How Important Are Russia's External Economic Links?

Russia-related geopolitical tensions have increased substantially over the past year. Russia's relations with Western countries have become strained as the risks related to the Ukrainian conflict have intensified. Instability has also increased inside the Eurasian Economic Union (EAEU),¹ including political tensions in Belarus, unrest in Kazakhstan, and border clashes between Armenia and Azerbaijan.

This note, premised on the notion that shocks related to foreign economic relations can have important effects on the Russian economy, explores some of the key characteristics of Russia's current foreign economic relations from the viewpoint of international trade and financial flows. The key finding is that Russia, despite its effort in recent years to reduce dependence on global economy and increase self-sufficiency, remains highly integrated with the rest of the world.

The paper is organized as follows. In the Section 2, we analyze the general picture of Russia's foreign economic relations. In the Section 3, we take a more detailed look at the economic relations between Russia and China. The final section concludes.

This section provides an overview of Russia's economic relations in a global framework. We examine Russia's foreign trade in aggregate, at the sector level, and briefly at the product level. We then discuss cross-border financial flows to and from Russia with an additional look at the banking sector.

The top ten export products, which include various energy commodities, wheat, gold, platinum, aluminum, and wood, accounted for about 60 percent of Russia's goods exports in 2019. The EU is Russia's main export market for energy raw materials and aluminum (Table 1). The UK, the hub of the global gold trade, accounts for nearly all of Russia's gold exports. The United States is an important export market for platinum. Over half of Russia's wood exports go to China, which is also an important export market for Russian crude oil. Coal and platinum are exported in large amounts to other East Asian countries. The EAEU countries are not main markets for any of Russia's top ten export products. Most wheat and steel products go to countries other than those examined here.

Although the share of the United States is relatively small in Russian exports, 55 percent of Russian exports are invoiced U.S. dollars (data from 2021:Q1–Q3). Perhaps the biggest reason for this is that oil is typically priced in U.S. dollars. The euro accounts for 29 percent of export invoicing in Russia's total exports. The dollar and euro also dominate export invoicing in Russia's trade with most emerging economies, including China and Turkey. Exports to EAEU countries are mainly invoiced in rubles (70 percent) and about half of Russian exports to India are priced in rubles (India is a key export market for Russian military technology).

The top ten import products (e.g., medical products, machinery, equipment, and motor vehicles) accounted for about one-quarter of Russia's goods imports in 2019. The imports of these top products largely come from certain regions (Table 2). The EU dominates Russian imports of medical products, machinery, and motor vehicles. The United States is the main source of imports in products related to the aircraft industry. China is by far the largest provider of telephone sets and computers. Other East Asian countries dominate the imports of motor vehicle bodies. The share of the EAEU countries is small in all of Russia's top ten import products, ranging between 0 percent and 4 percent.

The U.S. dollar was used as the invoicing currency for 36 percent of Russian import transactions, slightly ahead of 31 percent for the euro (as of January–September 2021). While the dollar dominates as the invoicing currency for Russian imports from emerging economies such as China and India, the role of the yuan in imports from China seems to be growing. Most imports from the EU are invoiced in euros. The Russian ruble is used as the invoicing currency for the majority of Russian imports from EAEU countries.

FDI statistics are, however, subject to large uncertainties. They depict cross-border financial flows that are often channeled through three (or more) countries for reasons both legitimate and illegitimate.⁴ It is estimated that the bulk of FDI inflows to Russia are actually of Russian origin. These are funds that are merely round-tripped via foreign countries such as Cyprus in the EU or tax havens like the Bahamas and Bermuda. Many large Russian corporates are registered in offshore tax havens such as Cyprus.

Companies from other countries than Russia also use financial intermediaries. Estimates calculated by the United Nations Conference on Trade and Development (UNCTAD) suggest that the share of investment from Russia and unspecified sources (flows for which the ultimate source could not be identified) is about 40 percent of Russia's FDI stock. The EU is the largest source of FDI, even in ultimate investor terms, but the shares of the UK and the United States are much higher than in the official statistics. It appears that about 70–75 percent of the FDI stock in Russia is associated with the EU, UK, or the United States, either as the ultimate investor or as an intermediate country. The roles of Asian countries and EAEU countries are apparently much smaller.

As of the end of June 2021, the stock of foreign portfolio investment in Russia was US$ 180 billion.⁵ The Central Bank of Russia (CBR) provides no detailed statistics of the geographical distribution of foreign portfolio investment.

Russia's stock of foreign debt was US$ 480 billion (30 percent of GDP) at the end of 2021. The dollar's share of foreign debt was 42 percent, the euro's share 20 percent, and most of the remainder is ruble-denominated debt (as of the end of September 2021). At just US$ 60 billion, the level of the Russian government's foreign debt is relatively moderate by international standards. The value of Russia's ruble-denominated government debt that is held by foreigners was about US$ 40 billion and the value of foreign-currency denominated government debt US$ 20 billion. Foreign participants accounted for 20 percent of the ruble-denominated government bond market and 50 percent of the government eurobond market.

The stock of Russia's outward portfolio investment was US$ 120 billion (8 percent of GDP) as of the end of June 2021. The geographical distribution of portfolio investment is similar to FDI distribution; the EU again accounts for the majority of investment (Figure 6b). The relative shares of the UK and the United States, however, are much larger for portfolio investment than Russian outward FDI.

The picture is similar for the foreign assets of the Russian banking sector. The value of foreign assets was US$ 190 billion as of the end of June 2021. The EU accounted for half of the assets, while the combined share of the UK and the United States was about 15 percent. The share of the EAEU countries was 6 percent.

While Russia's relations with Western countries have deteriorated since 2013, economic relations between Russia and China have deepened. Nevertheless, the economic relationship between Russia and China is asymmetric. Russia is a far less important economic partner for China than vice versa. The sole exception is energy products. Russia is a significant—although not dominant—source of energy imports for China. There have been several high-profile projects such as Power of Siberia natural gas pipeline and the Yamal liquified natural gas (LNG) project, where Chinese funding has been crucial. In general, however, the role of Chinese financing has not grown substantially in the Russian economy. The countries have also promoted use of their national currencies in bilateral transactions to reduce the role of the U.S. dollar. This has succeeded to some extent, but the limited convertibility of the yuan and the volatility of the ruble have hampered this trend.

China imports mainly energy products from Russia. In these products Russia is a more important source of imports than in the overall trade. Russia's importance has grown in past years with the increasing transport infrastructure capacity for oil and natural gas between the countries and the growing LNG production in Russia (as LNG can be transported more flexibly to various markets). Transport infrastructure projects include the extension of the oil pipeline from Russia to China, the construction of the Power of Siberia gas pipeline, and the Yamal LNG project. Chinese financing has provided important support for these projects.

About 15 percent of Chinese crude oil imports and 8 percent of natural gas imports came from Russia in 2021. Russia accounted for about 20 percent of Chinese coal imports. Russia's share in Chinese natural gas imports can increase when the Power of Siberia pipeline will reach full capacity, and possibly further if other planned natural gas projects are realized.

The Power of Siberia gas pipeline is currently slated to reach its full capacity of 38 billion m³ per year in 2024. Gazprom also recently announced an agreement to supply an additional 10 billion m³ gas per year to China. This arrangement, however, requires additional investments, so it is unclear when these shipments might start. Another gas pipeline (planned capacity 50 billion m³) running from Russia to China via Mongolia has been discussed, but so far no official agreement has been reached on its construction. In any case, China has been quite careful in balancing and diversifying its oil and gas supply to avoid over-reliance on any single supplier.

Russia initially hoped to offset its loss of access to foreign financial markets from the 2014 Western sanctions with Chinese financing. Although subject to several uncertainties, the available data suggest this aspiration has been only modestly realized. Chinese state-related financial organizations have provided financing to projects considered beneficial to China's general interest. such as construction of the Power of Siberia pipeline and the Yamal LNG project. Some other Russian entities have also received Chinese financing, but China's role in financing Russia remains modest at the aggregate level.

While China's importance to the Russian banking sector has increased somewhat, it is still quite limited. At end 2013, the amount of the liabilities of the Russian banking sector to China (including Hong Kong) was only US$ 1.8 billion. By mid-2021, it had tripled to US$ 5.7 billion, and accounted for about 4 percent of the foreign liabilities of the Russian banking sector.

AidData, which provides estimates on Chinese government-related development project financing abroad, suggests that the amount of finance flows from China to Russia began to decrease after 2013 (data on project values are not available for all projects). The apparent change, however, largely reflects the massive loan provided by China National Petroleum Company to Rosneft in 2013. In 2010–13, the total value of project financing was US$ 41.6 billion. In 2014–17, it decreased to US$ 28 billion.

Russia and China are both promoting increased use of their own currencies in international transactions and reducing dependency on the U.S. dollar. This shift is reflected in bilateral trade, Russia's foreign exchange reserves, and China's state-led financing of Russian projects. In Russian exports to China, the share of ruble and other currencies (apparently yuan) as the invoicing currency has increased from 3 percent to 15 percent in 2013–21. The euro has also strongly replaced the U.S. dollar. In Russian imports from China, the share of ruble and apparently yuan as the invoicing currency has increased from 6 percent to 31 percent in 2013–21. The use of yuan seems to have increased substantially in imports, while the share of ruble has stayed stable. The share of euro has increased also in Russian imports from China but is still only about 10 percent. In Russia's foreign exchange reserves the share of yuan has increased from practically zero to 13 percent by mid 2021.

According to AidData, the development financing from Chinese state-associated entities to Russia is also shifting to yuan. During 2010–13, just one relatively small project was financed in yuan—all the others were financed in dollars. During 2014–17, financing for several projects was disbursed in yuan, accounting for 20 percent of total financing (for projects where their value has been reported).

Despite its aspirations for greater economic self-sufficiency in recent years, Russia still has substantial economic connections to the global economy through international trade and financial markets. In trade, Western countries are still Russia's most important partners. The EU is the main export market for Russian oil and gas, and the key provider of Russia's imports of medical products, machinery, and motor vehicles. The shares of China and other Asian countries have increased substantially in Russian trade. As for many other countries, China already accounts for the vast majority of Russian imports of electric equipment and electronics. In financial markets, Western countries continue to dominate Russia's international connections. EAEU members figure much less in Russia's trade and financial flows, but there are exceptions. For example, Belarus is an important supplier of food imports to Russia.

As China's role in the global economy continues to increase, we expect that its importance for the Russian economy will also grow. In contrast, China's importance to Russian financing has remained relatively modest, partly owing to China's own capital controls.