Monday 5 September 2016 6:15 pm

In from the cold: Russia’s Chinese strategy could hurt European stocks

Since the Russian annexation of Crimea in 2014, western sanctions have choked the Russian economy.

Though Russia is considered to be the biggest loser from these trade and service restrictions, the sanctions are thought to have cost western firms billions of dollars in lost business too. And with the greatest share of Russia’s market, it is fair to say that European exporters have taken the biggest hit.

The sanctions have limited EU trade with Russia in three areas. Western financial firms have been barred from assisting Russian state-owned businesses in the energy, banking and defence industries, while two embargoes have restricted exports of military goods and equipment to assist with oil exploration and production.

Russia hasn’t stood still in the face of these barriers to trade. As relations with the West have cooled and low oil prices have thrown it into recession, the country has turned to neighbouring China to bolster its economy.

A partnership in the pipeline

A natural gas pipeline is in the works. Railways, telecoms and other cross-border infrastructure deals have been agreed by Russia and China. Low oil prices may have caused bilateral trade to fall by almost 30 per cent last year, but the volume of Russian oil exports to the world’s second largest economy actually increased, making Russia its second, if not largest, crude oil exporter, the Carnegie Moscow Center’s Alexander Gabuev noted in June.

Financial ties have also improved. Last year, China provided $18bn in loans to Russia, according to Gabuev. And while Chinese commercial banks have been wary of ignoring western sanctions and lending to Russia, import-export banks and those with state ties have been willing to provide capital. A parallel financial structure is also in the works which would bypass a global financial system dominated by the United States.

A worry for the West?

Why should EU companies be worried? After all, China’s economy and army is too vast for any Sino-Russian ties to be considered a partnership of equals.

“China depends far more on the West for markets and technology, and its trade with the EU and the US is nearly 10 times larger than trade with neighbouring Russia,” said Gabuev. “In short, the argument goes, the partnership between Moscow and Beijing is a shallow one, so the West shouldn’t fret too much about it.”

Read more: The South China Sea is a powder keg with disturbing echoes of 1914

But a recent working paper by Bruegel looks at how the EU could be affected by closening ties between China and Russia. Its authors found that, while the EU remains an import-dependent Russia’s largest trading partner, its share of the Russian market has been dwindling for years. Between 1998 and 2014, the bloc’s share fell from almost 70 per cent to 55 per cent, while China’s has risen from 3.9 per cent to more than 21 per cent.

Losing market share

While the types of goods the EU supplies to China tend to be more consumer-focused than those sold by Russian firms, there is overlap between the types of exports China and the EU sell to Russia, such as nuclear reactors, boilers, electrical machinery and, to a lesser extent, plastics.

Of course, the threat of Chinese companies to European firms and their share prices shouldn’t be exaggerated just yet.

Russia is just one market, and the Russian sectors which see the most intense competition between China and the EU – mineral products and raw hides, skins, leathers and furs – account for less than 2 per cent of Russia’s imports from either China or the EU. But a Sino-Russian free trade deal could worsen things for European firms. Bruegel estimates that, if Russian and China reduced their import tariffs to zero, total EU exports to both countries could fall by 1.5 per cent.

As European equities suffer a dismal 2016, recording more than 30 consecutive weeks of outflows, any news of weakening trade links should make for sober reading.