Ukraine invasion: China’s economy is not immune from the effects of Western sanctions on Russia

Commodity prices were already high, and the war in Ukraine will make the energy, food and raw materials that drive China’s economy even more costly
Given the risks, Beijing might well conclude that its interests are best served by not going far beyond ‘normal’ trade with Russia

Neal Kimberley

Published: 9:15am, 9 Mar 2022

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“There are decades when nothing happens, and there are weeks when decades happen,” Vladimir Lenin is credited with writing of the Russian Revolution. Fast forward to today and those words again resonate. Russia’s invasion of Ukraine is a humanitarian crisis that will also have lasting, and consequential, economic and financial repercussions.

China is an economic titan, but it will not be insulated from these consequences. Soaring commodity prices are a case in point.

China imports vast amounts of energy, food and raw materials to power its economy, but prices are soaring in the wake of Russia’s invasion of Ukraine. That would not be great news for the Chinese economy at any time, and it is even worse when the latest rises in commodity prices started from already-high levels.

A strong yuan provides something of a buffer against higher US dollar-denominated commodity prices, but it’s not a complete offset. China’s yuan-denominated commodity imports bill is going to rise and bring with it unwanted inflation.

But that is only one of the issues that policymakers in Beijing will need to consider.

China has become embedded in the global economy in the 50 years since Mao Zedong met US president Richard Nixon. China’s economy is not an island, and the financial waves generated by Russia’s invasion will lap at China’s shores and could be accompanied by ripples generated by US monetary policy changes.

Having accepted that rising US consumer prices require a monetary policy response, the Federal Reserve is set to raise US interest rates but is doing so at a late stage of the economic cycle.

An increase of 0.25 per cent later this month looks almost assured. Going forward, though, the risk is that the Fed ends up with a slowing pace of US economic growth and sticky inflation, a risk arguably only heightened by the global economic side-effects of the war in Ukraine.

That is not a healthy scenario for the US economy or for China, given the importance of the US market as an export destination for Chinese goods. Neither will Europe be in any position to take up the slack.

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How international sanctions imposed since Ukraine invasion are hitting Russia

European firms and financial institutions have spent decades growing operations and lending to the Russian economy. In solidarity with Ukraine and in adherence with sanctions imposed on Russia, those decades are being unwound in days.

That means big losses. This will inevitably crimp European economic growth prospects, but it is a price Europe’s policymakers have decided has to be paid.

What is not yet known is where the biggest losses will be felt and what that means for the solvency of affected firms. In financial market terms, lack of clarity breeds doubt. This often generates an institutional “dash for cash”, or rather a dash for US dollars, the currency that remains the lifeblood of the global financial system.

That dash for US dollar liquidity can even underpin the currency’s strength on the foreign exchanges, possibly even against the renminbi. Already-soaring US dollar-denominated commodity prices them become even more expensive in local currency terms.

Poor countries can be priced out of commodity markets. This can cause societal unrest and leave them unable to service external debts, such as obligations to China under the Belt and Road Initiative.

Then there are the sanctions themselves. Among the sanctions that many countries have imposed on Russia are the exclusion of certain Russian banks from the Swift international payment system and restrictions on the types of business that can still be legally conducted with Russia.

For example, the unwillingness of Western insurers and shipping companies to engage with Russia in light of the sanctions will restrict Russia’s ability to export commodities such as grains or oil by sea, adding to the upwards pressure on global commodity prices.

In theory, Chinese companies are not affected by such measures unless Beijing itself adopts similar sanctions. In practical terms, and given that the US claims extraterritorial jurisdiction, Chinese companies and financial institutions that operate in both Russian and Western markets might choose to proceed cautiously.

Beijing may also conclude that, in the current circumstances, China’s own national interest is best served by not going too far beyond “normal” trade with Russia.

Fifty years after Mao met Nixon, and at a time when the world feels as if it is going through weeks when decades happen, China is at the epicentre of the global economy. As such, China will not be insulated from the global economic and financial consequences of Russia’s invasion of Ukraine.

Neal Kimberley is a commentator on macroeconomics and financial markets