Russia has always looked in two directions: towards the east and the west. Asiatic by instinct and nature but with a yen for European culture and US standards of living, it has long struggled to maintain a healthy balance, tending to swivel every few decades between the two in search of friends, strategic allies and trading partners.
That process of rotation is happening again. A tit-for-tat battle of sanctions between Russia on the one hand and a broad collection of Western nations on the other has led to a new crank of the dial. President Vladimir Putin’s ill-starred war of attrition in eastern Ukraine led the US and Europe to slap funding restrictions on state-linked Russian energy corporates. Russia has responded with import bans on Western agricultural produce and threats to limit European carriers from entering Russian airspace.
Of the two, Russia has the most to lose. The West’s economic recovery has been slow and spotty, with growth returning faster to Anglo-Saxon nations than to core eurozone states. But Russia, already struggling to cope with lower oil prices, rising gas production in the US and the Gulf and a malformed domestic economy, is in a far more precarious position.
Charles Robertson, chief economist at Moscow-based Renaissance Capital, notes that while earlier sanctions had “minimal impact” on Russia, later rounds, notably those passed by European governments in early September, would choke off funding for leading Russian corporates and “really hurt growth”.
In an August 6 research note, London-based Capital Economics tipped growth in an undiversified economy shackled by ropey infrastructure and poor education to remain “close to zero”. Worse, further retaliation by Russia would lead to greater isolation, higher inflation and tighter credit conditions, forcing Russia’s economy “into a deep recession, with output contracting by 2%-3%”.
CAPITAL FLIGHT
Russia’s economy ministry projects that $100bn will flee the country in 2014, though others believe that figure has already been exceeded. US president Barack Obama in August placed the number at up to $200bn. Human flight is also tearing at the country’s economic and cultural fabric, with the best brains leaving to find employment in Europe, Australia and the US. According to domestic statistics service Rosstat, 186,000 Russians left the country in 2013 against just 37,000 in 2011, though the real number, given that many émigrés remain formally registered in the country, is likely to be far higher.
Even Russia’s rather weak sanctions look set to backfire. By banning the import of everything from Scottish salmon to German salami, Moscow is hoping to kick-start its own, moribund agricultural sector. That won’t be easy: Russia imported $10bn worth of high-end food products from the West in 2013, out of a total import bill of $25bn. Nor will it prove cheap. When Moscow banned dairy imports from Lithuania last year, Russian milk prices jumped 20%. Capital Economics sees higher food prices adding up to 2 percentage points to inflation, making the central bank’s fight against inflation harder, and “raising the chances of additional interest rate hikes this year”.
CHINA TO THE RESCUE?
Painfully aware of the perilous state of Russia’s creaking economy and the over-reliance of leading domestic corporates on Western capital markets, Putin has made his own somewhat jerky pivot toward Asia in general and China in particular. In May, Russian energy firm Gazprom signed a blockbuster deal with Beijing-based CNPC to pipe $400bn worth of gas from central Russia over a 30 year period, from 2018. In early September, it was Rosneft’s turn.
A few weeks after it appealed to the Kremlin for $40bn in financial aid — a direct result of heightened sanctions — Putin unveiled an alliance between the Russian oil company and CNPC to develop Vankor, a vast oilfield in northern Siberia. Announcing the deal, Putin took a swipe at the West, noting that while Russia was “very careful” about admitting certain foreign partners, there were “no limits... for our Chinese friends”.
Nor is China the only big emerging market on the Russian radar. In July, as the Ukrainian government struggled to repel Russia-backed rebel forces in the east of the country, Putin embarked on a sweeping tour of Latin America, brokering a deal to build power plants in Cuba and waiving 90% of the Caribbean country’s soviet-era debt. He then swung south, signing nuclear power projects with Argentina’s president, Cristina Fernández de Kirchner, and laying the groundwork for the sale of Russian planes and satellite systems. Before departing, he met the leaders of China, India, South Africa and Brazil to launch a new $100bn development bank, the New Development Bank, which aims to lend up to $34bn annually to projects in Latin America, Africa and Asia.
Other deals have also emerged, notably an announcement in August that Russia had agreed to buy up to 500,000 barrels of Iranian oil a day over the next five years in return for Iran’s willingness to import Russian made power plants and consumer goods. The deal would turn Russia overnight into the largest importer of Iranian oil while defying US sanctions against the Middle East state.
HALF-BAKED STRATEGY
But strip away the topline data and shock value on the various deals and you are left with, at best, a bits-and-pieces development strategy rapidly stitched together. Russia remains painfully dependent on energy sales to the wealthy West. Just three European states — Germany, Italy and the Netherlands — absorbed nearly a third of the country’s exports in 2013, according to data from the CIA world factbook, contributing $144bn to Russian coffers. By contrast, bilateral trade with Argentina, recipient of such lavish summertime attention by the Russian president, topped out at $1.5bn in 2013, with two-way Cuban trade totaling just $185m.
And for all the fanfare surrounding Gazprom’s monster deal with CNPC, Russia remains a marginal trading partner for China. That will change over time but it’s still a surprise to find that China does more business each year with, say, faraway South Africa than it does with a neighbour that shares a 3,500km-long border stretching from Central Asia to the Pacific Ocean.
The challenge Russia faces in the years ahead is deciding: first, who it really wants to do business with; second, whether it has anything to offer any given counterparty; and third, how equitable any trade relationship will be. For all of Putin’s paranoia about the West and its perceived determination to encircle and tame Russia, Europe has long been a reliable, equitable and durable commercial ally, sucking in oil and metals and seeking, in return, to sell automobiles, food, technology, defence equipment and luxury goods.
CHINA AT THE DOUBLE
China is likely to prove a far more testing business partner. Take the Gazprom-CNPC pipeline, a deal on which Russia’s rulers have stalled for more than a decade, seeking to ratchet up the price China was willing to pay. Only when Western sanctions began to bite did Putin act, forcing the Russian president to negotiate from a position of weakness and giving China the chance to secure favourable terms on price.
“Russia has been forced to accept a high cost to get its relationship with China up and running,” says Renaissance’s Robertson. “The risk for Moscow is that it becomes a neocolonial deal, with Russia becoming a colonial subject for China. That’s the danger of the direction Russia is heading and a consequence of the tougher and changing geopolitical landscape.”
For proof, he points to a raft of deals struck between Russia and China since May, many of which are linked to the original gas pipeline contract. In June, Huawei secured a 10 year contract to provide services to Gazprom. The same month, the Shenzhen-based telecommunications equipment maker signed a $600m deal to provide 4G services to MegaFon, Russia’s second-largest wireless carrier. And in early September, Beijing-based infrastructure firm China Communication Construction secured the right to build a $6.2bn bridge across the Kerch Strait linking Russia with Crimea, the Black Sea peninsula recently annexed from Ukraine. Such projects, analysts say, smack of the sort of deals China prefers to clinch with governments in Africa and southeast Asia, in which the Chinese government agrees to build infrastructure — rail lines, ports, pipelines, highways — in exchange for access to energy and minerals.
Others see a far more nuanced picture in which trade between the two sides grows and even blossoms while remaining fundamentally imbalanced, with Russia exporting primary commodities to resource-hungry China and securing higher value manufactured goods in return.
“I can see the drivers of this trade relationship remaining very much the same,” for years to come, says Andrew Polk, resident economist at The Conference Board China Center for Economics and Business in Beijing. “The relationship between the two sides has always been very opportunistic, swinging from friend to enemy and back again over the past half century. There is a healthy level of mistrust between China and Russia and that will endure.”
Others believe Russia’s accelerated engagement with China is merely the latest in a long series of steps designed to boost trade ties with the wider emerging world. Until recently, the International Economic Forum, an annual meeting held every May in St Petersburg and referred to as ‘Russia’s Davos’, was largely the preserve of local politicians and global chief executives keen to secure or extend operating licences.
Yet around 2011, visitors noticed a change. “You’d suddenly see government officials from Asia and the Middle East,” says a Moscow-based investment banker who attends every year. “At one roundtable, you’d meet the Indian commerce minister. You had the vice premier of China speaking after [German chancellor] Angela Merkel. There would be corporates galore, many from the US and Europe but also many from Asia or the Gulf states. African governments and companies would be better represented too.”
A LIST OF EM FRIENDS
This point is telling. Russia, analysts say, has quietly drawn up a list of emerging markets, notably those boasting large reserves of human or financial resources that it wants to court. “The clear priority is India, Asia and the Gulf states,” notes Renaissance’s Robertson. Each target sovereign also has a long, if sometimes fraught, history with both Russia and its predecessor, the Soviet Union.
Putin is particularly keen to renew links with India, a great friend to Russia during the Cold War when it imported vast amounts of Russian steel and munitions. In July, the Russian president met with newly elected Indian premier Narendra Modi in Brazil to discuss a raft of oil and gas ventures, including a potential $30bn gas pipeline linking the two countries via Central Asia or western China. Russia’s president is also desperate to boost commercial ties with the Middle East. “Reaching out to the Gulf is all about saying: ‘We have an industrial base; we have 140m people; we are a new play on the oil and gas sector for you; you should invest in our economic future’,” says Renaissance’s Robertson.
Others aren’t so sure that play will work. “There are signs of Russia attempting to” secure greater inward investment from the Gulf to build and diversify
its economy, says William Jackson, emerging market economist at Capital Economics. “But Russia has a poor business environment, which is a concern for Gulf investors, particularly now they are investing for a future when the oil runs out. Also, it’s not clear why Gulf investors would opt for a market currently quite as risky as Russia’s.”
Even the formation of the Eurasian Economic Union, a new tariff-free zone binding together the economies of Russia, Belarus and Kazakhstan has not gone entirely smoothly. Set for its formal launch in January 2015, the EEU is a curious concept, viewed by some as a belated attempt by the Russian president to recreate the Soviet Union and by others as either a counterpoint to European Union enlargement, or a logical reaction to the disintegration of once-thriving industrial ties that once bound together the imperium.
There has been friction here over trade policies, with Russia appearing torn at times over whether to cajole, hector and at times even threaten its new partners. When Russia slapped sanctions on Western produce, Belarus president Alexander Lukashenko refused to follow suit, sending a warning that no one — not even Russia — should meddle in his country’s internal affairs.
Even longstanding Kazakh president Nursultan Nazabayev, a veteran occupier of neutral ground in any dispute, described the sanctions war as a “road to nowhere”. Kazakhstan, he warned, would “not enter an organisation which threatens our independence”, adding that the Central Asian state retained the “right to leave” the EEU at any time. Putin bit back with a few darkly choice words of his own, hinting at a “Ukraine scenario” when the 74-year-old Nazarbayev leaves office, thus conjuring the image of Russian soldiers on Kazakh soil.
| Bad for business Russia’s economy is in a sorry state. Sclerotic and tangled in red tape, it also faces a worrying future in which the majority of its people are either very young or very old. The population is expected to tumble to 107m by mid-century, with the number of working-age people set to drop by six percentage points between now and 2020. As the best young brains also leave the country, investors will increasingly struggle, warns Charles Robertson at Renaissance Capital, “to get excited by Russia as a story”.
Russia’s president Vladimir Putin recognises the threat. Over the past two years, generous new maternity benefits have been introduced while senior ministers have moved to make the country an easier place in which to do business. Regulations relating to registering land and new companies and securing reliable access to electricity have eased, helping the country jump 19 places in the World Bank’s 2014 Doing Business report, to 92nd place. Russia wants to break into the top 20 by 2018, eclipsing the likes of Germany, Japan and the Netherlands. But this remains a very difficult country in which to do business. Western sanctions have left Russia increasingly friendless, exposed as belligerent in a world weary of conflict. In recent decades, the country has busied itself pumping hydrocarbons rather than building a diverse economic base, meaning it often has precious little, other than oil and gas, to offer new sovereign investors. Worst of all, despite a flurry of Chinese megadeals, the nation remains dependent on exports to a European continent with which it is engaged in an increasingly bitter war of words and sanctions. Capital Economics’ William Jackson says: “Whether Putin likes it or not, the West in general and Europe in particular will remain Russia’s only major trading partner for years, and maybe even decades, to come.” |