Putin Deals China Winning Hand as Sanctions Power Rival

(Bloomberg – boomberg.com – Henry Meyer, Evgenia Pismennaya – October 13, 2014) Defying his former enemies in the U.S. and Europe may force Vladimir Putin to aid the ascent of his biggest rival in the east.

Isolated over Ukraine, Russia is relying on China for the investment it needs to avert a recession, three people involved in policy planning said, asking not to be identified discussing internal matters. This means caving in to pressure to grant China privileged access to the two things it wants most: raw materials and advanced weapons, two of the people said.

Russia’s growing dependence on China, with which it spent decades battling for control over global communism, may end up strengthening its neighbor’s position in the Pacific while hastening its own economic decline. With the ruble near a record low and foreign investment disappearing, luring Chinese cash may deepen Russia’s reliance on natural resources and derail government efforts to diversify the economy.

“Now that Putin has turned away from the west and toward the east, China is drawing maximum profit from Russian necessity,” said Masha Lipman, an independent political analyst in Moscow who co-authored a study on Putin with former U.S. Ambassador Michael McFaul.

China is wasting no time filling the void created by the closing of U.S. and European debt markets to Russia’s largest borrowers. A Chinese delegation led by Premier Li Keqiang signed a package of deals today in Moscow in areas including energy and finance. Among the accords was a three-year 150 billion yuan local-currency swap deal, a double-tax treaty, satellite-navigation and high-speed rail cooperation and an agreement on implementing a May natural gas contract.

‘Strategic Partnership’

China’s Export-Import Bank signed framework deals with VTB Group and Vnesheconombank, Russia’s development bank, and a trade financing agreement with Russian Agricultural Bank. The Russian state-controlled banks are subject to sanctions.

Li’s three-day visit “will inject new impetus to the development of the China-Russia comprehensive strategic partnership,” Vice Foreign Minister Cheng Guoping told CCTV.

Russia’s embrace of China reflects a vulnerability that the country hasn’t experienced since the collapse of the Soviet Union, which triggered a depression that fractured society and led to the emergence of oligarchs who were often at odds with the state. Unlike 1991, Russians now are united in support of their leader and, with $455 billion in foreign currency and gold reserves, the country isn’t broke, according to Lipman.

Without Allies

“The economy was much worse then, but Russia was in a much better position geopolitically because it had the support of the U.S. and Europe,” Lipman said. “Now that Putin has opted for confrontation, he’s been left without allies. China is totally unsentimental and pragmatic.”

Putin’s spokesman, Dmitry Peskov, who was traveling with the president over the weekend, didn’t answer calls to his mobile phone or reply immediately to a text request for comment.

The deepening ties between two of the five permanent members of the United Nations Security Council may reverberate beyond the region as Putin moves to meet one of China’s key military goals: acquiring cutting-edge technology.

Russia is preparing to sign contracts for the delivery of S-400 missile systems and Su-35 fighter jets to its fellow nuclear state as early as the first quarter of next year, said Vasily Kashin, a China expert at the Center of Analysis of Strategies and Technologies in Moscow. Russia may also supply China with its newest submarine, the Amur 1650, and components for products such as nuclear-powered satellites, Kashin said.

Arms Race

This may trigger a conventional arms race in East Asia, said Omar Lamrani, a military analyst at Stratfor, a U.S. geopolitical risk analysis company.

“Japan, Taiwan, the Philippines and Vietnam are already worried about the Chinese developing their military and those concerns will only increase if China gets this Russian equipment,” Lamrani said by phone from Austin, Texas.

The S-400, which only Russia currently uses, would extend China’s reach to encompass all of Taiwan’s airspace, while the Su-35 would allow the Chinese to use the technology to expand their air force, Lamrani said. While Russia has been a major arms supplier to China for decades, it’s withheld its best systems until now because China often uses reverse-engineering to create competing knockoffs and swell its arsenal, he said.

Russia has long been reluctant to further empower a neighbor that already has four times the economic output and almost 10 times the population. Sanctions changed all that and Putin now risks playing a role he’s not used to playing: junior partner, said Fyodor Lukyanov, head of the Moscow-based Council on Foreign and Defense Policy, an adviser to the government.

China’s Sway

“It’s one thing to shift to China when it’s just one of several options, but quite another when you have to rely on the Chinese for political reasons,” Lukyanov said. “There’s a risk that Russia will end up considerably under China’s sway.”

Even with his options limited globally, Putin’s power remains practically unlimited at home. His approval rating is hovering near a high of almost 90 percent and confidence in the military is at a post-Soviet peak.

Still, China has already achieved a strategic objective: Russian gas supplies. Putin ended more than a decade of talks by striking a $400 billion, 30-year accord during a summit in China in May. Putin called the deal between state-run OAO Gazprom and its Chinese partners “epochal.”

Putin’s Courtship

A sign of the importance Putin is placing on his renewed courtship of China, which condemned the sanctions, is the appointment of one of his most trusted allies, billionaire Gennady Timchenko, to the head of the Russia-China Business Council. The announcement was made on April 29, a day after the U.S. blacklisted more than a dozen companies linked to Timchenko, who was personally sanctioned by the U.S. in March.

“Attitudes toward the Chinese have become more serious and friendly” since the start of the Ukraine conflict, said Timchenko’s predecessor at the council, Boris Titov, the government’s ombudsman for the rights of businesses.

Broadening commercial links with China, which overtook Germany as Russia’s largest trading partner in 2011, was vital for Russia even before the separatist war in Ukraine, but it became a matter of urgency after the U.S. and the European Union closed their debt markets to Russia, Titov said.

Before the sanctions, Russia kept tight control over Chinese investments, with the biggest being overseen by people with direct access to Putin, such as Timchenko.

New Deals

Last year, China acquired 12.5 percent of Russia’s OAO Uralkali, the biggest producer of potash, and China National Petroleum Corp. agreed to prepay OAO Rosneft (ROSN) about $70 billion as part of a $270 billion, 25-year supply deal. That was followed by Rosneft’s $85 billion, 10-year accord with China Petrochemical Corp. and CNPC’s purchase of 20 percent of an Arctic gas project from OAO Novatek (NVTK) for an undisclosed sum.

All of these contracts involved members of Putin’s inner circle: Uralkali’s chairman, Sergey Chemezov, has known Putin at least since the 1980s, when they lived in the same complex in Dresden, Germany, when the future president was a KGB agent; Novatek is partly owned by Timchenko; and Rosneft is run by Igor Sechin, who’s worked for Putin for two decades.

Earlier this year, though, as companies became more desperate for cash, Russia started lifting restrictions to offer the Chinese a wider pool of potential investments, while continuing to shield certain projects involving gold, platinum-group metals, diamonds and high-technology, two senior government officials said in May.

Barriers Lifted

“Some fairly serious barriers were lifted after the conflict in Ukraine started,” Titov said.

Putin’s charm offensive appears to be working in China, where state media praises his defiance of the U.S. A Pew Research Center poll in July found 66 percent of Chinese had a favorable view of Russia, up from 49 percent a year earlier and the most of 44 nations polled after Vietnam and Russia itself. Russian state television reciprocated last month by accusing the U.S. of fomenting protests that paralyzed Hong Kong.

When Putin came to power in 2000, Russia imported less than $1 billion of Chinese goods a year while exporting almost $6 billion, according to data compiled by Bloomberg. That surplus has turned into a deficit, with Chinese imports reaching a record $53 billion last year, compared with less than $40 billion of Russian goods going the other way.

Personal Touch

For Putin, 62, the China relationship is becoming increasingly personal. He has met with his counterpart, Xi Jinping, nine times since Xi’s promotion last year.

“Our relations are the best among the great powers,” Xi, 61, told students in Moscow in March 2013 during his first foreign trip as president. That bond “guarantees” world peace, he said.

The two leaders are also working in tandem on efforts to curb the dominance of the dollar in the global financial system.

Yuan transactions on the Moscow Exchange, the first bourse outside of China to offer regulated trading in the currency, jumped 50 percent in September from August to the equivalent of $1.1 billion, according to the exchange. Though still tiny compared with the $367 billion in dollar-for-ruble sales in August, importers now pay for 8 percent of all Chinese goods with yuan instead of dollars, up from 2 percent four years ago.

Crude Rubles

Those volumes will rise exponentially if Russia decides, as it’s now debating, to accept yuan under Gazprom’s $400 billion gas contract, according to four senior officials and executives who spoke on condition of anonymity.

China, too, is starting to move away from dollars in its trade with Russia. Gazprom’s oil arm, OAO Gazprom Neft (GAZ), has started selling crude to China for rubles, Putin said Oct. 2.

Still, convincing the Chinese to switch more of their settlements to rubles is an uphill battle after the currency sank 14 percent against the dollar last quarter, the most among global currencies monitored by Bloomberg. The central bank’s currency and gold reserves have fallen by more than $50 billion this year, in part due to efforts to defend the currency.

The Chinese remain primarily interested in raw materials and not in helping Russia diversify its economy, according to Alexei Maslov, head of the Asian Studies School at the Higher School of Economics in Moscow.

‘Taking Advantage’

“A top priority is to diversify trade because 70 percent of exports are raw materials,” Maslov said. “We want to cut this share, but China is not interested.”

China so far has little incentive to cater to Russia’s wishes. While Putin expects bilateral trade to grow from about $90 billion last year to more than $100 billion next year, that would still only represent just 2 percent of China’s global trade and a fifth of U.S.-Chinese flows, according to Maslov.

The Chinese are tough and patient investors who sense Russia’s increasing need for money and are holding out for major acquisitions, according to Maslov. China accounted for just 2.5 percent, or $3 billion, of total foreign investment in Russia last year, he said.

“They’re taking advantage of the situation,” Maslov said. “There used to be a western alternative but now there isn’t, so China is using its uncontested position.”

Titov, the ombudsman, said one of the barriers to deeper ties with China is cultural.

Russians are used to the U.S. and European corporate style, with lawyers who draw up “rock-solid” contracts, while the Chinese don’t rely as much on written pledges, Titov said.

Chinese Expansion

“We’ll have to learn new many new things in dealing with the Chinese,” Titov said.

Whichever way China’s corporate style is characterized, it’s clearly been more successful than Russia’s.

In 1979, at the start of Deng Xiaoping overhaul of the economy, China’s output was 40 percent of that of the Soviet Russian Republic — the present-day Russian Federation, according to a study by the Center for European Reform. By 2010, it was four-times larger.

That disparity gives Xi the upper hand over Putin, who, with few options left, will have to keep making concessions to China, according to Ja Ian Chong, a political science professor at the National University of Singapore.

“Russia is only important to Asia for two reasons: energy supplies and arms sales,” said Ian Storey, a senior fellow at the Institute of Southeast Asian Studies in Singapore. “And even though Russia-China relations are strengthening, it is more a marriage of convenience than a love match, with suspicions on both sides.”

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