Russia remaking EEU trade relations in an increasingly fractured world

Russia remaking EEU trade relations in an increasingly fractured world
Global trade is being fractured by the geopolitical tensions unleashed by Putin's war in Ukraine. The Kremlin has taken over the chairmanship of the EEU and will try to develop its reach to create new and larger markets for its members. / bne IntelliNews
By Ben Aris in Berlin March 28, 2023

Russia took over the chairmanship of the Eurasian Economic Union (EEU) at the start of this year and is looking to the trade club as one of the ways it can expand its trade after the Western world has increasingly cut ties due to the extreme sanction’s regime imposed since the start of the war in Ukraine.

Over the last few decades, the Emerging Markets have been building up new institutions that operate outside the control or influence of the traditional Western dominated institutions such as the World Bank and International Monetary Fund (IMF). While nominally global, these multilateral development banks are still seen by many emerging countries as dominated by the leading developed countries and espousing Western values.

The war in Ukraine has driven a wedge between the West and East as these institutions are increasingly being forced to take sides, and could lead to a fractured world as described in a feature by bne IntelliNews. Former UN Secretary-General Ban Ki-Moon raised exactly this concern on March 27, warning that the conflict could create separate trade blocks delineated by "geopolitical borders" due to the increasingly acronymous disputes.

"The globalised world economy risks fragmenting into separate trade blocks delineated along geopolitical borders," Ban noted at the opening of the Boao Forum for Asia.

Russian President Vladimir Putin set up the EEU as a mirror image of the EU with the hope of joining them together in a free trade area that would stretch “from Lisbon to Vladivostok''. Those dreams are dead now, which has changed the nature of the EEU for Russia as it looks to extend its catchment area not west to Europe but south and east to Asia.

The EEU already has free trade agreements (FTAs) with Serbia, Iran and Vietnam, while at least twenty other countries, including major nations such as India, Indonesia, Thailand, Egypt and the UAE are currently negotiating the same.

China has become a key market for Russia and trade turnover is expected to top $200bn by the end of this year. China also has a loose FTA with the EEU, classified as ‘non-preferential’ where tariffs are lowered on specific goods and products on an ‘as needed’ basis rather than set in stone as is the case for most FTAs. However, Russia continues to dwarf the other members of the EEU and accounts for 80% of the inter-regional trade.

Like the EU, the EEU was designed to allow the free movement of labour, capital and goods amongst its members. But since sanctions were imposed on Russia it has become a conduit source for banned items like machinery and technology by using the parallel imports schemes.

As Russia’s logistical infrastructure has long been serving its main trade partners in Europe, now sanctions have arrived, which means Russia needs to invest heavily in reorienting this infrastructure to the South and East to ensure the easy flow of goods within the member countries as well as develop new supply chains with third countries that have refused to join the sanctions regime.


Banking headaches

Another problem to overcome is the SWIFT sanctions that were imposed only days after Russia’s invasion of Ukraine in February have made settlements of trade deals difficult. Russia has strived to set alternatives and get other countries to join the Russian Central Bank's financial message transmission system (SPFS) – an analogue to SWIFT – but without much success.

To deal with this problem there has been a steady process of yuanisation of the Russian economy as it adapts China’s currency in place of the dollar as the preferred foreign exchange vehicle for settling international trade deals.

“China has become woven into the seams of Russia’s economy since the war, which has helped Russia to adapt to Western sanctions. Russia has tried to replace imports from the West with Chinese goods and the Chinese renminbi has taken on a bigger role in currency transactions,” says Liam Peach, an emerging market economist with Capital Economics.

“But we think there are still limits on how much Russia can rely on China in the future. China is unlikely to step in and fully replace all the FDI in Western Russia that previously came from the EU. And Russia is still facing a permanent loss of gas exports (we estimate around 30% by the end of this decade) as a result of losing access to the EU market,” Peach adds.

Indeed, in banking even Russia’s friends have been wary of doing business with it, as all the large EM banks have branches and business in the West and so are exposed to secondary sanctions on their US or European business.

“In early March 2022, the China-led Asian Infrastructure Investment Bank (AIIB) and the BRICS New Development Bank (NDB) announced the suspension of transactions to Russia and Belarus,” says Alexander Korolev of the Russian International Affairs Council. “The decision of these financial institutions, in particular to freeze lending to both countries, indicates growing pressure on global financial institutions, which may adversely affect Russia’s intended participation in the implementation of various infrastructure projects.” Other EEU Institutions have also had to rethink their remits. Russia has reduced its stakes in both the Eurasia Development Bank (EDB) and International Investment Bank (IIB). The former is an analogue of the European Bank for Reconstruction and Development (EBRD), a regional development bank with Russia, Kazakhstan, Belarus, Tajikistan, Kyrgyzstan and Armenia as members. The latter was founded in Soviet Times as an international development bank for the Warsaw Pact countries and other socialist sympathetic regimes like Cuba, but the 50% Russian-owned bank is now reportedly near bankruptcy after its funds were sanctioned. 

The EDB is of especial interest, as it already has funds and business with many of the EEU countries and is looking to expand its footprint.

The bank’s charter capital totals $7bn, including $1.5bn of paid-in capital and $5.5bn of callable capital. The investment portfolio as of March last year amounted to $3.9bn and the cumulative investment portfolio (including completed projects) $10.4bn. A total of 84 projects are being financed. It would not be a surprise to see a recapitalisation of the EDB and an expansion of its shareholding especially from China and India, as both have vested regional interests, according to Korolev.

Trade and the budget

In the short term the sanctions have negatively affected Russia’s balance of payments, which may result in a 22% decline in Russia’s export flows in 2023 against a 14% increase in 2022 largely due to record high energy prices, according to Russian investment bank BCS.

“Imports will increase 5% in 2023, but remain 4.5% below its 2021 level as a result of sanctions and partially due to the ruble weakening,” BCS said in a note. “Expecting that the primary and secondary incomes remain at $50-55bn in 2023, the current account surplus will plunge from $227bn in 2022 to $72bn in 2023.” “We see the current account surplus to hit bottom in 2Q as energy prices and its export volumes continue to fall the turning point is expected not earlier than in 3Q23, when Urals prices will show 14% growth quater on quarter, accompanied by some recovery in gas export flows. In 2024, the current account surplus will remain,” BCS added.

As the exchange rate is more firmly linked to the trade surplus this will also mean the ruble will probably weaken – BCS predict it will fall to RUB79 to the dollar – that will offset the fall in trade somewhat, as it becomes more profitable to export. But like many analysts and MinFin, the bank anticipates oil and gas revenues will recover in the autumn, leading the ruble to strengthen to RUB76 by the end of the year.

“In general, a weaker ruble is viewed as a positive development for Russia’s budget positions; however, it cannot entirely offset the drop in oil & gas budget revenues,” says BCS. “For 2M23, they contracted by 46% year on year, resulting in a 13% y/y decline in total revenues. Amid elevated government spending, the deficit widened to RUB2.6 trillion, accounting for c90% of total deficit envisaged in the Budget Law. BCS estimates suggest that the budget deficit will widen to about RUB4 trillion in 2023, above the official MinFin forecast for RUB2.9 trillion. In 2024, the deficit based on our energy flows assumptions (with Urals price recovery from $56 per barrel in 2023 to $64 per barrel in 2024 and 6.5% y/y increase in oil production) is expected to narrow to RUB3.5 trillion.

New trade directions

Sanctions are not designed to stop Russia from trading, but they are designed to cut it off from its biggest market in Europe and depress the amount it can earn from things like oil exports. Russia has been forced to look for new customers and redirect its trade from Europe to the Global South. Proximity is important, as bne IntelliNews discussed in a piece on geography of diplomacy, and the sanctions have forced Russia to reorientate its trade through 180 degrees.

This process had already begun before the war as Putin prepared from the coming clash and a general diversification design to better tap the fast-growing Asian markets.

It is no coincidence that in his January address to the heads of the EEU member states, President Putin specifically outlined the importance of expanding the geography of the EEU’s international contacts and concluding new preferential agreements.

“Since its foundation in 2015, the Eurasian Economic Union has been developing steadily, clearly demonstrating its effectiveness and relevance. In absolute terms, trade between the Union's member states has increased by 60% during this period to reach a historic high of $73.1bn in 2021, while foreign trade increased by 46% to $846.3bn, and the share of payments in national currencies was close to 75%,” Putin said.

“I would like to specifically stress the importance of building mutually beneficial and equal co-operation between the union and external partners and international associations. We can see the obvious positive effect of the existing free trade agreements with third parties. We intend to provide all assistance to complete the work on similar agreements with Egypt, Iran and India, and to activate new negotiation tracks, including with Indonesia and the United Arab Emirates. Expanding the geography of the EEU’s international links and contacts with countries in the Asia-Pacific Region, the Middle East, Africa and Latin America would help boost exports of the union’s products and build new logistics chains,” Putin stressed.

The Kremlin’s rhetoric has already highlighted the non-aligned multinational organisations such as Shanghai Cooperation Organisation, the Commonwealth of Independent States, ASEAN and the Latin America trade bloc MERCOSUR, while updating guidelines for the global and regional positioning of the EEU.

Under the direction of Russia, this year the EEU will continue to sign FTAs with more countries of the Global South. The organisation has already signed off on an FTA with close Russian ally in Southeast Asia, Vietnam, in 2015, which has underperformed due to weak logistic links. That is another aspect of the organisation Putin called for strengthening in his January speech to the members.

The task has been complicated by former trade partners that have rejected closer co-operation with the body. The first was Ukraine that refused to join Russia’s so called Customs Union, the precursor to the EEU, that eventually transformed into the Euromaidan revolution in 2014, when the Ukrainian people were forced to choose between a Western or Russian future.

In Asia, Singapore was formerly close to the EEU and actively developing trade with the bloc with a preferential trade deal in 2019, but suspended the deal after sanctions were imposed on Russia a year ago. The story with South Korea is similar, which suspended a preferential trade deal with the bloc after the start of the war in Ukraine.

But the Kremlin still has plenty to work with. In the Middle East, the UAE is emerging as a major financial and technological hub in trade with the EEU. India could play the same role as an economic hub in South Asia, and Mongolia as a transport, logistics and infrastructure hub in Northeast Asia.

Singapore was a big loss due to its pivotal role in SE Asia, but increasingly it seems that Indonesia will step into those empty shoes, as the most populous country in the region has been a strong supporter of Russia and is currently in FTA talks with the bloc that should be in place by 2025. Intense talks with Jakarta are reported underway to try to accelerate the process.