War in Ukraine could put Russia deeper in China’s pocket than ever. Here’s how Beijing could use that economic leverage

When Western countries hit China with an arms embargo following the Tiananmen Square massacre in 1989, Beijing turned to Moscow, restarting an economic relationship that had dwindled in the last decades of the Soviet Union. In 2014, after Russia annexed Crimea, it was China’s turn to help, providing Moscow relief from Western sanctions through a raft of energy deals.

Today, with Russia’s invasion of Ukraine turning it into what U.S. President Joe Biden has termed a “pariah on the international stage,” and the ruble’s value crashing in the wake of new sanctions, Moscow will again be looking to Beijing for succour.

“With the West and many allies and partners around the globe united in sanctioning Russia, the country’s economy is bound to take a severe hit, and only a few countries will be willing and able to help Russia mitigate this,” said Helena Legarda, a lead analyst at the Berlin-based Mercator Institute for China Studies. “China’s economic support will be key.”

While it remains unclear how willing China is to undermine Western sanctions – the country’s banks seem to be conforming with them for now, as they have in the past with sanctions against Iran and North Korea – the new measures will accelerate Russia’s pivot eastward and make the country more economically dependent than ever on China.

This transformation began in 2014, when Russian President Vladimir Putin travelled to Beijing after the annexation of Crimea.

There he signed a US$400-billion deal to supply gas to China. New energy export deals followed, while in 2017, Chinese banks provided about US$12-billion in funding for a liquefied natural gas project on Russia’s Yamal Peninsula.

China has also provided high tech equipment and expertise to Russia, helping the country ramp up internet censorship and surveillance, tools that have become helpful in suppressing dissent against Moscow.

Feng Yujun, deputy dean of international studies at Shanghai’s Fudan University, said in a report last year that “attracting the maximum amount of Chinese capital has become an important means for Russia to break through U.S. and European sanctions, ease financial pressure, and safeguard the national economy, people’s livelihoods and even political stability.”

Since 2014, China has overtaken Russia’s three largest European trading partners – Germany, the Netherlands and Italy – with exports surging from US$37-billion to almost US$50-billion by 2020, although the European Union as a whole remains Moscow’s single largest market, at US$92-billion, according to International Monetary Fund data.

In terms of imports, Russia already buys almost as many goods from China, US$55-billion in 2020, as it does from the entire EU, US$62-billion.

These trends will likely accelerate as a result of new sanctions and decoupling measures, such as Germany’s halting of the Nord Stream 2 pipeline, as well as deals worth an estimated US$117.5-billion that were announced after a meeting between Chinese President Xi Jinping and Mr. Putin in Beijing in early February. Beyond tripling Russian natural gas exports to China by 2025, the new agreements included the lifting of Chinese restrictions on Russian wheat, opening up new export markets for Moscow.

But while China is of ever-increasing importance to Russia, the economic relationship is not an equal one.

Russia only makes up around 1 per cent of China’s global trade activity, compared with 15 per cent in the other direction. In terms of gross domestic product, China’s economy is almost 10 times larger than Russia’s, and while Moscow is becoming ever more dependent on Beijing to buy energy and other goods, China has numerous lucrative markets around the world: Total foreign trade for 2021 was US$6-trillion, four times the size of the entire Russian economy.

“Russia is less than 2 per cent of global GDP, it’s a minnow,” said James Fok, a Hong Kong based analyst and author of Financial Cold War, a book on the United States-China rivalry. “From a trade perspective, Russia is not that important to China, far less than the U.S. or the EU is.”

For all that Beijing may sympathize on with Moscow, this discrepancy could make China wary of taking actions that could result in further economic blowback from the Ukraine crisis. Chinese stocks opened lower Monday and there were already signs of logistical problems affecting trade in Europe as a result of the war, state media reported.

“While China will continue its economic engagement with Russia, I think China doesn’t want to be perceived by the international community as helping Russia to evade sanctions,” said Tommy Wu, Hong Kong-based lead economist with Oxford Economics. “I think China’s major commercial banks will scale back their financial transactions with Russia given their exposure to the U.S. dollar system. But it is less clear what China’s policy banks will do, given their exposure to infrastructure and energy projects in Russia.”

Regardless of what Beijing decides, Russia may have no choice but to tie itself ever closer to China, including conducting more deals in the Chinese yuan.

Since Crimea, Moscow had sought to reduce its exposure to the dollar. New European sanctions, as well as the cutting off of several Russian banks from the SWIFT network, could drive adoption of the renminbi as a reserve currency.

While even major investors in China tend to prefer dollar-denominated deals over the renminbi, owing to the lack of offshore markets, Mr. Fok said “the Russians are going to have very little choice” but to convert a substantial amount of their foreign currency reserves into the yuan, although he predicted Moscow may also increase gold holdings in an attempt to diversify.

Both Russia and China have launched competitors to SWIFT in recent years, but Mr. Wu said Beijing’s Cross-Border Interbank Payment System (CIPS) is “probably the only viable alternative for Russian banks now because of the sanctions.”

“But while CIPS has become more sophisticated and has more members now, it is still far from being able to compete with SWIFT,” he added.

Depending on how sanctions are enforced, the system itself may not make a difference. Analysts said foreign banks and companies will likely be wary of being caught out and err on the side of caution, given the risk of Washington cutting them off from the dollar payment system or U.S. market.

The result of this could mean China comes out of the Ukraine crisis with a “weighty satellite state … almost completely dependent on Chinese finance and technologies,” Victor Shih, a China expert at University of California San Diego, wrote in a piece for the Wire China, a U.S.-based China news website, on Sunday. “Via this Russian dependence, China would also be able to entrench its dominance over most of the Central Asian republics, with which it already has close ties.”

Moscow has previously been wary of China’s designs of its geopolitical backyard. The Russian-led Eurasian Economic Union was once seen as a potential counterweight to China’s Belt and Road Initiative, but the agreement signed by Mr. Xi and Mr. Putin in February included plans to link the two projects “with a view to intensifying practical co-operation” and “promoting greater interconnectedness between the Asia Pacific and Eurasian regions.” It also called for greater economic integration of the Shanghai Cooperation Organisation, a grouping of Eurasian powers dominated by China.

Joe Webster, an independent analyst and author of the China-Russia Report, wrote Monday that the war in Ukraine and subsequent blows to Russia’s economy “cannot but reduce Russian hard and soft power regional capabilities, offering a vacuum that Beijing will fill by dint of its massive economic regional presence.”

In the February joint statement, the Russian and Chinese leaders said they “oppose the return of international relations to the state of confrontation between major powers, when the weak fall prey to the strong.” By the time the dust settles in Eastern Europe, Moscow may be looking at that passage in a new light.

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