Until quite recently, many in the Russian elite were nurturing the hope that China might offer them a miraculous escape route from their damaging confrontation with the West. The dynamic eastern neighbor—so the theory went—would create additional demand for Siberian raw materials and replace Western capital markets, while its know-how would fill the gap left by Western technology.

Recent signs of economic turbulence in China are delivering a more sobering message. Even as dozens of bilateral cooperation agreements are due to be signed, China is now the Number One source of anxiety for Russia's high-ranking officials, state capitalists, and oligarchs.

China's recent stock market crash wrote off 4.5 trillion dollars of capitalization (nearly three times Russia's GDP). The devaluation of the yuan by 1.9 percent on August 11 sparked comparisons with the Asian crisis in 1998, which still summons up painful memories in Russia. 

Russia's decisionmakers are now suddenly noticing facts and figures they had ignored: the fact that China's debt constitutes more than 280 percent of its GDP, its ghost towns, millions of empty apartments, fictitious statistics reports, and mysterious "shadow banking."

How big are China's problems in actual fact and how much should Russia be concerned about them?

There is actually nothing new in the problems that the Chinese economy faces.

Alexander Gabuev
Gabuev is a senior fellow at the Carnegie Endowment for International Peace.
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The latest crash in the Chinese stock market is not a major cause for concern. The over-regulated exchange hardly reflects the actual state of the economy. Between 2002 and 2005 the Shanghai and Shenzhen indices fell by 55 percent, while the economy grew by almost the same amount. The Russian scenario, where a decline in the stock exchange triggers a chain reaction in the whole economy, should not be expected. There is no indication that it will cause social unrest.

The impact on Chinese exports is more serious. An 8.8 percent drop in exports in July was probably the last straw that caused the People's Bank of China to let the yuan float more freely. The decline in exports is hurting employment, especially in the eastern provinces.

China's debt burden is also painful, although again nothing new. According to McKinsey, China's total debt in 2014 was 28 trillion dollars, or 282 percent of GDP. Much of this comes in the form of loans from "shadow banking" outside the control of regulators. Fitch estimates that China needs a GDP growth rate of 15 percent (while the current official rate is 7 percent) to service this debt.

If Beijing is strict and focused in its policies, it can restructure and alleviate the debt burden, while the economy is readjusting to a growth model based on domestic consumption, which is rising at a healthy rate, as are the volume of domestic flights, retail, and sales of Apple products. Oil imports—a key indicator for Russia—rose by 29 percent in the last year.

The Chinese leadership at least understands where the weaknesses lie. In the fall of 2013, the CPC Central Committee adopted a comprehensive reform program, under which the state would turn from owner to regulator. However, this beautiful and detailed plan mostly remains on paper. In order to implement reform, Xi Jinping decided to cleanse the ruling party and increase centralization, a step that has had a negative impact on the economy.

The biggest worry arising from the recent stockmarket crash was not the bursting of a bubble that could have been easily predicted, given that share prices were far outpacing GDP growth. A bigger concern was in how the state media continued to egg on investors and later, once the bubble had burst, the government entered the market in a bid to maintain the prices of shares that were still overvalued. After spending nearly 200 billion dollars on this endeavor, Beijing kept the market overheated so as not to spoil its World War II Victory Parade on September 2.

Why did the Chinese government act so strangely?

Some insiders said the government had two goals: to make share capital more attractive so as to reduce the dependence of state-owned companies on the bond market, and to allow ordinary people to make money and strengthen the popularity of the leadership. 

No one advised how dangerous this approach was. Most of the senior officials running the economy have a background in state planning or the regional bureaucracy. Lower-ranking officials chose the bureaucrats' favorite strategy, which was to do nothing. The concentration of enormous powers in the hands of a few officials and the requirement to do everything at once meant that Chinese mandarins missed the overheated market, and then dealt with a hopeless situation in a clumsy fashion.

There is every sign that this dysfunctional system will continue and that for the foreseeable future the Chinese leadership will mismanage its efforts to tackle manifold economic problems.

What are the key conclusions that Russians should make from this situation? First, that Russia needs to develop expertise on China to avoid falling victim to emotional mood swings in its relations with major global players (not just with China). Second, the "pivot to the East" should include more than just China, especially when it comes to the supply of raw materials.

Finally, as it turns to the East, Russia will still be facing the same global economy as it did before. Chinese businesses are also factoring the impact of Western sanctions into their dealings with Russia. A pivot to Asia will not succeed, as long as Russia is engaged in a confrontation with the West. This is a lesson Iran learned and Russia must heed too.


This publication originally appeared in Russian in Vedomosti.

By:
  • Alexander Gabuev