And So It Begins. US Agricultural Producers Should Look To Russia In Order To Supply China

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russia-wheat

Op/Ed By Chris Devonshire-Ellis

The US-China Trade war has been taking a large toll on agricultural produce sold by the United States to China. This is partially because China retaliated in a measured response to Washington, knowing that US President Donald Trumps voter base has a large agricultural segment crucial to his being re-elected. Thus far, while sales to China have plummeted, the US President has compensated American Farmers by providing them with grants – effectively meaning the US taxpayer is bailing them out. We can see how sales have plummeted to China in the graphic below, courtesy of the US Grains Council

us-grains-council

An issue facing American farmers however is that China needs to protect its interests. It is a one-party state and will not tolerate interruptions to its supply chain. We can already see in Hong Kong the results of what happens when discontent sets in. For such a situation to develop across China would be catastrophic, both for the country and the global economy. China has already endured civil war and revolution, and such a scenario today is unthinkable. This means that food security is of paramount importance to Beijing. If Washington wishes to illustrate it is not prepared to offer China this, then it becomes a matter of Chinese national security to find alternative sustainable suppliers without a trade agenda to upset the status quo.

It should be a matter of concern then to the American agricultural industry that China has been doing just that. Russia has stated it will ramp up production of grains; it is already the world’s largest producer. The supply chain gap left by the US effectively leaving the China market is seeing the Russians and others move into the China market to replace the US farmers exports to China. Primary products among this are wheat, corn, soy and other grains. I wrote about this in the article Russia Takes Advantage Of The US-China Trade War To Expand Grain Export Potential Russia has also been delivering. According to Bloomberg, this years wheat harvest is both high quality and significant in volume. The Russian production trend is certainly on an upward tick, the 2017 grain harvest was the highest for 40 years, with Russia’s arable steppes benefiting perhaps from global warming. We can see the Russian market position here:

bloomberg

However its not only Russia that is looking to make up the US-China supply gap. The Kazakhstan President, Kassym-Jomart Tokayev was in Beijing last week to discuss numerous issues, not least among them a tripling of Kazakh wheat exports to China.

These new trends away from US suppliers are not just limited to grains. They also include poultry, pork and other foodstuffs, in addition to technologies such as semi-conductors. What the US-China trade war has done in effect is to move the US supply chains that China previously had in place to countries nearer to home and less likely to create problems within that supply chain. With 1.4 billion people, Beijing requires a sense of stability – Russia and other neighboring countries such as Kazakhstan can offer comparable agricultural produce, with shorter delivery times and less political nuances. So where does this leave American farmers?

It means, that if the desire to supply China is still there, then US farmers and the agricultural industry in the United States as a whole will need to invest in countries such as Russia. The China market for agricultural produce is growing, and demand is likely to continue. We can take a look at China’s consumption of Soy as an example.

china-soy-imports

Investing in Russia however is a sanctions issue. We can examine this as follows:

US-Russia Sanctions Impact on Bilateral Agricultural Trade
US exports and direct selling to Russia of most agricultural products are banned by action of the Eurasian Economic Union, of which Russia is a member. (This was itself in response to sanctions against Russian exports). This clarification is from the US Export.gov website:

“Russia has maintained a ban on the importation of nearly all U.S. as well as most European food products since August 2014 in response to Ukraine-related sanctions. Specifically, Russia imposed a ban on imports of certain agricultural and food products (covering about 52 specified HS classifications) originating from the United States, European Union, Canada, Australia, and Norway. The ban applies to meat, meat products, milk, dairy products, fish, fish products, fruits, and vegetables. Salt was added to the list of prohibited products in November 2016. The agricultural product import ban, originally in place for one year, has been extended annually, most recently on June 24, 2019, when President Putin signed a decree re-extending it through 2020”.

Some sources note the sanctions in both directions have actually been good for the domestic Russian agricultural industry as it has kept away foreign competition.

US-Russia Sanctions Impact On Agricultural Foreign Direct Investment
US businesses are not forbidden per se on the US side from actual FDI into agricultural sectors in Russia as long as they do not deal with blacklisted companies or individuals. The Russian agricultural sector is also open for foreign investment, with businesses from China, Japan and South Korea all present in the market. Given the need to expand production to meet Chinese demand, there are opportunities for US investment into Russian agriculture. In certain areas in Russia’s Far East and Siberia, both of which have extensive borders with China, the Russian government is also prepared to offer free land use rights to foreign investment in order to regain productivity of arable land that has lain fallow since the break up of the Soviet Union. Whether US companies should invest in a US-Russian JV or go it alone is a legal and market issue. However the opportunity is there.

Overall US sanctions are most concerned with disallowing access to the US market/financial system to targeted Russian individuals and companies, and stopping US companies from engaging in investments that involve these targets. Outside of a few strategic industries the US is not however concerned with stopping all outbound investment by US firms and persons as long as it not deemed harmful. It is a moot point as to whether an American company investing in Russian agriculture in order to sell production to China would be deemed ‘harmful’ to US interests, especially as the China tariffs placed on US agricultural products was essentially self-inflicted.

The position of commercial strength and growth between Russia to China can be measured by the fact that bilateral trade between the two countries is currently growing at rates of half a billion dollars a month, while bilateral trade in total is expected to reach US$200 billion by 2024. The question is how far US businesses are prepared to tolerate to support their own Governments actions in targeting China in a trade war.

We are not aware of any US agricultural business of late that has decided to invest in Russia to sell to China. That may happen over time, and certainly when the penny drops that the China market may not be coming back for US based farmers. If so, then opportunities to access the China market are present for American farmers in countries such as Russia, Kazakhstan and Ukraine. In the meantime, contingency plans could start to be put into place to examine the possibility. As President Trump moves the global supply chain around through his trade war actions, US businesses need to be aware of how to access a market effectively priced out of their reach, and unlikely to return. That requires bold actions and innovative thought processes. Establishing a manufacturing presence in a country friendly to China is one way to get around the sanctions and tariffs barriers.

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About Us

Russia Briefing is written by Dezan Shira & Associates. Chris Devonshire-Ellis is the practice Chairman. The firm advises foreign investors and governments in strategic advisory, legal and tax solutions to doing business throughout China, Russia, India and the ASEAN nations and has 28 offices throughout the Eurasian region. We also have a US desk based in the Mid-West, please contact Dustin Daugherty at dustin.daugherty@dezshira.com for US-China and US-Russia issues, or visit us at www.dezshira.com

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