allies, it’s unlikely to succeed in doing so. China may soften the blow to the Russian economy from sanctions by supporting trade, financial services, payments and the CBR. But any suggestion that China could be Russia’s white knight is overblown. Over time, China could support the Russian economy more effectively as new gas pipelines to China are built, CIPS becomes a realistic alternative to SWIFT and the West’s payment systems or the E-CNY is used more for cross-border payments. But in the meantime, the bigger benefit could well accrue to China in the form of greater Russian economic and financial dependence on Beijing.

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