OPINION May 25, 2018

Russia’s Pivot to Asia: Desirable, but Possible?

I once asked a Russian friend: “Vanya – what associations do Russia, China and India trigger in your mind”? Being a typical Russian, he responded with a line from a Pushkin poem. His response translated roughly into: “A horse and a trembling deer in the same harness.”

Clearly, my friend was describing things that are similar, yet intrinsically different. And if you think about it, apart from the similarity of “largeness” that these three exceptional countries share – Russia being the largest country, India the largest democracy, and China the largest by population – they are all fundamentally different.

So, is Russia’s economic “harness” to China and India, albeit desirable, even possible? Well, geography and history matter. Over 4000 km long, Russia and China, of course, share a common border – the world’s sixth longest border. This is economically significant because both economic models and evidence show that neighboring countries still tend to trade more with each other than with other countries. And Russia -- India ties have been historically strong since Soviet times (and, in fact, go all the way back to the 1460s, when Afsany Nikitin, a Russian explorer from Tver, penned his book “The Journey Beyond Three Seas”, which documented his trading mission to India). History and geography bind these three fundamentally different countries in more ways than one.

Nowadays, China is now the world’s second largest importer (after the US), and in many metal markets, constitutes more than half the global demand. India has emerged as the third largest economy in the world, in PPP terms, after the US and China, and ahead of Japan. So in an increasingly multipolar world, Russia would do well to pivot East. The signs are already promising: merchandise trade between Russia and China has tripled over the past decade. Net FDI inflows from China to Russia have increased substantially, despite the decline in net inflows from the rest of the world. And, Russia’s trade with India has increased more than 15% in last 5 years, going beyond the defense sector and into agriculture and pharmaceuticals.

Despite these promising signs, however, our analysis shows that Russia vastly under-trades with both countries, and its integration into the global value chains of China and India is limited. Indeed, we estimate that Russia could increase merchandise exports to China by around 24% and to India, by another 17%. And Russia’s value-added, embodied in the exports of China and India as a share of total foreign value-added embodied in these exports, remains dismally low.

In total, Russia has less than a 3% market share in China and less than a 2% market share in India (measured on a value-added basis). Moreover, Russia’s exports to China are dominated by natural resources, while its imports from China mainly consist of manufactures.

Mineral fuels and other natural resources (such as wood) account for almost 80% of Russia’s exports to China, whereas manufacturing products comprise about 95% of Russia’s imports from China. And, even though India is a global exporter of low-cost digital services, it exports hardly any to Russia. The country’s pivot to China and India is real, but tempered by under-trading and untapped potential.

Going beyond current trading patterns, it is important to note that both China and India are undergoing major dynamic shifts in their economy. In the future, China is expected to rebalance and slow down, whereas India is expected to accelerate and grow. So, which way will the pendulum swing for Russia?

In the aforementioned analysis, we first constructed a scenario where China and India would continue their pre-2013 trends until the year 2030. We call it the “reference scenario”. We then constructed another scenario where China rebalances and slows, and India grows, again, until 2030. We call that the “dynamic scenario”. We then projected how Russia’s GDP would evolve under these two scenarios and compared the two.

We found that, by the year 2030, Russia’s GDP would be only 0.07% lower in the dynamic scenario vis-a-vis the reference scenario. This is rather small, and reminiscent of what Robert Lucas, an economics Nobel laureate, once said “…most changes, when quantified, have trivial effects.” Indeed, the overall impact of a rebalancing China and resurging India on Russia is neutral to marginally negative.

One interpretation of these findings is that Russia is not well-positioned to benefit from these dynamic changes in China and India. The good news, however, is that Russia can largely address this.

Promoting and attracting FDI, and accelerating domestic reforms that increase mobility of capital and labor within Russia would certainly help. In particular, the expected rise in outward FDI in China is likely to present an important opportunity for Russia to capture a larger part of the higher end of the value-chain.

Supporting trade in services, particularly in high-skilled services (e.g., communication, financial insurance, business services, tourism, defense, education, and health services) emerges as another promising area that could cement burgeoning economic ties between this BRICS block of countries.

Ultimately, like most nations, Russia’s economic prospects remain closely linked to its ability to export and penetrate new dynamic markets. For Russia, strengthening its economic relationships with China and India – to the benefit of all three countries – could not be timelier.