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Gilbert Rozman has good reason to be skeptical about the Russian Far East (RFE). In my first installment, I advanced a similar argument that the root cause of the RFE’s troubles lies in Russia’s own shortcomings, particularly the rampant inefficiency of government institutions. A sad reminder of how inept bureaucracy can compromise Moscow’s own well-intentioned measures to develop the RFE came just recently, when the widely advertised visa-on-arrival regime for foreign visitors to the Vladivostok free port area did not materialize, despite high-ranking officials’ earlier promises that the procedure would start working on January 1, 2016. Lack of inter-agency coordination and failure to set up necessary infrastructure have delayed introduction of the simplified entry regime for the RFE, with July 1, 2016 now set as a new launch date.

Is Russia on the Brink of Structural Reforms?

That said, it is not all doom and gloom. Russia’s notoriously difficult business climate seems to be getting better. According to the World Bank’s latest Doing Business rating, which evaluates whether the national regulatory environment is conducive to starting and operating a local firm, Russia rose by eleven positions and now ranks 51st among 183 economies. This puts Russia ahead of all the other BRICS countries.¹ Furthermore, Bloomberg’s Innovation Index, which scored economies using factors including research and development spending, tertiary education, and concentration of high-tech public companies, gives Russia a comparatively high twelfth place, just between Israel and Austria.²

The collapse in commodity prices, above all hydrocarbons, has seriously undercut Russia’s ability to finance modernization programs, including those in the RFE. At the same time, the oil crisis presents a blessing in disguise as it may finally galvanize Russia into action on the long-overdue reforms. As it is becoming increasingly clear that petroleum prices are not going to rebound any time soon and can stay at low levels for a very long time, more and more members of the Russian political class are coming to the conclusion that the existing model—state capitalism with elements of neo-feudalism—is no longer viable and in need of profound changes.  Reflecting this mood are very blunt assessments publicly voiced by some prominent figures in the Russian establishment. For example, German Gref, the head of state-owned Sberbank, Russia’s largest bank, and a person close to Putin, recently declared that Russia had descended into the ranks of  “losing, downshifter countries.” He said that the era of oil was over and called for radical overhaul of state institutions.³ The head of Russia’s central bank Elvira Nabiullina called for “structural efforts to diversify the economy.”⁴ Even official documents, such as the latest edition of Russia’s National Security Strategy, signed by Putin in December 2015, admit that Russia’s economy is characterized by low competitiveness, technological backwardness, and dependence on commodity exports.⁵

Has Russia Really Failed in its China Gambit?

Rozman argues that China utterly failed to meet Russia’s high expectations concerning trade and investment, particularly with regard to the RFE. Yet, the picture may be somewhat more nuanced and complex. It is true that in 2015 Russia’s trade with China dropped significantly—by 27.8 percent.⁶ At the same time, Russia’s trade with the European Union plunged by a whopping 40 percent.⁷ This means that, in relative terms, China’s share in Russian foreign commerce has increased.

Importantly, trade statistics reflect the dollar-denominated value of international commerce. Russia’s principal exports are commodities, such as hydrocarbons, whose prices substantially declined in 2015—hence, the shrinking value of Russia’s foreign trade. Yet, the physical volume of Russian exports to China, as measured in tons and barrels, has largely remained stable. Indeed, when it comes to oil exports, Russia has even increased its share of China’s market, rivaling Saudi Arabia.⁸ In 2015, Russia sold to China over 41 million metric tons of oil, an increase by some 25 percent against 2014.⁹

Low hydrocarbon prices have not reduced Beijing’s interest in Russian oil and gas. As I argued in my first piece, China is attracted to the RFE’s resources not only for commercial but also for strategic reasons. Even though oil supplies via cross-border pipelines—like the pipeline from the RFE into Northeast China—are normally more expensive than seaborne shipments from the Middle East, Beijing continues its “continental petroleum strategy” as an insurance against a wartime contingency or blockade.¹⁰

In another significant development, after ten years of negotiations, Beijing began to lift restrictions on exports of Russian grain to China. Of note, Chinese regulators have opened the domestic market specifically to the wheat, rice, corn, and soybeans produced in Siberia and the RFE.¹¹ Russia’s vast agricultural potential is relevant not only to China, but also to much of the rest of Asia, whose food security looks increasingly precarious.¹²

2015 also saw a surge in Chinese tourism to Russia, including the RFE. In 2015, the border regions of Primorsky Krai and Amur Oblast reported a doubling of the number of Chinese visitors compared to the previous year. The main attraction for Chinese tourists has been the favorable exchange rate due to the ruble’s drastic devaluation against the yuan. More and more Far Eastern hotels, restaurants, and shops roll out the red carpet for Chinese travelers, customizing services to their tastes. The RFE’s cities, particularly Vladivostok, also hold cultural appeal to the Chinese, being the places of European civilization nearest to China.

Rozman is right to point out that big Chinese investments in Russia largely did not materialize. As of the end of 2014, China’s cumulative stock of direct investment in Russia stood at USD 3.37 billion. Compare this to Japan’s USD 14.4 billion and India’s USD 3.6 billion.¹³ There were only a few major deals in 2015. China’s Silk Road Fund obtained a 9.9 percent stake in the Yamal liquefied natural gas (LNG) project in the far north of Siberia.¹⁴ Sinopec bought a 10 percent stake in Russia’s petrochemical giant Sibur.¹⁵ A consortium of Chinese companies acquired a 13.33 percent stake in the Bystrinskoye gold and copper field in eastern Siberia.¹⁶ In the RFE, China’s officially recorded foreign direct investment (FDI) continues to be in the range of one to two percent, albeit this figure does not include “grey area” investments, when, for example, Chinese business people use Russian companies and citizens as fronts to conduct acquisitions and other commercial transactions.

One reason why—despite Moscow’s newfound willingness to let the Chinese into the strategic and most prized sectors like oil and gas—relatively few investment deals have been completed may be disagreements over price. For example, price differences between Russia’s Metalloinvest and China’s Hopu Investments led to suspension of negotiations on the sale of a stake in the giant Udokan copper field in Zabaikal Krai, even though, in May 2014, a preliminary agreement was reached for the Chinese company to buy 10 percent of the shares in Udokan and finance the field’s development.¹⁷ A similar fate befell Rosneft’s agreements with CNPC on the sale of stakes in Taas-Yuryuakh and Vankor oil fields in Eastern Siberia, MoUs on which were signed in 2013 and 2014, respectively. Neither deal has been finalized because the parties are still haggling over price.¹⁸ By contrast, Russia found it easier to cut a deal with India, selling it a 15 percent stake in Vankor.¹⁹ The Chinese are seeking to buy Russian assets on offer as cheaply as possible, biding their time and betting that cash-strapped Moscow would eventually surrender to China’s terms. Besides, there are more and more cases in which the Chinese condition their investments on acquiring an enterprise’s controlling stake, something they have not demanded before.²⁰ We are likely to see an increasing number of investment deals, with Russia selling to China minority, and even majority, stakes in its most valuable assets, particularly in Eastern Siberia and the Far East.

Russia’s Pivot to the East Still Needs the West

If Moscow ever had any illusions about replacing the West with China, they are almost gone now. China may be a huge market for Russia’s natural resources, but it lacks advanced equipment, technologies, and expertise needed to tap the riches of the RFE. These can often be found only in the West and its allies like Japan and South Korea. Furthermore, as a rule, Western lenders and investors offer more generous financial terms, such as lower interest rates. Whereas China often attaches extra conditions to its funding, especially insisting that Chinese equipment and workers be used in Chinese-financed projects, Westerners do not have any such requirements.

Not surprisingly, Moscow’s loss of access to Western technological and financial markets has enabled China to drive an increasingly hard bargain with Russia. Tellingly, in recent months Moscow’s senior officials have started to emphasize that Russia’s “pivot to the East” should not be at the expense of the ties with Europe whom Russia continues to see as its most important economic partner.²¹ According to Minister of Economy Alexei Ulyukaev, it is, after all, the European Union that is the world’s biggest economy.²²

The RFE does feature some ongoing positive examples of Western business involvement. ExxonMobil and Rosneft continue their strategic partnership in the Sakhalin-1 oil and gas project, even though new ventures between them have been largely put on hold due to the sanctions. Kinross, Canada’s major gold mining company, owns and operates two gold and silver mines in Chukotka, with an accumulated investment of over USD 2.2 billion. The share of Russian production exceeds 20 percent in Kinross’s worldwide business operations. Kinross has earned a favorable reputation in the RFE, providing jobs to local people, introducing advanced mining technologies, building infrastructure, and maintaining solid environmental standards. The Australian Tigers Realm Coal has invested in developing rich deposits of high-quality coking coal in Chukotka and plans to start coal shipments to Japan, China, and other Asia-Pacific countries from 2017.²³ However, if the current climate of a “new cold war” between Russia and the West persists, the RFE will mostly be shunned by major Western companies. There are some grounds for modest optimism as relations between Moscow and Washington have lately improved somewhat, with Secretary of State John Kerry even suggesting that the anti-Russia sanctions could be removed in the next few months.²⁴

Conclusion

The Russian Far East’s future will be determined by Russia’s own evolution, relations with China, and relations with the West. Russia’s internal trajectory remains profoundly uncertain but there are growing signs that the country’s political elite may be willing to embrace necessary structural reforms. This gives reasons for cautious optimism. China will remain the most important external factor for the RFE, even though Moscow seems to have adjusted downward its China-related economic expectations, which were riding high in the immediate wake of the Ukraine crisis, and has begun to stress the enduring importance of close ties with Europe. Nevertheless, if a “new cold war” with the West persists, Russia may have no choice other than to accept the tough conditions imposed by its quasi-ally China, such as the prime Far Eastern assets being handed to Chinese investors at fire sale prices.  Eventually, this may lead to the RFE becoming an area of China’s predominant geo-economic influence, followed possibly by a degree of geopolitical control.²⁵

If the RFE becomes a kind of “Outer Manchuria,” whose fate is being decided in Beijing and Harbin rather than in Moscow and Vladivostok, the main loser, of course, will be Russia itself. However, this will also have strategic implications for the United States and its allies. If nothing else, this alone should give the West a stake in the future of the RFE.