How Russia Is Using Chinese Largesse to Circumvent the West's Sanctions

September 3, 2015 2:45 PM

China has been energetically touting the benefits of its New Silk Road initiative, which aims to spend $40 billion a year to link Europe and Asia via roads, rail, and water. The stated goal is to open a whole region—Central and South Asia—to the world.1 The goal, China says, is to cut transport times for many goods by two-thirds, reducing costs. And countries that are currently closed to the rest of the world will enjoy the benefits of international trade. The initiative is one of many examples of China using its massive reserves, piled up after years of trade surpluses, to extend its influence. Its other major initiative, the $100 billion Asian Infrastructure Investment Bank (AIIB), has been embraced by the West but questioned by the United States as undercutting multilateral development efforts in the region.

One little appreciated aspect of China's extension is the reversal it has caused in Russia. When the initiative was first announced in Kazakhstan in 2013, Russian officials viewed it with suspicion—as an instrument of Chinese influence in Russia's backyard of Central Asia. In response, Moscow then pushed hard for the implementation of the Eurasian Economic Union, a competitor project. Since then, however, Russia has had a change of heart and joined several New Silk Road projects and has become a founding member of the AIIB. President Putin's two-day visit to China this week is expected to include support for the AIIB spending $4 trillion, the total cost of the New Silk Road over time.

What explains this change of heart? The answer is simple: money.

The New Silk Road initiative has become a way to circumvent Western sanctions on the Russian banking sector and gain access to much needed investment and credit lines. Earlier this year, Russian companies signed the first financing projects under the New Silk Road initiative: a $5.8 billion high-speed rail between Moscow and Kazan (to be continued to Yekaterinburg at a later date); a $966 million credit line to Sberbank, Russia's largest state-owned bank—to finance road and logistics infrastructure; and a $483 million credit line to VTB, Russia's second largest state-owned bank,—for investments in agriculture and transport. The high-speed rail project is of particular importance as it links cities that will host the 2018 World Cup. Several other projects are being negotiated—including in sectors like high-tech—far from the originally-stated purpose of the initiative.

And these are just the initial investments—the full rail project connecting Russia's capital to the border with Kazakhstan is priced at $21.4 billion, mostly Chinese investment. In return, the bulk of the construction work will be performed by Chinese companies.

In ordinary times, Russia may have thought twice about giving Chinese companies access to its lucrative market. But these are not ordinary times—Western financial sanctions have sapped liquidity in the banking sector and the new source of financing is vital. Altogether, this financing is substantial—the Silk Road Fund has $40 billion initial capital, and the AIIB has $100 billion. Together they are nearly as large as the World Bank.

Russian companies also expect to participate in the construction of infrastructure in Central Asia—where initial projects, mostly in Kazakhstan, are estimated at $200 billion. In a period when the Russian federal government has reduced budget expenditures on infrastructure by a third, due to the increasing fiscal deficit, this is a welcome substitute.

It also helps that all contracts are signed in local currency, thus obviating the need to worry about currency exchange fluctuations and dependence on the dollar. Over time, Chinese and Russian policymakers hope that a fully-fledged initiative, worth the equivalent of $4 trillion, will reduce the power of the dollar as global currency. This is however far into the future. For now, Russian banks and select construction companies are happy that they have found fresh money.

Note

1. Chinese Ministry of Foreign Affairs, "Vice Foreign Minister Cheng Guoping and Russian Deputy Foreign Minister Hold Consultations on the Working Group of Coordination Mechanism for Connecting the Construction of the Silk Road Economic Belt and the Eurasian Economic Union Between China and Russia," press release, August 26, 2015, Beijing.