By Maria Kotova, Dezan Shira & Associates St.Petersburg
Russia has claimed to be a European power since Peter the Great, even though most of the territory of the country is located east of the Ural Mountains, in Asia and was considered by Europeans as the ”significant other”. In general, the debates of the 19th century between the Westerners and the Slavophiles were about Russia’s place in European civilization. In the 1920s, the concept of Eurasianism legitimized the “Asian” part of the “Russian soul” and proclaimed an “exodus to the East”.
A little over 100 years ago, Russia first time formalized it’s “turn” to the East. During reign of the Emperor Alexander III the “Pacific Party” was gaining strength, moving away from the traditional divide between Westernizers and Slavophiles, arguing that Russia is an Asian country whose future lies in relations with China, Japan and the British Empire. Sergei Witte, the then Minister of Finance, expressed this view in a memorandum to the Tsar on the need for the accelerated development of Siberia and the Far East, including the connection of the Trans-Siberian Railway under construction with ice-free ports in the Pacific Ocean. Russia tried to implement this program by leasing the Kwantung Peninsula with Port Arthur from China, building the Trans-Siberian Railway and the Chinese Eastern Railway.
The revival of Eurasianism in Russia is the 1990s was accompanied by disappointment in the West after the collapse of Soviet Union, as it transpired that the West did not intend to communicate with the new Russia on equal terms. The key trend of global development in 21st century is the shift, unprecedented in scale and speed, of the global economic and political center to the ‘new Asia’, precisely to East, to China, Southeast Asia and India. While Russia’s “Europeanism” has always been a matter of identity, Russia’s “Asianism” is a pragmatic choice. Consequently, Asia’s changing role and its importance in terms of Russia’s development are recognized and reflected at the highest level of the Russian hierarchy.
In 2014, deteriorating relations with the US and its allies created an additional political impetus for the latest ‘turn to the East’. The Eurasian Economic Union (EAEU) was established that year with mainly former Soviet Union countries as closest allies, and continued improving cooperation with Asia, helped it mitigate the consequences of the conflict with the West by giving substance to a multipolar international order.
Moreover, the economic rationale for closer Russian-Chinese ties bring to the forefront Russia’s intention to develop its far-eastern regions through increased economic cooperation with regional heavy-weights. In part, US and EU sanctions forced Russia to activate a rebalancing of the geographical patterns of Russian trade, which since the fall of the Soviet Union were mostly focused on Europe. Russia considers China as a large market for Russian agricultural goods, manufactured products in addition to the vast natural resources of Siberia and the Russian Far East, consisting of oil, gas, coal, metals, timber amongst other commodities. Russia’s oft-forgotten proximity to Asian countries are the most obvious – and for the time being Russia’s most important new markets. Also, Chinese investors are beginning to play an important role in Russia’s economy against the backdrop of sharply lower investment flows from the West.
In 2020, Russia’s largest trade partner was China, as the volume of export and import trade between the two countries reached nearly US$108 billion and aspires to double their mutual trade to US$200 billion in the coming four years. China was both Russia’s leading import origin and export destination. In the first 10 months of 2020, the share of Russian-Chinese trade turnover in total amounted to 18.4%, which is 2% higher than a year earlier. Germany, the Netherlands, Belarus, and the United Kingdom completed the list of top five partners.
Trade turnover between China and Russia decreased by 2.9% compared to the same indicator in 2019 – which is acceptable since analysts predicted an approximately 20% decline in Sino- Russia trade – to US$80-90 billion at the beginning of the Covid-19 pandemic in 2020. However, such a gloomy forecast did not materialize, and the bilateral trade figure remained at US$108 billion. Exports from China to Russia increased by 1.7% and reached US$ 50.585 billion, Russian exports to China, on the contrary, decreased by 6.6% to US$ 57.18 billion.
Russia’s main exports to China have included non-edible raw materials, fossil fuels and lubricants. China’s exports to Russia include finished products classified by raw materials, machinery and transportation equipment, and miscellaneous finished products, including food, textiles, steel, and machinery.
At the same time, the decrease in Russian supplies to China occurred only in value terms and was mainly due to a significant drop in prices for hydrocarbon raw materials, while in real physical terms this indicator actually increased
In the opposite direction, there was an increase in the supply of medical goods, electronics and textiles from China to Russia. China came out on top among the importers of Russian agricultural products. In January-October 2020, imports of agricultural products from Russia to China were stable and maintained double-digit growth, and especially with an increase in soybean imports. In addition, China opened its doors to Russian chilled and frozen beef.
Cross-border e-commerce between China and Russia also began to develop. At present, over 10,000 Russian enterprises are registered on the Aliexpress platform alone.
For those who want to “test” the market without heavy investment, there is a great variety of international platforms such as Tmall Global, JD Global etc. The company can be enrolled on the platform with the company and trademark registered overseas. This is a useful and inexpensive model to allow traders to understand if there is the demand for their product on the market.
The ultimate goal in e-commerce trade for the international brands lies in entering the domestic platforms like Tmall China or JD China. Due to the high traffic on Chinese platforms (comparing to its international version), the platforms can be selective and want to see those brands with high demand in China – regardless of the international exposure of the brand. If China is not “hungry” for your product, all the medals won on other markets will not matter. Many Russian brands already succeeded in conquering Chinese market, for instance, Splat, chocolate “Alenka”, Lukoil are among the others with flagship shores on the platforms.
Entering Chinese domestic platforms requires Russian businesses to incorporate a local company in China and register their trademark in China (TM registrations in other countries do not apply in practice). The exposure to the largest consumer market through the e-commerce provides huge opportunities for Russian brands to significantly increase sales.
While the registration process itself has been simplified further with the new Foreign Investment law that came into effect at the beginning of 2019, and aimed to provide equal rights to the domestic and foreign invested companies, the major pitfall for the Russian investors lies in opening of the bank accounts.
This typically creates difficulties and requires additional due diligence processes in China and other Asia countries to satisfy local banks ‘know your client’ protocols. Continuing sanctions imposed on Russia have added the countries businesses to high risk (although the lighter category) status, and this increases pressure on local banks to complete detailed due diligence. It is not uncommon for banks to reject account opening applications without any official explanation, and after the company provided all the information required. Additionally, cross-border transactions with Russian banks can be also difficult due to the OFAC sanctions list where certain Russian State banks are included, and this includes Sberbank, Russia’s largest. It is at the discretion of the local bank to make a final decision and take the risk. Therefore, it is useful to consider banks that already have a history with your Russian business overseas and can introduce local contacts. Investment flow is also critical from both perspectives, both in opening the bank accounts and the subsequent repatriation of profits.
A company may consider investing in China from other jurisdictions commonly used by Russian business to accumulate profit, such as the Netherlands, or Cyprus. Importantly, the investing structure should not include Russian nationals as directors to avoid falling under “Russian investment check”, although, banks still have the discretion to request disclosure of the entire ownership structure, including the ultimate beneficial shareholders.
The role of the Netherlands as a convenient tax haven may change in 2021 as the Kremlin, in its hunt for more tax revenues, is seeking to bring more Russian companies onshore and is threatening to end the double tax treaty arrangement that encouraged so many Russian firms to incorporate there. Cyprus has already succumbed to an increase in the duty, but Cyprus is much more heavily dependent on Russian business than the Netherlands, where talks are ongoing, so the outcome of this negotiation is still uncertain.
Profit repatriation strategies for Russia businesses from China have also changed over the past few years. The old model of structuring the investment through Hong Kong to enjoy lower withholding taxes on the dividends (5% instead of 10%) and its proximity to China, became absolute. Hong Kong signed a Double Trade Agreement with Russia that provided Russian investment with 5% tax rate under the DTA. However, opening bank accounts in Hong Kong for Russian business became very difficult over the past twelve months.
This contrasts with Singapore, where opening the bank account is a matter of several weeks, with Russian investors receiving no different treatment from investors from any other country. Singapore has become something of a haven for Russian companies looking to accumulate profits in Asia, to reinvest in other projects in the region. Singapore remains a good alternative to other global jurisdictions where Russians are used to accumulating profits. The tax rate on dividends from China to Singapore is 5% and 0% on the transfer of the money elsewhere out from Singapore.
Changing investment flows are also dictated by the new developments of Belt and Road Initiative and Free Trade Agreements that Russia has recently signed.
The understanding that Asia is no longer a “third world” requiring the “leadership” of more developed countries and is also not a silent “world workshop”, but instead an increasingly independent economic and political actor on the world stage, did not happen overnight. Both China and India, the Asian giants, did not hurry to achieve global ambitions. In 2013, President Xi Jinping introduced a specific term, “The Economic Belt of the Silk Road”, which became an important signal from Beijing. Initially, this project was aimed at developing China’s western regions by transferring production from coastal areas and developing trade and transport links between them and Central Asian countries. Moscow backed Beijing by endorsing 90% of the strategy of China’s Belt and Road Initiative, following the same path as the first 19th century “turn” to Asia, and putting the Trans-Siberian Railway and the Chinese Eastern Railway once again at the epicenter of a great path that runs through the entire Eurasian landmass and unites them into one economic space. The Belt and Road Initiative has grown into truly global framework, with China signing cooperation agreements with 140 different countries throughout Asia, Africa, Europe, and Latin America.
Several important initiatives have subsequently emerged in China-Russian relations, including a currently non-preferential trade agreement between China and the Eurasian Economic Union (signed in 2018) as well as cooperation within BRICS to promote settlements in Russia’s strategy in the Far East.
This will likely be directed at diversifying its ties with the main players in the region, rather than concentrating solely on developing ties with China. To some degree Russia will be seeking to promote greater competition among the dynamic powers of the Asian Pacific for greater access to its large domestic markets as well as to its natural-resource wealth in the regions, including Japan, South Korea and the ASEAN countries, as well as with India in the Indo-Pacific region.
Russia has actively pursued FTA talks with several members of ASEAN, launching discussions with Russia’s partners in the Eurasian Economic Union. This resulted in a first FTA with Vietnam in 2016, which was followed by an FTA with Singapore. These provide opportunities for Russian companies to structure trade flows via Vietnam or Singapore and brings the products to these countries duty free. Thailand and Indonesia have also expressed interest in potential FTA with the EAEU that will provide greater exposure to entire ASEAN market for Russian brands.
Earlier this year, Russia also launched talks on trade liberalization in services and investment with South Korea. And while tensions do exist in the East Asian region among key players for geopolitical dominance and involve disputed territories, the emergence of regional integration projects are now approaching the mega-regional scale. This is bringing together the largest heavyweights in Eurasia, such as the Shanghai Cooperation Organization, Trans-Pacific Partnership, Regional Comprehensive Economic Partnership, and so on and is encouraging Russian brands to look for new trading opportunities. The opportunities are there and are gradually becoming more apparent as Russia turns once again to the East.
Maria Kotova has a master’s degree in Management and Chinese from South China Normal University and a bachelor’s degree in International Affairs and Relations from Saint Petersburg State Polytechnic University. She also holds a certificate in Chinese studies from Liaoning University, and is responsible for the development of the Russian market into Asia. She is currently based in St.Petersburg having spent eight years advising clients in Dezan Shira & Associates Shanghai office assisting corporate tax structuring, equity transfers, profit repatriation issues, cross border transactions, analysis of legal and tax implications under M&A and corporate restructuring of Asian groups.
Any views or opinions represented in this blog are personal commentary, belong solely to the contributor and do not necessarily represent the views of Asia Briefing Limited or Dezan Shira & Associates.