Thursday 23 March 2017

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Speaker: Honorary Associate Professor Stephen Fortescue, School of Social Sciences and International Studies UNSW and Visiting Fellow, ANU Centre for European Studies

Abstract

Although Russia does not see itself as an Asia-oriented power, it does see itself as a ‘great power’, with a pragmatic interest in geostrategic and commercial engagement with an increasingly important part of the world. Russian economic engagement with China, and other Asian economies, has increased in recent years, but not enough to suggest a fundamental shift in Russian economic orientation. While Australia and Russia are no more than blips on each other’s geostrategic horizons, the effort of Russia, a resource exporter, to increase its presence in Asian markets has potentially serious implications for Australia.

About the presenter

Stephen obtained his PhD in Soviet Politics in 1977 and went on to work in Soviet-related business. He has held academic positions at the ANU and the University of Birmingham (UK), and taught and researched Soviet and Russian politics at UNSW from 1987 until his retirement in 2013. He has published extensively on Soviet and Russian politics and economics, concentrating recently on the Russian policy-making process, management of the resource sector, and policy in the Russian Far East and Asia-Pacific. His most recent publication ‘Russia’s security-related decision-making: the case of Crimea’ appears in M.S Fish, G Gill, & M Petrovic, eds, A Quarter Century of Post-Communism Assessed (Palgrave, 2017).

Note

This document is based on Professor Fortescue’s personal speaking notes, rather than a formal speech. This means that quotes are not fully referenced. The Library is grateful to him for agreeing to make his notes available for distribution.

 

Introduction

Russia does not naturally see itself as an Asia-oriented power. But it does see itself as a ‘great power’, and therefore with a pragmatic interest in geostrategic and commercial engagement with an increasingly important part of the world, particularly in circumstances of poor relations with the West. Engagement with Asia means above all, engagement with China—a very sensitive issue for Russia and Russians. Russian economic engagement with China and other Asian economies has increased in recent years, but not enough to suggest a fundamental shift in Russian economic orientation, something presumably with geostrategic implications. Russia’s obsession with the West is far from over.

While Australia and Russia are no more than blips on each other’s geostrategic horizons, the effort of Russia, a resource exporter, to increase its presence in Asian markets has potentially serious implications for Australia.

In a recent interview with the Australian Institute for International Affairs (AIIA), Tony Kevin said: ‘part of that second-track new diplomacy should involve Russia because Russia is an Asia-Pacific power’.

Constantin Pleshakov, an American-based commentator, has written: ‘Russia is simply not fit to be a Pacific power. It is too big not to have pockets of underdevelopment, too poor to be able to fix them all, and too Eurocentric to give precedence to the Pacific provinces’.

In this presentation I will endeavour to provide evidence on the basis of which we can decide whether Kevin or Pleshakov is correct.

In opening, I note that I am not a foreign policy/international relations person. I am a political scientist who has always concentrated on domestic policymaking, mostly related to economics, and that bias will be shown in today’s presentation. In current circumstances one cannot entirely avoid foreign policy/IR issues; nevertheless I will do my best to do so.

 

How does Russia see itself?

A. ‘Civilisations’

We will start with some ‘civilisational’ considerations—to which world ‘civilisation’ does Russia see itself as belonging, if any? In my view Russia does not see itself as ‘Asian’ or part of an ‘Asian’ or ‘Pacific’ civilisation. It’s true that the movement of Russian explorers, military personnel and settlers/convicts steadily east is an important part of Russia’s historical narrative, but the earlier Mongol invasions no less so.

When it comes to the ‘big’ pictures of where Russia belongs, the two biggest are the two sides of the old debate: Westernisers vs Slavophiles, plus a newer addition—Eurasianism. Despite the presence of the word Asia in that one, it sees Russia as a bridge between Europe and Asia, not part of either.

So there are no Russian ‘civilisational’ views that see it as Asian or Pacific.

B. Great power and pragmatic need

I do not discount the importance of such views. Nevertheless there are other approaches to explaining Russia’s place in the world that might allow us to describe it as an Asia Pacific power. First, Russia sees itself as a Great Power, and even if much of the focus of its Great Power activities are in the European borderlands and Central Asia, as a Great Power it believes it has the right/expectation to be engaged anywhere and everywhere.

But beyond that, and perhaps most importantly, Russia feels a serious and indeed increasingly urgent pragmatic need to engage with the Asia Pacific; this is perhaps as much a sign of weakness as of strength. Recognition of that need dates back before the Crimean War in the nineteenth century, but was considerably strengthened and made more urgent by those events. While there is much debate and a general discounting of the effects of sanctions on the Russian economy, both their psychological and real effect—in terms of limiting access to Western finance and technology—had major implications precisely for Russia’s turn to the East: how to fund and find the technology for Eastern-based resource projects, and how to reduce Russian dependence on Western finance, technology and imports in non-resource sectors.

This is the basis of claims that sanctions and the West’s attitude to Russia in general are driving Russia into the arms of China, a bad thing for Russia and for us, and indeed that a West-Russia alliance against China is desirable.

 

What happened?

A. China

Those last comments make it clear that the turn to the East is largely a turn to China. Russia has a long and complicated relationship with China, psychologically and historically:

• the Sino-Soviet split
• particularly sensitive regarding the Russian Far East: population; unequal treaty

I offer some quotes which suggest that it is still not a cloudless relationship.

In an interview with Yuri Trutnev, deputy prime minister and presidential representative in the Russian Far East, Kommersant, 17 February 2014:

Interviewer:

One gets the impression that Moscow is consciously limiting Asian, particularly Chinese, investment in natural resource projects in the Far East.

Trutnev:

Do we need to attract foreign companies to work in Russia? Of course we do. But there is one small question: under what conditions? It seems to me that priority must be given to the interests of Russia. One way to do so is obvious – through the maximum adding of value on Russian territory. That is, if you want to get access to a deposit, build a pipeline, and then simply pump – then, excuse me, but of course we have to discourage that.

Interviewer:

And while we sit like a bashful bride, Asian resource markets are taken over by Australians, Canadians, Qataris, and our neighbours from Central Asia. They don’t wait while China or Japan agree to build a plant for some sort of synthetic yarn.

One of the issues regarding the ‘Sila Sibiri’ pipeline has been who should pay for and build the pipeline on the Russian side. The Chinese have offered to finance the construction, but on the condition that Chinese companies get the contracts. As the deputy chair of Gazprom’s management board, Aleksandr Medvedev said in late June 2015: ‘There is no need to have them on our territory, there never has been, and there never will be’.

So the expected Chinese loan has not been forthcoming, and Gazprom is building the pipeline from its own resources.

A Chinese business academic, Yuan Chen, the deputy director of the Centre for Russian Studies of the East China Pedagogical University has said:

Chinese entrepreneurs in Russia and the Far East have already come across the ‘feed the pig’ model, when to begin with they are very welcome to invest, but once the business begins to bring in some money, using various mechanisms they are squeezed out. Such an approach, needless to say, affects the attitudes of the next generation of entrepreneurs. Add to that corruption, the tight link between business and the state, the use of the law to suit oneself, the constant policy changes by regulatory agencies.

The Chinese ambassador to Russia, said at a RIAC [Russian International Affairs Council] conference: ‘Gazprom is playing hide and seek with China and generally is no gift (voobshche ne podarok)’.

To those can be added endless warnings that one should not expect quick results when dealing with the Chinese—they work slowly, they are hard bargainers, etc. Two recent proposals—actually unexceptionable in themselves—produced a hugely negative reaction in Russia: the lease of a lot of agricultural land in East Siberia to the Chinese, and that the Chinese build factories on the Russian side of the border. I liked the case of the delegation of Chinese business people being detained by immigration authorities for doing business on tourist visas as they left a meeting with the mayor of the city they were visiting. Quotes can of course be found of a cloudless relationship—I will not bother providing them.

But it is words like those I have quoted, plus some economic issues I will return to, that led many—including myself—to be sceptical that the Chinese would come to the party.

That scepticism seemed to be initially justified, as few deals were done and there were very big question marks next to those that were signed (Sila Sibiri). The bald statistics were—and generally still are—far from inspiring (Russian-Chinese trade turnover in 2015 was $68 billion—projected to rise to $200 billion by 2020; Australia’s was A$160 billion in 2013–14). See Table 1 for historical data.

Table 1: Russia-China trade turnover, $US billion

Year	China-Russia	Russia-China	Total
2010	39.0	20.3	59.3
2011	48.3	35.2	83.5
2012	51.6	35.8	87.4
2013	53.2	35.6	88.8
2014	50.8	37.5	88.3
2015	35.0	28.6	63.6

(Source: Vedomosti, 19 May 2016)

Regarding investment, in 2015 some 0.7 per cent of Chinese Outward Foreign Direct Investment (OFDI) was in Russia ($794 million), with accumulated investments of $8 billion. About ten per cent of Chinese Foreign Direct Investment (FDI) in the former Soviet Union is in Russia. Russian accumulated investments in China were $1 billion, although note the complexities and debates over real FDI figures.

Despite these unpromising figures, the deals are building up, enough for the well-informed Aleksandr Gabuev of Moscow’s Carnegie Centre to quite noticeably change the emphasis of his reporting on the relationship. He writes, with clear concern, of Russia becoming China’s ‘little brother’ or falling into its ‘firm embrace’ (he suggests that the West should take note of this when it discourages improved Russian-Japanese relations). He notes that the Russians have removed three key barriers to a close relationship: a truce in Central Asia; renewed arms sales; and ending the ban on China’s involvement in resource projects.

So we indeed see Chinese involvement in resource projects, but also in other sectors: a whole range of different sectors throughout Russia, including agriculture, forestry and manufacturing/technology. Involvement can take the form of both equity and debt. See Table 2 showing corporate borrowing in China, with a sharp increase after 2012, but from very low levels.

Table 2: Russian corporate borrowings in China, $US billion

Year	Amount
2007	0.25
2008	0.18
2009	19.32
2010	6.38
2011	1.21
2012	0.58
2013	7.77
2014	13.68
2015	18.07

(Source: Gabuev, Friends with Benefits? Russian-Chinese relations after the Ukraine crisis, Carnegie Moscow, 29 June 2016, p. 12)

Here are some examples of individual projects:

• Thirteen per cent equity in Nornik’s Bystrinskoe copper project in Chita region, Chinese investment fund Highland Fund. Nornik had been looking for someone to take a share in this much-downgraded project for some time. China Development Bank has also lent $1.6 billion (at the same time, there were no takers for the much larger Udokan deposit).
• Sinopec’s ten per cent stake (for $1.3 billion) in Sibur, a private Russian petrochemicals company, majority owned by Leonid Mikhelson. Working together on the Amur gas-chemicals plant.
• Yamal LNG. Owned 50.1 per cent by Novatek (Timchenko and Mikhelson), 20 per cent by Total and CNPC, and 9.9 per cent by Silk Road.

Many are small-scale, projected/planned rather than real, and fraught with problems (such as the Amur oil refinery which received a negative evaluation from Minenergo and was not included in the Amur special development zone, unlike the gas-chemicals plant just mentioned—does not have cronies involved; Nizhneleninsk bridge). But the Chinese presence is no longer negligible.

B. Other Asian countries

We see the involvement of other Asian countries, either as an effort to offset Chinese domination or to step in after it has been impossible to do a deal with the Chinese.

While not quite in that category, in that those stepping in are not Asian, but worth mentioning is the sale of 20 per cent of Rosneft. It was generally believed that the Chinese would buy the stake, but they insisted on a genuine place on the board. Agreement could not be reached and in the end a rushed and obscure deal was done with Glencore and the Qatar Sovereign Wealth Fund; it is likely that management participation (and construction by Chinese companies) has been a consideration in other hydrocarbon deals in which the Chinese have not participated in the end.

As a result, India has, if anything, done more resource deals with Russia than China. For example, 49 per cent of Rosneft’s Vankor was sold to various Indian companies for $4.4 billion.

Russia has endeavoured (or is endeavouring) to have a commercial presence in Vietnam, Thailand, Indonesia and elsewhere. Vietnam and Thailand are major investors in the Russian (European) dairy industry.

Japan is of course a special case. There is a lot of Japanese investment in Russia (in hydrocarbons, automotives, etc.), but the islands issue remains a problem. Abe has been pushing the commercial relationship hard, although the most public excitement on the Japanese side has been over Japanese expertise on urban renewal (Abe suggested Vladivostok, but he got Voronezh) and Japan sending specialists to Russian factories to improve practices, and training Russian shop heads in Japan.

Will it work?

Will economic engagements with the Asia-Pacific work, in the sense of replacing the West as a source of funding, technology and markets, and in that sense provide Russia with a new basis for prosperity, security and a diversified economy? I will not answer that question in full, but will discuss some issues.

This is an area where talk of projects and deals come and go, and one can never be quite sure of their status. But as already mentioned, there are signs of some momentum in deals with China and other Asia-Pacific countries, and some long-talked about projects might even be getting away.

But they tend to be very state-based, rather than truly privately inspired and implemented. That might or might not be a bad thing, depending on one’s ideology, but there are grounds for wondering whether factors other than commercial viability might at times get in the way. The heavy state influence takes various forms:

• The main players are state-owned, particularly in hydrocarbons (although not all: Novatek is an increasingly important privately-owned LNG producer).
• There is an almost ubiquitous presence of state subsidies and tax concessions, in both resource and non-resource projects. These are often projects that were initially presented as private, in which private investors were willing to take on infrastructure costs (say a spur line from a mine to the main line). Increasingly the Russian state has taken on those costs, and provided direct subsidies, interest rate relief and tax breaks for projects that were not initially seen as requiring them. One gets the impression with marginal projects that the state feels obliged to get over the line of commercial viability because of current geostrategic circumstances.
• Funding bodies are increasingly state-owned, whether they be the ‘development bank’ VEB or various special investment funds, such as the Fund for the Development of the Russian Far East, the Russian Direct Investment Fund, and so on. Often they are joint funds with an overseas state-fund, such as the Russian-Chinese Investment Fund (amusingly described as a private fund of RDIF [Russian Direct Investment Fund] and China Investment Corporation). It is true that these funds work to attract private partners in their projects, although many of the partners are about as private as the funds themselves.
• Most deals require heads of state and formal government involvement. There are claims that Xi has given instructions not to take excessive advantage of the Russians (although also, that non-commercial deals not be entered into), but that he has also pushed deals that Putin has a particular commitment to, not least because his cronies are involved (such as in the above-mentioned Novatek, and Sibur, although note the Bystrinskoe project).
• I also note the involvement of Chinese regional governments.

Some of the projects, especially in oil and gas, that have been funded through the Russian state and various state-linked Chinese, Indian and even Japanese agencies might well have attracted Western interest if the projects were on offer to them; a number I suspect would not be. That leads me to wonder whether they are good investments.

What might be wrong with them?

Regarding the hydrocarbon projects, there are demand and supply problems. The demand ones relate to the profitability of increasingly remote and difficult deposits, including deep-water Arctic deposits. The supply problem is whether there will be enough—at a reasonable cost of production—to cover all the projects. There are a lot of competing demands: domestic vs export; pipeline vs LNG; crude vs refined and further value added; and competition between various projects with their own bureaucratic champions.

There are other issues:

• the poor ore quality of non-hydrocarbon resource projects
• very high location/transport costs [I will come back to these two issues with regard to coal later] and
• in the non-resource areas; labour costs (although often claimed to now be lower than Chinese) PLUS the size of the Russian market often makes export essential if economies of scale are to be reached (note lack of Russian success in non-resource export markets (e.g. the Sukhoi Superjet 100 (SSJ100); agricultural machinery)).

This is relevant to the hopes the Russians have of the contribution the turn to the East will make to diversification of the economy. The change in focus is indicative of the problem: originally to bring in Asian money to produce manufactured goods for export; then to bring in Russian money to produce basic things for the domestic market; increasingly for pure resource projects, of the sort referred to above, that were not supposed to need tax breaks and so on.

I have sympathy for views that there are inherent geographical/topographical/climatic/geological issues that limit Russia’s capacity for growth and diversification, and that Russia adds to the competitiveness problem by constantly wanting to populate the whole country. So there are doubts about the viability of the projects, and therefore about the money going into them, whether from the Russian state or others.

Before offering some broad conclusions, what does this mean for Australia?

 

What does this mean for Australia?

I said in the abstract of this presentation that we are no more than blips on our respective horizons—Putin’s reputed remark: ‘I know Australia exists, but I do not think about it much.’ But as a would-be resource exporter into the Asia-Pacific, Russia is not irrelevant to Australia economically.

• Russia’s biggest export earner—oil—is not relevant to us (I note that in 2016 Angola become China’s biggest source of oil imports).
• Gas is: it is beyond my expertise, but there are Russians who believe that their gas, both pipeline and LNG, is more than competitive with Australia.
• Agriculture: I know considerably less about it than even gas. But to give you some sense of the threat, in March 2015 the governor of the Amur region reported to Medvedev on efforts to breed Herefords that can survive outside in –45. I am not sure whether the idea is that, like reindeer, they will eat moss PLUS make Sakhalin self-sufficient in food. More seriously, in the Russian Far East there is a lot of emphasis on agriculture, but mostly soy and greenhouse vegetables (and pork for domestic consumption).
• Iron ore: no threat. Russian iron ore deposits are in the European part of the country. There are a couple of small marginal projects in the Russian Far East, one best-known as the driver of the infamous Nizhneleninsk bridge.
• Coal: the most serious one, in a sector with some demand issues, so Russian competition could be a serious issue. It is an unusual one, in that—as Novak proudly pointed out—it is all private, which is not to say there are no subsidies. There is a lot of emphasis on coal, including a lot of investment in expanding rail and port capacity. Rail capacity is of particular importance because at the moment the main source of supply is the Kuzbass, in South West Siberia. This highlights the extreme importance of transport costs (a big policy issue—how much should everyone else subsidise shipping coal?). But at the moment transport represents up to 80 per cent of the cost of production, as around 80 per cent of coal exports are hauled over 4,000 km by rail, usually to a port, and there are major bottlenecks. There are coal deposits coming on line in East Siberia and big hopes in the longer term future on Sakhalin. But East Siberia is still a long way from anywhere, there are the usual questions of quality, it is not clear that Sakhalin has that much coal, and it has ice and shallow water problems.

 

Conclusion

If there are doubts about competitiveness with Australia in the resource area, that might be enough to raise doubts about the whole ‘turn to the East’ project, particularly if we are generally sceptical of Russia’s capacity for generating non-resource exports (I could have mentioned the ‘Dutch disease’ in that regard—current panic at the rising oil price and the strengthening rouble).

The amounts of money being spent are substantial, although in terms of the federal budget, all the subsidies and so on described are still small next to the really big-ticket items—social spending and defence. But that makes the effectiveness of the spending even more important AND possible that Chinese (and others’) ‘irrational exuberance’ in Russia and elsewhere, is important if we consider earlier Japanese and Russian experience.

As always, I find myself drifting to the geographical determinist conclusion that Russia is limited in its growth potential and in that sense it does not matter where it gets its money from—internally, the West or the East. It can never be spent well enough to allow Russia to meet its ambitions. In that sense, the turn to the East will not ‘save’ or transform Russia. I believe this is recognised by the leadership, and so despite all the rhetoric and action, the desire is there to keep lines to the West open. That leaves the West with a decision: to make it easier for Russia to restore relations, or to be very firm in setting the conditions under which that will be allowed.

 

This paper has been provided by a presenter in the Parliamentary Library’s Seminar and Lecture Series. The views expressed do not reflect an official position of the Parliamentary Library. The copyright remains with the original author and permission may be required to reuse the material.