Putin's Asia Strategy for 2015

Morena Skalamera

December 16, 2014

In the midst of a confrontation between Russia and the West evocative of the Cold War, Russia has reinforced its pivot to Asia. With large-scale international sanctions launched against Russia over Ukraine, the ruble has fallen to near record lows and Western investments have disappeared as Russia’s economy is facing zero growth and a likely recession. To add fuel to the fire, the price of oil has fallen below $70 a barrel at the time of writing, with disastrous consequences for an economy where the energy sector makes up 70% of the annual exports and over half the federal budget.

These economic challenges have made President Vladimir Putin more desperate than ever to dip into China’s robust finances. The West has also imposed many rounds of asset freezes, financial restrictions, and prohibitions on purchases of Russia’s widening debt. At the same time, Russian state banks are now excluded from raising long-term loans in the European Union (EU), and exports of dual-use military equipment to Russia are banned, as are future EU-Russia arms deals and transfers of a wide range of Western energy industry technology. Many in the West hope that toughened sanctions will make Putin change course on Ukraine, but that has not been the case. At home, where he is wildly popular, renewed pride in the country has been far more consequential than retaining Western money. Challenging new threats to isolate Russia, Putin has pledged that the country is again realizing its greatness. But the sober reality is that Russia is a deeply troubled nation, both politically and economically. Brushing off the West will only be possible at a huge cost: becoming a junior resource appendage to China.

In 2015, Putin will appeal to Asia’s resources as a part of his foreign policy toward the region. Asian capital markets, including Hong Kong, Singapore, and Shanghai, are not obliged to accept the sanctions adopted by the United States and the EU. Yet in the last decade the share of Asian investors in Russia’s financial markets has been extremely low, meaning that they are not familiar with borrowers from Russia. Generally, Asian investors are also quite conservative and rarely make quick investment decisions, given that these capital markets are less “deep” than the Western ones. Due to these factors, Asian investors will be more prudent with purchases of Russian debt and building trust will take time. Therefore, we should not expect a rapid influx of Asian capital to Russia.

Japan, Asia’s largest financial market, is now part of the financial sanctions that limit international economic ties to Russia. What is more, at the end of September Japan announced a hardening of sanctions, banning the issuance of securities in Japan by certain Russian banks and tightening restrictions on defense exports to Russia. From Putin’s perspective, these measures emphasize the extent to which Japan’s ability to conduct foreign policy independently from its alliance with the United States and overall alignment with the West is limited.

Regardless, left with very few friends, Russia needs to knock at China’s door. Both Putin and Prime Minister Dmitry Medvedev have taken great pains to emphasize that bolstered cooperation with China is unrelated to the current political situation. A year ago, Russia’s overtures toward China were motivated by showing the Europeans that Russia had options to the East, while it still hoped to reap the benefits of doing business with both. Today, China is Russia’s only option, and Beijing has immediately risen to the challenge by filling a gap that emerged subsequent to the closing of European capital markets. On October 13, a Chinese delegation in Moscow signed more than 30 agreements with Russia, including a deal on the supply of gas through the new Power of Siberia pipeline and a currency swap of 150 billion yuan ($24.5 billion), which will allow Russia to issue bonds in yuan, the Chinese currency, and convert the proceeds into rubles, thereby bypassing foreign banks.

If the past is a guide, though, Chinese assistance will only come at the cost of conspicuous concessions to Beijing: more raw materials at low prices, direct access for Chinese companies to Russian energy fields, and privileged access to modern arms technology. According to Vasily Kashin from the Moscow-based Center for Analysis of Strategies and Technologies, deepening Sino-Russian ties could affect the course of events outside the region because Russia is likely to agree on the delivery of S-400 anti-aircraft missile systems and Su-35 fighters in the first quarter of 2015. Russia could also supply China with its newest submarine (the Amur-1650) and complex components for satellites. [1] This marks a change from Russia’s decades-long practice of shipping large quantities of weapons to China but refusing to cede its best arms. Japan, Taiwan, the Philippines, and Vietnam are already alarmed by China’s operations in the East and South China Seas, and their anxiety will only increase if Beijing receives this Russian equipment.

Putin’s hopes for a rapid influx of Japanese and South Korean capital may be further diminished if these nations perceive Russia as helping China encroach on their security. This may leave Russia with one single friend to rely on, turning the country into China’s resource appendage. In fact, after more than ten years of negotiations, Moscow and Beijing signed a $400 billion agreement in May 2014 for the delivery of 38 billion cubic meters of gas over the next 30 years. Putin described the deal as an “epic event.”

For all of Putin’s bravado about “liquidating” former president Boris Yeltsin’s oligarchs who captured Russia’s state in the 1990s, today he is cheaply selling state riches to China for the benefit of his own cronies. In the past year, China has acquired 12.5% of Russia’s open joint-stock company Uralkali, which is Russia’s largest potash fertilizer producer. In 2013, Rosneft contracted a $70 billion prepayment under a deal that will supply about 360 million metric tons of crude to China over 25 years for a total of $270 billion. Prior to that, China National Petroleum Corporation acquired a 20% stake in Novatek’s Yamal LNG, for an undisclosed sum. These megadeals have made Putin’s loyalists incredibly rich and allowed Putin to court China with preferential political and economic treatment. If the Chinese are the biggest beneficiaries of this courtship, a restricted network of loyalists that extend back to Putin himself are profiting handsomely as well.

Chinese president Xi Jinping is working in tandem with Putin to try to limit the dominance of the dollar in the global financial system. They will use the newly launched, Shanghai-based New Development Bank (NDB), formerly referred to as the BRICS Development Bank, to that end. Moreover, in September 2014, Russia took the presidency of the Shanghai Cooperation Organisation, within which its main goal will be to strengthen collective security cooperation in Asia as a counterweight to the U.S.-led security architecture. [2]

Due to the fact that China’s economy is developing and Russia’s is not, China is gaining much more from such economic cooperation. In the case of gas, there is a consensus among experts that in order to build the Power of Siberia pipeline, Putin will have to sacrifice economic benefits to pursue geopolitical objectives. The rate of return on this pipeline, which will cost more than $55 billion, will be low or negative. On November 9, Putin and Xi signed a memorandum of understanding on the so-called western gas supplies route to China for a potential delivery of additional 30 billion cubic meters of gas to China. Most recently, Putin announced the cancellation of the gigantic South Stream pipeline to Europe. All these moves prove that Russia is frantically pivoting to the East, especially China. Given that the European market is not as lucrative as it used to be, Russia desperately needs profitability in the Chinese market to feed its ailing budget, which gives China the leverage in the relationship.

All this is playing splendidly into China’s hands. The country has secured cheap fuel to power its extraordinary growth and new weapons that will allow it to strengthen its position in the Pacific, all against the background of a shrinking Russian economy. For all of Putin’s talk about embracing Asia-Pacific dynamism by logically expanding ties with the entire region, he may yet find himself constrained in such a “diversification of ties.” Chinese state media will continue praising Putin’s audacity in defying the United States, thereby further feeding his ego and creating a delusion of equality between the countries, but in reality China will squeeze all that it can from this partnership. [3] Meanwhile, Putin and his cronies will profit as well, while the Russian people will be left with a dwarfed economy.

Endnotes

[1] Vasily Kashin, “Russia Must Expand Relationship with China,” Moscow Times, October 5, 2014; and Henry Meyer and Evgenia Pismennaya, “Putin Deals China Winning Hand as Sanctions Power Rival,” Bloomberg, October 13, 2014.

[2] Vladimir Putin (speech at the fourth summit of the Conference on Interaction and Confidence Building Measures in Asia [CICA]), May 21, 2014, available in Russian at http://news.kremlin.ru/news/21058: and “Declaration of the Fourth CICA Conference,” May 21, 2014, available in Russian at http://news.kremlin.ru/ref_notes/1644.

[3] For example as Izvestia reports, “It seems that Putin’s attempts to charm China have an impact. Chinese state media praised him for the way he bravely defies the United States, and the Pew Research Center poll conducted in July found that 66% of Chinese people have a positive attitude towards Russia. This is the highest figure thus far. A year earlier the rate was 49%. Russian state television last month courtesy counter responded by accusing the United States of provoking protests that paralyzed Hong Kong.” “Kak Putin sdal Rossiyu kitajcam—InoSMI” [How Putin Has Handed over Russia to the Chinese], Izvestia, October 15, 2014, http://news.eizvestia.com/news_abroad/full/723-kak-putin-sdal-rossiyu-kitajcam-inosmi.