As China’s Belt and Road Initiative gathers momentum, new opportunities in Russia are attracting Chinese investors drawn to the huge market, trade and investment potential between these two super powers.
Recent monetary reforms and government incentives are further encouraging Chinese investors to see Russia as an inviting destination for offshore investment.
At a recent breakfast discussion in Hong Kong, hosted by FinanceAsia and Russian law firm the Pepeliaev Group, investors took the opportunity to gain valuable insights from a panel of expert commentators doing business in Russia, including Michael Hammond, chief executive officer Asia-Pacific at Gazprombank, Andrey Yakunin, co-founder of London-based alternative investment group,VIY Management, Pepeliaev Group senior partner Rustem Ahmetshin and group partner Ilya Bolotnov.
The reason for Chinese investor interest in Russia is simple, said Yakunin: “We both like profits and dislike losses and that’s a good common denominator.”
BEYOND OIL AND GAS
The world’s largest nation by land mass is recognised for its oil, gas and mineral resources, but Russia’s 144.3 million citizens and rising middle-class consumers are a huge potential market for fast-moving consumer goods, healthcare, pharmaceuticals, technology and retail.
The pace of economic cooperation between the two nations is dramatically illustrated by the growth in recent trade figures. Sino-Russian trade volume from January to September reached a modest $61.6 billion, but it was up 22% from a year earlier, according to the Kremlin. Russian President Vladimir Putin said in November that he was confident trade in 2017 would reach $66 billion.
Both governments are working together to encourage cross-border trade and deeper financial ties. In March the Central Bank of the Russian Federation opened its first foreign branch in China.
One of the largest China-Russia deals in 2017 was CEFC China Energy’s $9.1 billion purchase of a minority share in the Moscow-based oil major Rosneft. Elsewhere, Fosun led a consortium that bought a 10% stake in gold producer Polyus for $887 million.
China is organising cross-border investment partly by establishing specialised funds, such as the China-Central and Eastern Europe Investment Cooperation Fund and the Silk Road Fund.
A joint Russia-China Investment Fund, supported by sovereign wealth fund China Investment Corporation and the Russian Direct Investment Fund, has invested in 19 projects including Chinese taxi service Didi Chuxing and Russian hypermarket group Lenta. The $1 billion fund was established in 2012 and in November 2017, it was topped up with a further $1 billion.
Closer economic ties between corporates are likely to benefit Hong Kong.
“We believe you will see many more Russian companies having dual listings between Moscow and Hong Kong,” said Hammond.
So far though, there have been few Chinese companies tapping China’s onshore capital markets with a handful of exceptions such as Rusal, which placed in September the second tranche of Panda bonds, again for three years with a coupon rate of 5.5% in renminbi.
The scarcity is partly because access to Panda bonds – bonds issued by non-red-chip foreign names – is not entirely straightforward. International capital markets are very efficient and can provide fast access for raising large amounts of financing.
“While Russian companies would be very interested in coming to China, it is important for them to understand if the time spent in building the access to this new market will result in efficient transactions,” Riccardo Orcel, deputy CEO of VTB Group and head of VTB International Global Banking at VTB Capital, said via email.
BELT AND ROAD
Russia’s rich energy resources are also strategically important in the development of China’s Belt and Road Initiative, launched in 2013.
A number of key projects are on the move, including the Moscow-Kazan high-speed railway with construction scheduled to begin in 2018. The project is the first stage in a plan to build a 7,000 km transnational railway linking Moscow and Beijing.
Russia’s government has laid out the welcome mat to investors by implementing significant incentives, benefits and free customs zones in many of its 85 regions as it endeavours to shift focus away from Moscow and the port city of St Petersburg.
It’s keen to encourage regional growth, particularly in Siberia and its eastern border with China where it has implemented a preferential tax system for new enterprises.
“The One Belt One Road investment project for Chinese companies has created a real pivot towards the region and we anticipate a strong pick in investments,” said VTB’s Orcel.
REFORMS AND OPPORTUNITIES
Much of the growing relationship with China results from European Union and US sanctions imposed in 2014 following Russian military intervention in Ukraine. In response, Russia imposed counter sanctions. In August, the US passed further legislation extending sanctions in finance, energy and defense sectors. These moves, which initially caused the rouble to crash, are redrawing trade routes.
Corporates are expanding their markets beyond Western Europe and the US. Together with government fiscal discipline, Russia has reined in inflation to below 4%. It now has one of the world’s lowest percentages of government debt to GDP.
“Asian investors in Hong Kong, China, Taiwan and Korea are buying Russian eurobonds. If you want a safe investment with a relatively high yield, you should look at eurobonds. If you look at the Russian federation, it’s definitely investment grade. It’s split investment grade at the moment because, in our eyes, it’s a political stance from Fitch, Standard & Poor’s and Moody’s,” said Hammond.
This split investment grade rating is due to both Moody’s and S&P differing from Fitch Ratings. Moody’s rates Russian government bonds as Ba1 while the S&P rating is BB+ and positive, making Russian eurobonds high yield. Fitch’s credit rating for Russia is BBB-, and therefore eurobonds are listed as investment grade.
The financial infrastructure is also slowly falling into place.
As a currency of preference, the US dollar’s influence is waning with many Russian contracts now transacted in renminbi.
“Historically Russia was a US dollar-based economy and most foreign trade, finance and capital markets traded in it. Dealing in the US dollar is complicated for a large section of the Russian economy. This is an amazing opportunity for China to move a significant part of the Russian capital markets from its traditional US dollar-base into renminbi,” said Hammond.
National payments systems, such as China UnionPay and Russia’s domestic Karta Mir, have rapidly gained ground, bypassing transaction issues and reliance on US payment systems Visa and Mastercard. Internationalisation of the renminbi is Chinese government policy but Hammond is cautious about how long this will take.
“Unless there are real flows of business and money, the derivatives or FX markets will not develop sufficiently. It will take a long time for this internationalisation to become really heavy but it’s on its way. The slow de-dollarisation of trade between Russia and China is happening but it takes time. If you look at the British Empire, it took 50 to a 100 years for sterling to collapse. Now it’s the renminbi’s turn,” he said.
One company successfully operating in Moscow for the past five years is Shenzhen Absen Optoelectronic. General manager John Song has experienced foreign currency issues first hand.
“Two years’ ago the rouble declined 10% in one night which almost stopped the business because most international trading was in US dollars. This was bad for our customers as they couldn’t control their profit in the market, but it’s going very good now.” But he pointed to renminbi transfers to China and Hong Kong as an ongoing issue.
“We need to exchange roubles to renminbi via a central bank, but the central bank’s RMB amount is limited. Russian companies need to keep more renminbi in their accounts for transfers. Getting money from Russia is a slow process because it needs to be checked and verified by an intermediary bank in New York,” Song said.
AN EYE FOR INVESTMENT
The Pepeliaev Group has worked with Hong Kong and Mainland China clients since 2013. Ahmetshin said it’s been an interesting learning curve.
“We wanted to build a legal bridge between our two countries. We had to learn about Chinese traditions and business mentality that really differs from Russian and European cultures. We’ve learnt a lot from our clients like Alibaba and Great Wall,” he said.
When choosing a location or region in which to operate, Ahmetshin suggests investors need to evaluate what government measures are in place to support foreign investment, the potential for business growth based on economic and market analysis, transport, ease of doing business and investment climate.
Russian corporate and contract law specialist Ilya Bolotnov says Chinese investors must pay attention to their IP, and register trademarks and domain names in advance.
“It is essential to build a relationship with entrepreneurs and invest in the development of that relationship. It is equally important to make sure your legal position is right. I tell my clients to be very careful. Do your legal and tax due diligence step by step. This is not a complicated exercise because very basic information can be collected from open sources,” Bolotnov said.
Having successfully negotiated establishment and legislation, other Chinese companies are sure to emulate Shenzhen Absen Optoelectronic’s success in Russia.
“Profit is good and we have a good five year plan,” Song said.