Beijing-Style Friendship: Despite the statements from Putin and Xi, economic cooperation between Russia and China is deteriorating due to the threat of US sanctions

In an interview with Xinhua on the eve of his trip to Beijing, Vladimir Putin named the ‘development of financial infrastructure’ among the tasks that need to be solved to expand cooperation with China. Behind these words lies one of the most acute problems for the Kremlin at the moment. Major Chinese banks are refusing to service transactions involving companies that are directly, indirectly or potentially related to the Russian military-industrial complex. As a result, shipments of Chinese goods to Russia have been declining for three consecutive months, as first noted by Kommersant. In April, Chinese exports to Russia decreased by 13% to $8.3 billion, according to data from China's General Administration of Customs. The previous month, the reduction was 16%.

Russian businessmen have complained that problems arise when paying for any goods, not only those subject to Western sanctions. The situation is worse with purchases of industrial equipment, which are the most important items among Chinese exports for Russia. If in November-December 2023, Russia imported an average of $1.9 billion worth of electrical machinery and equipment (group 85 of the HS code) from China, and the average monthly volume for the entire year 2023 was $1.43 billion, then in February 2024, the import was $1.2 billion, and in March, it was only $1 billion. Thus, the average monthly supply for February-March is 77% of the average monthly value last year. If the trend of the last two months continues, it will become a major problem for the Russian economy.

How the export of equipment from China to Russia has changed since the beginning of the war, thousand USD 

At the same time, imports of dual-use goods fell by about a quarter, according to Nathaniel Sher, a senior researcher at Carnegie China. Throughout 2023, Russia imported about $400 million worth of these goods from China each month. In November, a month before the US Treasury Department's Office of Foreign Assets Control (OFAC) received the right to apply secondary sanctions, the volume of shipments rose to $500 million, and in December it exceeded $600 million. But in January, it dropped to $400 million, and in February and March, it was $300 million each. The goods banned for import to Russia by the US and the EU were divided into four groups according to their importance for the military-industrial complex. The supply of goods in the first group, which includes the most advanced microchips, has hardly suffered. The volumes of such purchases are small, so payments are managed through intermediaries. The supply of goods in the second group (communication devices and satellite navigation equipment) has slightly declined. However, the main reduction was in goods from the third and fourth groups (numerically controlled machines, certain electronic components, navigation equipment, optical instruments, bearings, etc.). This reduction could significantly impact the Russian economy overall.

Discussing the key rate at the end of April, the Central Bank leadership noted that the dynamics of imports do not correspond to domestic demand but rather that this anomaly is linked to emerging payment problems (this was reported by representatives of all regional directorates, noted in the summary of the discussion, indicating that this is a widespread issue). ‘In the past, companies have found solutions to these problems, demonstrating a high degree of adaptability,’ the Central Bank expressed hope.Indeed, one recent solution was to transfer operations to smaller Chinese banks, which either do not work with the West and thus do not fear sanctions or are willing to take risks for profit (→ Re:Russia: The Spillover Effect). But the experience of recent months has shown that even smaller regional banks are reluctant to serve clients from Russia. Chinese entrepreneurs interviewed by Reuters say that accounts take a long time to open and payments are regularly rejected. The South China Morning Post explains that it is not very profitable for small Chinese banks to launch new business to service clients from Russia. 

A systemic solution to the problem would be to conduct transactions through a service that is not linked to Western financial infrastructure. This is partly what Vladimir Putin implied in his statement. A report by the Institute of Financial Studies at the People's University of China, quoted by the South China Morning Post, suggests organising a new payment infrastructure based on China's Cross-Border Interbank Payment System (CIPS) and the Russian Central Bank's Financial Messaging System (FMS). The use of CIPS in mutual trade began to be discussed in the first year of the war. Leading Russian banks expressed their desire to join it, but not all of them were eventually connected. Those that were connected became ‘indirect participants’, meaning they can only work in CIPS through local partners. However, banks from other countries also participate in the system on the same terms. 

The development of China's CIPS is being carried out in case China itself has to face international sanctions (for example, in the event of an attack on Taiwan), Atlantic Council experts have written in a report dedicated to this problem. The service was created in 2015, and its closest analogue is the US Clearing House Interbank Payments System (CHIPS). As of December 2023, CIPS had 139 direct participants and 1345 indirect participants from 113 countries. Recently, the influx of new participants has increased. In 2023, banks from Argentina and Brazil joined CIPS. Partly thanks to the use of CIPS, the share of the yuan in cross-border transactions of Chinese non-bank organisations has grown from almost zero to 50% since 2010, notes Gita Gopinath, the First Deputy Managing Director of the IMF. However, compared to the American CHIPS, the figures for the Chinese system look modest: it processes transactions worth $51 billion per day, while the American CHIPS processes $1.8 trillion.

However, Vladimir Putin's hopes for the development of an autonomous ‘financial infrastructure’ are unlikely to be realised, at least not in the near future. The problem is that CIPS also relies partially on Western services, experts note, as messages are sent via SWIFT. However, China is moving towards resolving this problem as well: messages between direct participants of the system (Chinese banks) are already being sent without SWIFT. Refining CIPS or creating a new similar service should become a priority, the researchers at the Chinese Institute of Financial Research believe, much like Vladimir Putin. However, so far the overwhelming number of trading partners of Chinese firms work in SWIFT, and Russia's share in Chinese trade remains insignificant. Putin's opinion is unlikely to influence the decisions of the Chinese authorities. 

This situation clearly demonstrates the asymmetry of ‘Russia-China friendship’. Overall, the share of Chinese goods in Russian imports at the end of the first quarter of this year was estimated at 43%, and there are no alternatives for a significant portion of these supplies for Russia. At the same time, China has its own agenda of competition with the US and does not intend to escalate economic conflicts prematurely, i.e. it wants to avoid repeating the mistake that Putin made that made him dependent on China. Therefore, while in Russia the fact that Putin is making his first visit to China after his inauguration is presented as a confirmation of the two countries’ special relations and valued partnership, in China it seems like evidence of Russia's dependence on its ‘Chinese big brother’. Citing US sanctions, China has the ability to open or close the payments valve for imports that are vital to Moscow, using this as a political lever. It may be assumed that the payment situation will improve slightly immediately following the visit, but there is no guarantee that this effect will last long.