After two years in decline, Russian trade has made a U-turn. Aleya Begum Lønsetteig looks at what’s driving growth for the sanctions-hit, energy-rich nation.
Since 2014, Russia’s economy, currency and trade have all taken several blows in the battles against sanctions and crashing oil prices. EU and US leaders have confirmed that the sanctions will be staying in place if not strengthened, and, after some recovery and stabilisation, the oil price is still significantly lower than the peaks enjoyed just a few years back. However, despite the struggles, 2016 saw a reverse in the downward trend of Russia’s economy and its imports and exports. While trade is still at lower levels, market participants are “cautiously optimistic” about the country’s outlook, both in domestic and global terms.
On the domestic side, the weaker economy and crashing rouble has brought a halt to capital expenditure, placing major infrastructure and development projects on hold. This has resulted in reduced demand for financing, and lenders in the region have faced thinner margins as competition has heated up.
Meanwhile, tighter global regulatory requirements pushing for strengthened know your customer (KYC) and anti-money laundering (AML) compliance have forced banks to invest more time and money per transaction. The tougher environment has seen consolidation in the market, as well as some exits. But as the economy and rouble strengthen, fewer participants means room for modest optimism amongst those still in the game.
“Banks had to adapt credit policies and adopt a fine tuning of credit approach,” said head of structured trade and export finance for Russia at UniCredit, Svetlana Gromyko-Piradova, at GTR’s Russia Trade & Export Finance Conference 2017.
“[We had] pressure from both sides – fewer projects and a more cautious approach from the banks. There are now positive signals evident. Companies in many sectors that need investment to replace ageing projects – for example in oil and gas, petrochemicals and fertilisers – and that haven’t taken a decision [on projects] are now having to. The number of projects is growing, but not to the level where we can see the golden ages coming back.”
Export credit agencies working in Russia have also made some adjustments, with some reducing local content requirements. Both Germany and Austria have simplified their models to allow financing support for projects with less native content than previously. Euler Hermes has changed its three-tier model to a two-tier model requiring 51% German content. Moreover, projects not meeting this criterion are no longer expelled, but reviewed on a case-by-case basis. Meanwhile, OeKB is now pushing through projects with as little as 25% Austrian content.
“In Russia during 2016, we adopted more than 12 transactions with less than 51% German content, where some projects had foreign content of up to 78%,” says director of underwriting and risk management at Euler Hermes, Thomas Baum.
“It’s not an opening of gates but has to do with the benefit for exporters. Germany wants to retain manufacturing jobs, therefore we will review [Russian projects] on a case-by-case basis. It’s good news for transactions.”
Director of export guarantees at OeKB, Johannes Pflügl, says Russia is traditionally its top market for new business and exposure, but this has recently dropped.
“In 2016 it was our biggest market [in size] but number five in terms of new business. What’s more important is that we currently have a €1.8bn exposure and a project pipeline in excess of €600mn,” he says.
Nevertheless, he expects the country to return to pole position. “Given that and the stage of some of the transactions, Russia will go back to number one in terms of new business in 2017.”
New and revived trade corridors
Globally, Russia’s trade has been very much oriented towards the west, with strong trade relations with the EU, largely due to the latter’s reliance on its oil and gas. While the blocking of Russia from western markets is a relatively recent event, decline in trade between Russia and the EU dates back further.
When Russia finally became a member of the World Trade Organisation (WTO) in 2012, after 18 years of negotiations, it was widely anticipated that trade would be liberalised. However, five years later, Russia is still not meeting all its commitments and the EU has five ongoing disputes filed against the country with the WTO. For its part, Russia has four of its own against the bloc. Meanwhile, EU-Russia trade has been on a continuous slide, dropping 44% from €339bn in 2012 to €191bn in 2016.
While the EU remains Russia’s largest trading partner, the sanctions era has seen Russia increasingly focused on forging new trade relations eastwards.
In 2015, Russia led the formation of the Eurasian Economic Union (EAEU) with Kazakhstan, Belarus, Armenia and Kyrgyzstan. In a similar vein to the EU, the five countries have free movement of goods, services, capital and labour and pursue co-ordinated single policies in numerous sectors, including trade. The EAEU has not been formally recognised by most of the west but the union has set up free trade agreements (FTAs) with Vietnam and Moldova and is currently pursuing FTAs with Iran, Turkey and India.
In 2016, Russia revived its trade with Turkey after a short diplomatic spat following the downing of a Russian plane by a Turkish missile in 2015. The incident pushed Russia to impose sanctions on some Turkish imports and bilateral talks on TurkStream, a strategically important pipeline designed for Russian natural gas to reach the EU without going through Ukraine, were also suspended. The two countries resumed talks in 2016 and trade between them is now more or less back
Earlier in 2017, Russian President Vladimir Putin ratified the TurkStream deal, which will be constructed by Russian state gas company, Gazprom, and consist of two parallel pipelines running 900km along the Black Sea from Anapa in Russia to Kiyikoy in Turkey. GTR has learnt that Gazprom will finance the offshore part of the first line while Turkish state petroleum and pipeline company BOTAŞ will finance the onshore part that will connect it to the Turkish network. Meanwhile, the second line, which will run to southern Europe, will be paid for by both companies. The pipelines will each transport 15.75 billion cubic metres of gas per year.
In a similar sanctions-stricken situation, Iran has also been on Russia’s radar. Since its 2015 nuclear deal with the west – the Joint Comprehensive Plan of Action (JCPOA) – Iran’s economy has only seen modest improvements. With the election of President Donald Trump in the US, a staunch opponent to the pact, progress for Iran has come to a bit of a standstill.
According to local Iranian media, Iranian information and communications technology minister Mahmoud Vaezi and EAEU trade minister Veronika Nikishina met in May this year to discuss a free trade pact. Iran is reported to have put together a list of 200 items to trade with the EAEU, and would give EAEU members preferential tariffs for three years before launching free trade.
In December last year, the two countries signed a raft of agreements in the energy sector, with Iran declaring it will invest over US$62bn in the gas sector alone. They agreed to build a US$1.6bn thermal power plant, inked two agreements to survey the Cheshmeh Khosh and Changoleh oilfields in the west of the country, and signed a memorandum of understanding (MoU) on gas trade and investment. According to Russian officials, bilateral trade between the two countries doubled in 2016.
Moving further east, Russia has also worked to enhance its commercial relationship with India. The two countries marked 70 years of Indo-Russia diplomatic ties this year and kick-started negotiations for a free trade agreement between the EAEU and India in December. Both sides have accepted a report prepared by a joint feasibility study and formal negotiations are expected in mid 2017.
The trade agreement is rooted in the two countries’ plans to develop the International North-South Transport Corridor (INSTC) – a 7,200km-long land and sea-based network comprising rail, road and water routes. The INSTC, which was first mooted in 2000 by Russia, India and Iran, will stretch from Southeast Asia to Europe via Iran and Russia and aims at boosting trade along the route. A study conducted by the Federation of Freight Forwarders’ Associations in India shows that INSTC will be 30% cheaper and 40% shorter than the existing routes.
Russia has also stepped up efforts to boost its trade ties with Japan. Among various other initiatives, the two countries have agreed to create a ¥100bn (US$900mn) fund to jointly invest in development projects in Russia. The Japan Bank for International Co-operation (JBIC) and the Russian Direct Investment Fund (RDIF) will each contribute roughly half of the total amount, with funds expected to go to projects in medicine and urban development, as well as upgrades to manufacturing facilities. Tokyo plans to use greater economic co-operation to aid negotiations with Russia over disputed islands off Hokkaido, but Russia has been more tentative in stepping into territorial talks. The pivot to the east has seen the banks following suit.
“Last year we did deals in over 50 countries across the world,” Igor Ostreyko, VTB managing director of trade and export finance, tells GTR.
“Regionally our main focus today is to facilitate trade flows between Russia, the CIS, Europe and Asia. During the last year we saw increasing demand from customers for trade with Asian counterparties and China in particular. In 2015/16 VTB’s co-operation with Chinese banks aimed at financing Sino-Russian trade flows exceeded Rmb28bn. VTB’s China-related trade and export finance exposure as of the end of 2016 shows two-fold growth on a year-on-year basis.”
At Commerzbank, head of financial institutions, CEE, Russia, CIS and Baltics, Holger Kautzky, says the developments of a strong shift to the east are more evident this year.
“We see the reorientation of Russia away from Europe and towards China,” he says.
“We did not quite believe it in 2014 but we have strong growth plans and want to increase business here. We want to support all transactions from Russia to Asia.”
Russia, China and OBOR
Running in parallel to Russia’s ambitious projects is China’s One Belt One Road (OBOR) initiative, which aims to better connect the Eurasian landmass with China. Also consisting of a land and maritime branch, OBOR will boost connectivity and co-operation between China and 60 countries, and aspires to achieve annual trade worth US$2.5tn between the countries located along
the route within 10 years.
China started with an investment commitment of US$40bn for OBOR and created two international banks to fund projects: the Asian Infrastructure Investment Bank (AIIB), which now has
82 countries participating, including several European; and the Brics’ New Development Bank. Chinese spend so far is quoted close to US$1tn, with China saying it expects to spend a cumulative US$4tn.
Historically, Russia and China have treated each other with mutual suspicion and as geopolitical competitors, particularly in relation to influence over their shared backyard, Eurasia. However, when the west turned its back on Russia following the Ukrainian crisis, Moscow had a change of heart.
In 2015, following Russia-China talks with President Xi Jinping, Russia announced its support for OBOR, while Beijing formally recognised the EAEU. Many attribute the U-turn to Russia’s need for investment capital since it has now given China access to sectors previously considered strategic. An example of this is the high-speed railway between Moscow and Kazan, which was initially planned to be funded with western money. More strikingly, the OBOR fund also acquired a 9.9% equity stake in Novatek’s Jamal gas project. Novatek is under US sanctions, which means that the development is off limits for western financial institutions.
“Russia lies in the middle of this One Belt route and so of course Russian banks are already involved in some of the preparation work,” says Ostreyko.
“There are several intergovernmental organisations working to realise the opportunity with China both around OBOR and outside of it. There are also various other sectors and projects in, for example, chemicals and atom energy that are not part of OBOR.”
The strength and longevity of the Russia-China relationship remains to be seen. Whether Moscow will continue to be as enthusiastic about OBOR if western sanctions are lifted, and whether China will revert to bilateral relationships with Central Asian countries will only be tested over time.
Web of relations
While Russia speeds ahead with these new alliances, not all of its new partners share the same enthusiasm for each other. India and China have historically had a tense relationship, and the China-Pakistan corridor that has emerged as part of OBOR makes the Indians cautious. India and Pakistan have a complex relationship due to a number of historical and political events, dating back to the disputed partition of British India in 1947. Consequently, their relationship has been plagued by hostility and suspicion. Recent reports that China plans to have a military base in Pakistan will not have eased Indian nerves.
Meanwhile, tensions between Iran and Turkey have escalated recently over the Syria conflict. Both countries are on opposite sides, with Turkey supporting an overthrow of President Bashar al-Assad and Iran, along with Russia, backing the president. The two countries have been regional rivals for centuries, but enjoyed a more pragmatic relationship in recent years after Tehran supported Turkish President Recep Tayyip Erdogan following a failed coup last year.
Relations between Turkey and the EU are also at an all-time low. Europe is critical of Turkey’s human rights violations and post-coup crackdown. The EU has voted to freeze Turkey’s accession talks on the back of the country’s constitutional reform earlier this year that saw greater power handed to Erdogan, arguing such a system goes against EU values and principles.
How Russia manages these new relationships will be crucial to its biggest challenge now – to ensure its economic and trade recovery gains traction as sanctions look to stay in place and the outlook for oil remains dim.