Pesident Xi does not want Russia's actions to restrict China's ability to act, nor President Putin's destiny to shape his own.
Trying to avoid writing about the situation in Ukraine, I feel a bit like the manic hotelier Basil Fawlty who keeps trying to avoid mentioning “The War” when some Germans stay at his hotel. Still, there it is, a disruptive fact sitting in the midst of all our plans like a dog egg on the board room table.
Russia does not appear to have achieved its war aims in Ukraine. The Russian system means that Mr Putin will have to take personal responsibility for this. As Russia’s de facto Tsar for over 20 years, he is the only leader of the BRICS who for years has been able confidently to say, “L’etat, c’est moi.” That’s great when things are going well. When things go badly the buck stops in one place only. And if the man and the state are identical, then when the man fails, the danger has to be that the state fails.
It’s hard to see how Russia extracts itself from Ukraine without Putin being seen to have failed. The armchair generals reckon Russia could never successfully occupy Ukraine with the help of a puppet government. The eastern half of Ukraine, or even the Black Sea coastline, might be too much to hold. Already, the conflict has moved way beyond a “special military operation” whatever the Kremlin propaganda machine may say. And as Russia pulls troops away from other regions to bolster its forces in Ukraine, one can be sure that Russia’s internal and external opponents will be keen to take advantage. What will the Russian mothers say when thousands of their sons are clearly not coming home? What will the next round of conscripts do? Tens of thousands of young men have already left Russia.
Economically, Russia could be excluded from the European and US markets for far longer than it would like, though Gazprom continues to report the amount of gas being exported to the EU, hinting at the sums the EU is paying towards its notional strategic opponent. Russia can be self-sufficient in many foodstuffs and in energy. It can rely on its friend without limits to the east, China, to buy its surpluses and to supply it with consumer goods and technology. All of this trade will of course happen in RMB, not in USD, giving Russia a requirement for a currency which is not yet freely convertible and therefore tying its future prosperity ever closer to that of China.
This is both an opportunity and a big headache for China. The opportunity is to hold Russia closer to China itself and therefore to further China’s ambitions to control Eurasia. China wants that because the land bridge to Europe is its outlet should it at some future point be unable to access markets and source its energy via the sea, particularly through the Straits of Malacca. China wants to control the area within the nine-dash line for the same reason it has built, and continues to extend, its String of Pearls naval bases into and beyond the Indian Ocean. It is strategically vital to its long-term plan of replacing the US as the world’s leading economy. Should China not be able to hold open its ocean trade lanes, its access via Russia to western markets is its plan B.
The headache is that if China ties itself too closely to a failing Russia, it may be seen to fail too, a loss of face that would be hard for Xi to bear. Equally, Xi would also like to be able to say, “l’etat, c’est moi” for a couple of decades as his friend Vladimir has done. But just as Xi is achieving his aim in the year in which he will become President for a third term, the identification of his person with the State is coinciding with a number of challenges. As the cult of personality builds around him, he must take on personal responsibility for a slowly imploding property market, managing the pandemic, rising energy and commodity prices driving factory gate and foodstuff inflation, China’s response to the war in Ukraine, ongoing strategic competition with the US and a stalled Belt and Road Initiative.
These challenges all have implications for shipping. The Chinese property market, a Ponzi scheme if ever there was one, has spread risk into the savings accounts of millions of newly minted middle class Chinese consumers. The developers/speculators can no longer fund their debt payment instalments through new sales, a situation that will only get worse given the demographics in China. The policy response is to lower interest rates, but that reduces income on savings in a country whose population salts away a much larger proportion of their income than do their western counterparts. It also can weaken the RMB, just as China wants to pivot from being export led (for which a weak RMB has been a key element) to a consumer economy for which a stronger currency makes imports cheaper. Both these effects may reduce consumer spending growth, which is the opposite of the direction of intended travel.
Moreover, China’s slowing construction industry has resulted in lower steel output as demand for the metal plateaus. This had led to a year-on-year reduction in iron ore imports in Q1 2022 of nearly 20 million tonnes (266 million tonnes this year so far versus 288 million tonnes in Q1 2021). China imported 6.4 million tonnes of coking coal in Q1 last year and 4.2 million tonnes so far this year. The Baltic Capesize Index has so far been unable to shrug this off, having started the year at 2,874 points, falling to 1,765 on 2 Feb for Lunar New Year, but barely rebounding to 1,887 points on 25 March. The long-term prospects for Chinese steel production growth are also being dented by the National Development and Reform Commission’s plan to increase the amount of recycled steel from 20 to 30 per cent of total consumption by 2030.
China’s dependence on exports is still significant. Foreign sales represent around 20 per cent of GDP still, having peaked at 36 per cent in 2004. In fact, exports increased from 17.65 per cent of GDP in 2020 to an estimated 18.90 per cent in 2021. But this year China has been putting ever greater parts of it GDP under lockdown – as much as 30 per cent according to Goldman Sachs analysts. This will dent its ability to export goods.
And today (Monday 28 March) Shanghai’s municipal government has reported that the Pudong financial district and nearby areas will be locked down from Monday to Friday as mass Covid-19 testing takes place. Public transport is to be suspended. Non-essential offices and businesses will be shuttered. This extends a partial lockdown in Shanghai in which ‘closed loops’ were allowed – workers camping out at their workplaces to keep factories and offices operating. There is bound to be a knock-on effect on the productivity of Shanghai port, including world’s busiest container port which would be expected to process around 44 million teu this year without the lockdown compared to just over 43.5 million teu last year.
Chinese social media are sharing reports of panic buying and of ‘health barriers’ around neighbourhoods being breached. Could it be that the population is straining under the draconian Zero Covid policy? Xi’s government fears that a more relaxed approach would lead to infection levels that would swamp the healthcare system. The go-getting Shanghainese often bristle at Beijing’s officialdom and perceived arrogance. They may be a barometer of how well Xi is handling public health at a national level, with its economic consequences now clear to us all after two years of living with the pandemic.
China is also facing rising domestic inflation, though so far it is still below the long-erm average of around 2 per cent a year. In part this is due to global energy price increases being mitigated by buying more energy (at a discount and paid for in RMB, naturally) from Russia. But China’s agriculture minister has this month said that wet weather during planting will cut China’s wheat harvest by 20 per cent this year, making it, in his words, the worst year ever for the harvest. This means China will have to import more wheat at higher prices, in a year in which Ukrainian and Russian wheat exports (both supply around 10 per cent of China’s wheat) could be lower. This may inconvenient rather than political dynamite. But a locked-down public may rankle at a higher cost of living as well as a pandemic, necessitating Xi to give stirring speeches about the Great Struggle and National Destiny to keep the plebs on-side.
Lower GDP growth and lockdowns in China will restrict oil demand growth there as well as refinery throughput. This will have a direct effect on the tanker markets as China is the biggest crude oil importer globally and one of the biggest refined products exporters. Average VLCC earnings for Q1 this year are USD-13,032 a day, basis the Baltic Exchange’s calculations. Rising bunker prices are causing even more problems for operators. Frankly, I am amazed that more VLCC owners haven’t gone broke yet.
President Xi’s government said that GDP would grow 5.5% this year, but that figure is already looking optimistic. This is a headache for him. Xi would have hoped that the Year of the Tiger would have opened with a successful Beijing Winter Olympics and ended with his coronation as President for Life, with confirmation of his agenda to restore China’s geographical boundaries to include Taiwan and the area within the nine-dash line. But now, to add to his domestic challenges and his strategic competition in the Indo-Pacific, he has to keep one eye on Russia, because if the overland route to Europe should for example be sanctioned, then a key element of the Belt and Road policy is undermined.
Xi must prevent China from being embroiled in sanctions. So this week, Sinopec has pulled out of a USD 500 million deal to invest in a petrochemical plant in Russia with Sibur, a natural gas producer led by Gennady Timchenko, a long-term associate of President Putin who was personally sanctioned by the West after the annexation of Crimea in 2014. A Sinopec executive was reported by several media sources to have said, “Companies will rigidly follow Beijing's foreign policy in this crisis. There's no room whatsoever for companies to take any initiatives in terms of new investment."
There are rumblings that the Chinese government is losing patience with Mr Putin. It may be too early to say that, but the Chinese will look after their own interests regardless of the ‘friendship without limits’ between Mr Putin and Mr Xi. The real fear for Mr Xi is three-fold. Firstly, a long war in Ukraine endangers the overland Belt in his Belt and Road policy. Secondly, a failure of Russia's war in Ukraine could mean the end of Mr Putin’s authority in Russia. That would be a blow to autocrats everywhere, especially those who want to rule for life and those who might be considering military adventurism against a smaller, neighbouring, more democratic country with close historical ties and a common language. Thirdly, a Russian win in Ukraine might trigger a wider European war, taking China’s main export markets in Europe away indefinitely, and quite probably further damaging its relationship with the US at the same time. Xi might be aiming for Chinese hegemony but he knows that China is not yet ready to fight for it.
The bottom line is that Xi will not want Russia’s actions to restrict China’s interests, nor President Putin’s destiny to shape his own. The challenge for shipping is that Xi’s headaches are in many cases our headaches too. While Xi has the power to act and react, we can only observe and react, making our own strategic planning that much harder.
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