Pretty much best friends?

Russia and China edge closer together

  • China and Russia see their common world view as a clear antithesis to the West
  • War in Ukraine accelerates bloc formation, but a complete split is (at present) unlikely
  • Foreign companies in China could already be subject to higher risk premiums

The division of the world into blocs continues

Three years ago, Russian President Vladimir Putin gave his Chinese counterpart a cake, a vase and a giant box of ice cream when the two met at a conference in summer on Xi Jinping’s 66th birthday . On 15 June this year, Putin and Xi Jinping only spoke on the phone but according to the readouts of the conversation, the messages exchanged were quite something. Russia let it be known that on the subject of Ukraine, China had confirmed the “legitimacy of Russia’s actions” in “protecting its fundamental national interests in the face of challenges to its security created by external forces”. The two parties also aimed to expand cooperation in the areas of “energy, finance, industry, transport and other spheres”. China did not contradict this account – a gift for Xi’s “dear friend” Putin, perhaps?

On the day after Russia invaded Ukraine, China was still stressing its neutrality and professing to support “the sovereignty and territorial integrity of all states”. But Beijing has moved further and further away from this position in recent weeks. It has not obviously undermined western sanctions against Russia, although the Russian share of Chinese commodity imports has noticeably increased in recent months. However, China is now criticising the sanctions in ever stronger terms and warning that they are pushing up the price of food and energy. President Xi recently called them a “boomerang” and a “doubled-edged sword” and said that unilateral sanctions should always be opposed. At the same time, he indirectly blamed Ukraine itself and NATO’s eastward expansion for the war. One thing is clear: Russia and China are edging closer together. What does this mean for geopolitical equilibrium – and for foreign companies operating in China?

The Sino-Russian relationship is changing

The stronger verbal support for Russia is the continuation of a long-term trend, according to a textual and semantic analysis by the Mercator Institute for China Studies (MERICS)1. While joint communiqués issued by Russia and China during the time of Jiang Zemin (1993-2003) paid attention to good neighbourliness, and those in the Hu Jintao era (2003-2013) emphasised economic cooperation, under Xi (since 2013) there has been a clear focus on geopolitics.

The words ‘USA’ and ‘NATO’ now come up far more often in their jointly issued declarations – particularly in association with the word ‘oppose’. The analysis also shows that over the years, the joint statements have increasingly shifted from focusing on bilateral relations towards a shared global perspective. This world view sees the US and NATO as a threat to peace and opposes (western) human rights standards and democracy as well as interference in internal affairs. And since 2017, the two states have increasingly sought to expand their cooperation in strategic future growth sectors such as cyberspace, outer space and the Arctic.

Why China is not turning away from Russia

Russia’s war in Ukraine presents China with a dilemma. China is still extremely economically dependent on the West, but at the same time Beijing needs Russia for the creation of its new global order. Xi Jinping’s assessment is therefore clear: Russia can only remain a valuable partner for China if Putin survives the war politically. This is important as a political rapprochement between the European Union (EU) and China may well now be history. While China may have spent the past few years hoping for the EU to move further out of the US’s orbit as a part of a process of ‘strategic independence’, the Ukraine war has had precisely the opposite effect.

So China is facing an even more united transatlantic alliance which, including other partner countries, accounts for more than 50 per cent of global gross domestic product (GDP). As the sole heavyweight outside this bloc (with 19 per cent of global GDP), China is therefore reliant on Russia as a trading partner. Particularly as Russia can help to establish China as the leader of the Global South – with partners in Asia, Africa, Latin America and the western Balkans.

Ukraine war accelerates bloc formation

China is already attempting to use existing multinational institutions to further its political ambitions. The aforementioned ‘West’ (primarily the NATO states, but also Japan and Australia) account for only 35 of the 193 member states of the United Nations and make up just 14 per cent of the global population. The opportunities this imbalance presents for China are illustrated by the vote on the UN resolution on the aggression against Ukraine. Although 141 countries voted for the resolution, they represent only around 43 per cent of the global population.

The coalescence into blocs also manifests itself in other ways. Effectively, only the western industrial nations have imposed sanctions on Russia. In addition to China, the other BRICS states (Brazil, India and South Africa) as well as Argentina, Indonesia and Turkey are notable by their absence. And China is trying to bind these very countries more closely into its values system, for example through the planned expansion of the BRICS grouping. Turkey, Egypt and Saudi Arabia have recently been named as possible candidates, alongside Argentina and Indonesia. The aim here too is to create an alternative political and economic power centre as a counterbalance to the ‘West’. Russia’s support would lend China additional strength and credibility in this endeavour. Take armaments, for example. Russia has been supplying military hardware to many countries for a number of decades. Switching to American or European systems would be enormously complicated and expensive. This is one of the key reasons why it is so hard for India to turn its back on Russia.

The establishment of a China bloc on one side and a western bloc on the other is progressing apace – and will be further accelerated by the war in Ukraine. Although Beijing is not willing to completely snub the West in public, as this would certainly result in severe sanctions, it cannot leave its strategic partnership with Russia hanging for too long. China has therefore already begun to exert indirect pressure on the West by acting as a mouthpiece for the Global South, warning of the negative consequences of the sanctions and questioning their legitimacy.

China is walking a tightrope here. The longer the war goes on, the more likely it is that Russia will need help or that the support China is already covertly providing will come to light. The risk of a misstep is high, and could put China itself in the cross-hairs of sanctions.

China’s testing of the boundaries

The Taiwan tensions provide further evidence of China’s increasing testing of the boundaries. The scope of the military exercises conducted by China in response to the visit to Taiwan by Nancy Pelosi (Speaker of the US House of Representatives and thus formally the third most senior person in the country) was unprecedented. Numerous aircraft and warships crossed the de facto sea border between China and Taiwan. Chinese state television also reported that missiles had been fired over Taiwan’s capital Taipei.

The response of the West was initially muted and further escalation is unlikely at present. However, the situation remains tense – not only militarily but also economically. The strait between China and Taiwan is one of the busiest shipping channels in the world. Taiwan is the global leader in semiconductor production. A blockade would have drastic consequences for the already fragile supply chains and thus for the global economy.

However, the example of Taiwan also shows that there is no immediate threat of a rift between China and the West. China’s economic dependence is (for now) too great and its military strength is (for now) not great enough to risk open conflict. On top of which, at the end of this year China will begin the five-yearly process of choosing a new leader for the party and government, which will go on until the parliamentary session in March 2023. President Xi, who is seeking a third term, will want to avoid sparking any international turmoil during this period. After that, however, the risk will rise significantly, especially if the West is in a period of economic weakness at this point. A military escalation appears to be ruled out for now, but the persistent sabre-rattling could also accidentally spill over into actual conflict. And as soon as China is militarily strong enough and economically independent enough, the likelihood of Beijing adopting an even more aggressive stance will rise. This is unlikely to be the case before the end of the decade, though.

Impact of the bloc formation on sectors and companies

The direction of travel is set, however. China and the West will continue to disengage over the coming years and the war in Ukraine has shown that this can happen more rapidly than generally assumed. For investors, this can have significant implications. Companies that have invested heavily in China or export a substantial portion of their output there are in danger of being subject to higher risk premiums.

Which sectors could potentially be affected more severely or more quickly by the increasing disengagement? The US has had export controls in place for some time to restrict the supply of western technology to China in strategically important sectors. The best-known example is probably the smartphone and network technology manufacturer Huawei, which has long been on an export blacklist. Since August 2020, no firms anywhere in the world that use US technology are allowed to supply Huawei because of security concerns surrounding the company. Similar bans could be imposed on other Chinese companies in future, especially if their technology could also be used in military or other strategically important areas. This applies to many technologies in the high-tech sector. The CHIPS and Science Act that has just been passed in the US provides a foretaste of things to come. The Act prohibits investment in Chinese high-end chips by companies that have received US government funding. The focus is thus clearly on boosting US industry at the expense of production in China.

But Beijing is also driving the disengagement. The Chinese regulators are making it harder for Chinese companies to list their shares on foreign stock markets so as to keep technology and capital at home – as ride-sharing company Didi recently discovered to its cost. And Beijing is also making it more complicated for foreign companies to do business in China and to access the market in general. Companies at particular risk in the event of an escalation are those that have established large-scale industrial and production facilities in China in collaboration with Chinese joint venture partners – for example in chemicals, automotive (particularly electric cars), and some areas of engineering. Digitalization could also be an issue: as digital networking has become established in many sectors, China could seek to impose data transfer restrictions to force foreign competitors out of partnerships and thus out of the market.

Government-orchestrated boycotts of western brands could also be a tool of choice and would particularly affect manufacturers of consumer goods. This strategy has already been used in the past to ‘sanction’ western company leaders for statements concerning the human rights situation in China.

Unfair competition in China may pose a threat to foreign companies

Market shares of Chinese companies in China and in the rest of the world (%)

Unfair competition in China may pose a threat to foreign companies
Source: McKinsey Global Institute, Union Investment; July 2019.

Sectors that are strategically important to China and where China’s own capabilities are so far advanced that it is no longer dependent – or much less dependent – on foreign technology transfer may also be a target. China has already forced foreign competitors out of the domestic market in some of the sectors shown in the chart below, and is about to do so in others. For companies operating in these sectors, this will mean pressure to adapt. The markets will also be keeping a close eye on developments.

  1. 1 R. Kefferpütz, V. Brussee – China and Russia: united in opposition, 16 June 2022

Authors:

Volkmar Baur, Janis Blaum and Sandra Ebner

 

As at 16 August 2022.

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