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STRATFOR INTELLIGENCE BRIEF   (29 April 2004)

Moscow Takes Charge of Chinese-Russian Trade Relations

Summary

Moscow's fear of Beijing's encroaching economic power is prompting Russia to erect trade barriers against its southern neighbor. Russia will continue to sell China oil and weapons -- but on Russian terms.

Analysis

The Russian State Customs Committee said it will start valuing all Chinese imports at $3.5 per kilogram or more in response to what it calls gross violations involving Chinese importers under- reporting the value of their goods, Russian news outlets report. The heavy-handed measure ostensibly is an attempt to protect Russian markets against a flood of cheap imports and recover lost revenue.

Stratfor sources in the Russian government say Moscow is trying to limit the country's economic exposure to China as President Vladimir Putin continues to drive Russia westward. Russia -- according to its own figures -- imported $3.4 billion- worth of Chinese goods in 2003. Chinese customs, however, registered $6 billion-worth of exports, up to half of which had a declared value of no more than $1.4 per kilogram.

Russian authorities say Chinese traders are understating the value of goods in order to pay lower duties. By imposing a $3.5 per kilogram minimum value on all Chinese exports, the Russian Customs Service hopes to raise its income by as much as $500 million a year. The sweeping imposition of a minimum price level underscores the Russian anxiety that a deluge of consumer goods will cross the border and undercut domestic manufacturers.

Chinese state media report that Moscow's harsh and unsophisticated response to the problem of "gray trade" -- goods brought into the country by circumventing official channels and duties -- occurred with little to no consultation with Beijing. Stratfor sources in the Russian government say the decision occurred at the highest levels in Moscow. Trade Minister German Gref and Finance Minister Alexei Kudrin supported the action, convincing Deputy Prime Minister Alexander Zhukov to sign off on the plan. Gref and Kudrin are pro-Western economic liberals who would like to see Russia firmly integrated with the West. Zhukov, their direct superior, is if anything even more liberal when it comes to economic reforms, but he is also a Eurasianist politically; Zhukov would like to see Russia occupy a balanced position between Europe and Asia. All three government ministers say they truly believe the flood of Chinese goods is a serious threat to Russian control of the Far East and the country's broader economic health. All three oppose import tariffs on principle -- they even quietly favor shock therapy -- but all ultimately perceived the damage to be so severe that they willingly, if reluctantly in Zhukov's case, adopted a blatantly protectionist policy.

Stratfor has forecast that competition and mutual suspicion would prevent the rejuvenation of a strategic partnership between the Eurasian powers. Moscow's determination to economically integrate with Western Europe also is driving a wedge between the two. Moscow fears becoming too economically dependant upon its southern neighbor, whose citizens are already moving en masse across the border. The Russian government is erecting barriers to prevent encroachment by what some of its leaders still see as the "golden horde."

Chinese-Russian trade volume hit $15.76 billion in 2003 -- a 23.4 percent increase over the previous year. While bilateral trade is growing, it remains well short of the $20 billion-a-year-by-2000 goal set by presidents Jiang Zemin and Boris Yeltsin in 1996. Registering Chinese goods at a higher price floor represents another economic step away from Beijing. Moscow has announced that it prefers to construct a $7 billion oil export pipeline built by Transneft to the Pacific port of Nakhodka over a competing route by Yukos to the Chinese refinery city of Daqing. Yukos and former CEO Mikhail Khodorkovsky have come under fire as Putin's government works to destroy the oligarchs' stranglehold on the Russian economy. Yukos contracted with energy-starved China to sell 300,000 bpd of oil starting in 2006, but Moscow's decision to build the competing pipeline and its incremental dismantling of the firm takes the deal off the table.

Although Beijing is counting on cross-border trade to help revitalize its lagging northeastern corridor, Russian protectionism is not likely to prompt Beijing to raise a serious trade or diplomatic dispute.

Russia is China's eighth-largest trade partner, representing less than 2 percent of China's total foreign trade volume of $851.2 billion. Moreover, China needs Russian goods far more than Russia needs Chinese wares. China imports raw commodities -- such as timber, steel and oil -- from its northern neighbor, commodities it needs to fuel its busy factories. More important, Russia is China's main arms supplier, selling advanced air and naval platforms and state-of-the-art missiles.

The U.S. Department of Defense recently said China is more than doubling defense spending in 2004 as part of an ambitious military modernization program, which in part will be used to deter Taiwan from declaring independence. According to Stratfor's Russian government sources, China is particularly interested in purchasing naval assets to challenge U.S. dominance in the Western Pacific. China already has two Sovremenny-class destroyers, and two more are on order. The guided missile destroyers are armed with SS-N-22 Sunburn supersonic anti-ship cruise missiles designed to disable or destroy U.S. vessels. Sources say the two sides are discussing the sale of another three to six destroyers.

Russian weapons and oil sales to China give Moscow an upper hand in the relationship. From the Russian point of view, the Yukos oil pipeline would have given China an added impetus to reclaim Siberia, so it removed the temptation. By doing so, it also forces China to get its oil from elsewhere -- Nakhodka for instance -- and redoubles China's need to build a modern navy -- with Sovremennys, of course -- to protect the ship lanes feeding its ports. High-level diplomatic traffic between Moscow and Beijing follows the latest trade spat. Russian Defense Minister Sergei Ivanov traveled to China for a three-day visit April 20-22, meeting his Chinese counterpart, Cao Gangchuan, to discuss defense and military-technical cooperation and regional security issues. Chinese Foreign Minister Li Zhaoxing's three-day visit to Russia from April 21 to 23 was in reciprocation for Ivanov's trip south. Li met with Putin on April 21 and attended a meeting of the Shanghai Cooperation Organization on April 23. A source in the Russian Foreign Ministry said that while meeting with Foreign Minister Sergey Lavrov, the Chinese foreign minister was mildly indignant over the hike in minimum price levels for his country's imports and asked if it was done by Russian agencies without the knowledge of the president and prime minister. Li also expressed confidence that after the Kremlin looked into the matter, it would inform the Customs Committee to cancel or reduce the duty increases. Lavrov promised to investigate the matter. Li reportedly raised the issue again during his meeting with Putin, and the president promised to look into it. Displeased with the diplomatic snafu, Putin told Prime Minister Mikhail Fradkov that the measures against Chinese imports were too strong and that something should be done to appease Beijing. Fradkov said he would handle the problem, but the source says the new duties will not be lowered because the prime minister was not actually ordered to make any changes, and the government still favors the trade barrier. While it is eager for closer ties with the West, Moscow is not placing as much value on its relations with Beijing, but it does not want to provoke a response either. Moscow remains wary of the ascending Chinese power, but the two sides still find common ground. Moscow, for example, is more than happy to sell oil and weapons to China -- on its own terms. And Beijing, for the foreseeable future, will have to grin and bear it.



(c) 2004 Strategic Forecasting, Inc. All rights reserved. http://www.stratfor.com