Sanctions, Tanks, and Low GDP Growth: Not Russia, but China in 1989

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sanctionsThis year, Dezan Shira & Associates celebrates its 25th anniversary; I started the practice as a small, three person outfit, operating out of my bedroom in Shenzhen in November 1992. Just two and a half years prior to this, China had gone through the convulsions of the Tiananmen Square “incident”, where tanks had entered Beijing and faced down a student population demanding democratic rights. For a few days, the entire destiny of what is now modern China was in the balance. The Communist Party of China (CPC) ordered a crackdown on the unrest and the window for revolution passed. An initially uneasy, but then progressive peace returned. Today’s China is largely built on those few days, and it is worth – in historical context – to recall that the Soviet Union had collapsed just two years earlier. While many were supportive of the unfortunate, democratic wishing students, no one was ever able to suggest what the alternative to the CPC would be. China had teetered on the verge of splitting apart, and there have been provinces in China’s history that have at one time or another declared independence. China today would look very different had the CPC fallen in 1989.

What occurred at Tiananmen, in particular, created international outrage, and what happened next is worth recalling. The United States, together with its allies, quickly imposed a series of diplomatic and economic sanctions against China. The details of those sanctions varied from country to country, but in general they involved the suspension of high-level official visits, official development assistance and export credits, and sales of military and police equipment. The relaxation controls on the transfer of advanced technology to China, both by individual governments and by the Coordinating Committee (COCOM), was also postponed. Under pressure from the United States and members of the European Community, the World Bank and the Asian Development Bank agreed to halt lending to China. These official actions were supplemented by the unofficial and spontaneous decisions of private individuals and institutions in Europe, Japan, and the United States to reconsider the desirability of conducting business with China.

At the time, China’s economy was also rather poor. The country was just coming out of the upheavals of the cultural revolution; the national GDP in 1989 was just US$456 billion. That slumped to US$394 billion the next year – a full 10 percent being wiped off China’s productivity as a result of the US actions.  The annual GDP growth rate, which had been over 11 percent, slumped to less than 4 percent in 12 months.

The CPC reacted to this by putting into place a series of economic and market reforms; essentially opened up the economy to permit larger amounts of foreign investment and to permit tax incentives, initially only available to foreign businesses. Some of these were as low as 12 percent profits tax rates in specific, foreign investment encouraged industries (such as oil and gas) and these came with tax free periods lasting up to five years, plus development costs permitted to be clawed back. It was during this period when I decided to establish my firm in China. “Don’t go to China Chris”, said my Peking University educated, Australian boss in Hong Kong at the time. “They are Communist, it’s dangerous, nothing works, and they’ll rip you off.” All of this was in fact true but the point was none of it was commercially fatal. I also recall the large, overblown, American auto manufacturing executive who expressed his loud, boasting views in 2001: “The Chinese will never overtake the size of the US auto industry”. I suggested he might be wrong about that, and was laughed at and loudly ridiculed. But by 2009, the Chinese had sold 13.4 million vehicles to their domestic consumers, against an American result of 10.4 million in the US.

I relate these stories as I am constantly reminded of the Chinese experience while in Russia. For sure, the sanctions imposed on Russia have inflicted economic damage, yet, a carefully thought out plan of action has been re-calibrating the Russian economy. Having shrunk by 10 percent in the first year after Western sanctions were imposed, it has subsequently retreated to about 50 percent of its 2012 levels – a huge hit to be taking, and far worse than that what was inflicted upon the Chinese. To be fair, the suppression of oil prices has also had an impact – Russia is a major global supplier in crude.

Nevertheless, Russia is in a position to retaliate; in 1989 China didn’t have much foreign trade, and it passed up the option of reciprocal trade measures against the United States. Today, Russia has imposed counter-sanctions on American and EU (among other countries) goods being imported into Russia, and this has inflicted damage on European producers, in particular.

Further, the Russian economy is seen to be slowly recovering; the mean growth for 2017 is expected to be about 1.7 percent, which is ironically the same as the EU. That is not enough to suggest that all sectors of the economy are experiencing growth, neither does it suggest that all areas of Russia are either. But, on a national basis, Russia is rebounding, just as China did. It took China four years to recover from the hit it took in 1989, and the next year will be Russia’s fourth under sanctions.

Yet, looking around, those green shoots of development are to be seen everywhere. What used to be Scania (EU made) buses in the streets of St. Petersburg and Moscow are now supplied by King Long (China) and Daewoo (Korea). Russia’s IT, already world class, has moved ahead of that of the EU. Russia intends to roll out 5G on a national basis by 2019; Germany is unlikely to provide this to its citizens until 2025. Russia is also a major recipient of China’s OBOR plans, everything along the high-speed rail routes to and from Europe has to pass through Russia. Both Russia and China are funding and building this infrastructure now – another tick on the GDP development growth rate in Russia’s favor. Quietly too, Russia has at this same period, been paying off its old Soviet Union debt, and has just completed this. Russia also has one of the lowest debt-GDP ratios in the world at just over 17 percent, compared to the United States at 97 percent. This could prove very significant, very soon.

We can always learn lessons from history. One to be learned from China’s experience in 1989 is that sanctions can always be overcome through a range of alternative development plans and initiatives, and that is what Russia has been going through in the past three years. Ironically, as both the US and EU descend into a politically chaotic phase, and American economic experts warn of an immediate 10 percent devaluation, and some, an impending “crash“, investors in the United States and Europe looking for safe havens for their investments, may well start looking at Russia, in particular, as well as Asia. Russia’s economy, due to sanctions, is now largely insulated from both the United States and Europe, so what happens there will not impact the former as severely. With money looking for safe havens with sustainable political regimes, both Russia and China, although the latter is more exposed to global markets than Russia is, may offer welcome homes for American and European investors running from chaotic conditions back home. It is ironic that countries that have, due to sanctions imposed upon them by the United States in the past, used these as incentives to disengage from American style politics and financing, and may well end up as better managed economies than those punishing them. My advise to today’s entrepreneurs – having lived through the China experience – Russia is ripe for your attention, and it is likely to be career rewarding.

 

About Us

Chris Devonshire-Ellis is the Chairman of Dezan Shira & Associates and has a 30 year career assisting foreign investors into Asia, handing billions of dollars worth of investment into China, India and ASEAN over the years. He is now based in Europe and Russia, and travels frequently between the two, advising Russian businesses on investments into Asia and foreign businesses on investments into Russia. He has most recently lectured at the Russian Higher School of Economics. To contact him please email russia@dezshira.com, and to learn about our firm, visit our website at www.dezshira.com

 

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Assisting Foreign Investors into Russia

Dezan Shira & Associates´ Russian investment brochure offers an overview of the services provided by the firm – both foreign investment into Russia and Russian investment into Asia. It is Dezan Shira´s mission to guide investors through Russia´s complex regulatory environment and assist with all aspects of establishing, maintaining and growing business operations in the region.

 

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