Defying the U.S. and Europe is forcing Russian President Vladimir Putin to aid his biggest rival to the east. To avert a recession, Russia is turning to China for investment, granting it once restricted access to raw materials and advanced weapons, say two people involved in planning Kremlin policy who asked not to be identified discussing internal matters. 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. With the ruble near a record low and foreign investment disappearing, luring Chinese cash also may deepen Russia’s reliance on natural resources and derail 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,” says 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 delegation led by Premier Li Keqiang signed a package of deals on Oct. 13 in Moscow. Among them were an agreement to swap $25 billion in Chinese yuan for Russian rubles over three years, a treaty to protect companies operating in Russia and China from having their profits taxed twice, and cooperation on satellite-navigation systems and high-speed rail. To promote trade, Export-Import Bank of China agreed to provide credit lines to state-owned VTB Group and Vnesheconombank, Russia’s development bank, as well as a trade finance deal with Russian Agricultural Bank.
Russia’s economy is more vulnerable than it’s been since the collapse of the Soviet Union in 1991. Unlike then, Russians 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. “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,” she says. Putin spokesman Dmitry Peskov didn’t respond to requests for comment.
The deepening ties between Russia and China may reverberate throughout East Asia as Putin meets his neighbor’s desire for state-of-the-art weaponry. Russia is likely to sign contracts for the delivery of S-400 missile systems and Su-35 fighter jets to China as early as the first quarter of next year, says Vasily Kashin, a China expert at the Centre for Analysis of Strategies and Technologies in Moscow. Russia may also supply China with its newest submarine, the Amur 1650, he says.
These arms deals could trigger a conventional arms race, says 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 military, and those concerns will only increase if China gets this Russian equipment,” he says. The S-400 missile, which only Russia uses, would extend China’s reach to encompass all of Taiwan’s airspace, while the Su-35, the latest-generation Russian fighter, would provide a powerful boost to the Chinese air force, Lamrani says. Russia has supplied arms to China for decades, but it had withheld its most advanced weapons because China often uses reverse engineering to create knockoffs.
China overtook Germany as Russia’s largest trading partner in 2011, but before the sanctions, Russia kept tight control over Chinese investments. The most important deals as measured by size and strategic value were overseen by people with direct access to Putin. Last year, China acquired 12.5 percent of Russia’s Uralkali (URKA:RM), the biggest producer of potash in the world, and China National Petroleum agreed to prepay Rosneft (ROSN:RM), run by Putin associate Igor Sechin, 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 Sinopec and China National Petroleum’s purchase of 20 percent of an Arctic gas project from Novatek for an undisclosed sum.
Earlier this year, as Russia became more desperate for cash, the country started offering the Chinese a wider pool of potential investments, especially in raw materials. In May, China achieved a long-sought-after goal by securing Russian gas supplies for 30 years for $400 billion. These deals were done before the recent crash in commodities prices.
When Putin came to power in 2000, Russia imported less than $1 billion of Chinese goods a year while exporting almost $6 billion to the country, according to data compiled by Bloomberg. That surplus has turned into a deficit, with imports from China reaching a record $53 billion last year, compared with less than $40 billion of Russian goods, including oil and gas, going the other way. “A top priority is to diversify trade, because 70 percent of exports are raw materials,” says Alexei Maslov, head of the Asian Studies School at the Higher School of Economics in Moscow. “We want to cut this share, but China is not interested.”
The Chinese are tough, patient investors who sense Russia’s increasing need for money, so they’re holding out for major acquisitions, according to Maslov. They have the cash to buy. In 1979, at the start of Deng Xiaoping’s economic overhaul, 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, China’s output was four times larger than its rival’s.
