Ben Aris in Moscow -
The shouting match between west and east continues, but the Russian stock market was surging on May 19, a day before Russian President Vladimir Putin was due to arrive in China, where he is expected to sign a string of massive investment deals.
Some pundits have been warning of war. Nato has been moving assets up to its eastern borders while Russia's troops remain on "exercises" on Ukraine's border. However the markets have shrugged off the impact dangers of this "hot peace" and assume that a negotiated solution will be found eventually: what has been remarkable in the Ukraine imbroglio is how little Russian stocks have sunk given a third world war is a real possibility.
Russia's leading Micex index rose above 1400 for the first time in months on May 19. If Putin inks a historic deal to supply gas to China on May 20 that will link Russia to China by non-movable infrastructure – as is widely expected – expect the markets to surge again.
While the showdown between Washington and Moscow is based on principle – a continuation of America's Cold War policy of containment – the markets have taken a much more practical view of the likely outcomes. In the Cold War, the two sides were antithetically opposed, but in this "hot peace" both sides subscribe to the same principles of capitalism (albeit different versions). Business relations will save the situation, as business leaders will ultimately do their best to ignore the politicians as long as there are fat profits to be made. And for its part Russia has been explicit in separating business from politics. According to bne sources, last year at the St Petersburg Economic Forum Putin told the collected heads of US industry with investments in Russia: "We have a problem with your government, but we have no problem with you. You are welcome to invest and repatriate your profits."
Investors have watched the growing levels of business and investment that are linking Russia to the global economy. The point is highlighted by Germany's growing reluctance to follow through with tougher sanctions on Russia. At the weekend German Foreign Minister Frank-Walter Steinmeier made his strongest yet statements calling for cooler heads to reign when it comes to ratcheting up the sanctions regime to phase III, the economically damaging restrictions.
Berlin, and more importantly German companies, simply don't want to go there. Any really effective sanctions would quickly boomerang back onto Germany, and then to the rest of European, stymieing the nascent economic recovery. Moreover, as the EBRD said at its annual meeting last week, if the Russian economy is badly wounded, that could spark a region-wide crisis, as the smaller peripheral countries like Tajikistan and Armenia are extremely dependent on Russia's fate; larger ones like Kazakhstan and Bulgaria would be squeezed hard. Indeed, the sanctions policy runs the risk of sparking an emerging market economic crisis such as the 1997 Asia crisis if Russia itself goes into meltdown – its banking sector, for example, is already under a lot of pressure and the central bank has already lent domestic banks as much as it did in 2009.
The irony is the sanctions policy seems to be having exactly the opposite effect to what was intended. If the goal was to isolate Russia and make it a pariah, the actual effect has been to drive Russia into China is open arms. China and Russia have never been friends. They failed to unite during the Communist era in the face of a concerted and unified West. But now their cooperation is starting to look a bit deeper than the simple marriage of convenience that has ruled until now: China has the people and cash, while Russia has the raw materials the Middle Kingdom so desperately needs to supply its burgeoning industry.
The fracas surrounding Russia's actions in Ukraine has added a political dimension to this relationship. While western politicians routinely cite the "world" or the "international community" in the condemnation of Russia, the truth is that the condemnation is coming almost exclusively from Washington and Brussels. The rest of the emerging world has been remarkable by its silence.
Except for China. Beijing has openly condemned the policy of sanctions against Russia. Moreover it has openly offered to finance and build this symbolically important bridge that will link Russia's mainland to the Crimea. China represents a giant escape hatch in Russia's backyard should the sections become really painful.
What lies beneath this silence is the rest of the world's unease with the US' unipolar approach to foreign policy, epitomised in "do as we say, not as we do." Putin has been explicit that his foreign policy goal is to build a multipolar world. That's part of the reason why he has chosen to so dramatically face down Washington over Ukraine, regardless of the cost to Russia and the Russian economy.
Washington's miscalculation is not to factor in how its tough stance with Russia will be seen by governments in the rest of the world. Beijing and other emerging market governments must be looking on in alarm as the US attempts to bully Russia into following its dictates. China, for example, has a similar territorial dispute with Japan over some islands in the East China Sea, and could come in for similar treatment if it were not for the US' heavy investment exposure in China.
Putting aside the rights and the wrongs of the situation, recently the Kremlin has indicated on several occasions it is open for talks. However, so far Washington has ignored these attempts to begin negotiations. It seems that Washington is playing a zero sum game; there will be only winners and losers, but not a negotiated solution. Even if this is not true, that's how it looks to Moscow and Beijing.
The upshot is we can expect Russia to settle its differences with China and bite the bullet on the price for the mooted gas deal. Pipelines will make for a much stronger marriage than simple trade deals concerning the import of raw materials that will inextricably tie Russia and China together. The upshot will be that instead of isolating Russia, the sanctions policy will have successfully allowed Beijing and Moscow to overcome their long-standing mutual distrust of each other and increasingly it will be the US and the West that are isolated from the burgeoning emerging markets.
It was widely reported this month that China's economy is on the cusp of overtaking the US in terms of size. Putin's meeting in Beijing on May 20 could see Russia link itself permanently to the biggest and fastest growing economy in the world. Strategically, that does not look like a stupid thing to do.
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