For the past two decades, the world has been able to depend on a robust Chinese economy as a source of strong economic demand. But as China shifts from an investment-driven economy to a consumer-driven one, the world must contend with a new normal of slower Chinese growth. With the August 2015 devaluation of the Chinese yuan, the new normal may be arriving sooner than expected – much to the dismay of China’s trading partners. China is the world’s top consumer of many commodities and energy, which is why slower growth is worrisome to major commodities and energy exporters.
One country in particular that is affected by the yuan’s devaluation and slower Chinese growth is Russia. With oil and gas comprising the majority of Russia's exports and China serving as its largest trading partner, a devalued yuan signals a weakening Chinese economy that will demand less energy while making energy imports more expensive. Consequently, demand for Russian energy exports will depress even further.
China’s Importance to Russia
In the summer of 2013, Russian President Vladimir Putin made clear his intentions of reorienting the Russian economy’s focus eastward, away from its traditional markets in Europe. This pivot to Asia, however, was largely predicated on robust and unwavering Chinese demand for energy, which Russia was more than willing to satisfy.
As the world’s largest and second-largest producer of crude oil and dry natural gas, respectively, it is no wonder that Russia seeks closer ties with one of the world’s top energy consumers. Oil and gas make up two-thirds of Russian exports, and as much as 70% of Russia’s gross domestic product (GDP) is dependent on oil. Russia needs oil to be at least $90 per barrel to balance its budget as 60% of government expenditures are financed by oil taxes. The strength of Russia’s economy is largely dependent on its energy exports. (For more, see Why The Yuan (RMB) Is Russia's Favorite Currency.)
With the potential to tap into the large Chinese demand for energy, Putin was able to push forward a $400 billion deal in early 2014 that would supply China with natural gas via an eastern pipeline. Later in the year, negotiations over a second deal for a similar supply route in the west began, but with the plummeting price of oil serving as evidence of an oversupply, Russia lost some negotiating power. Slower economic growth in China and the attendant devaluation of the yuan will only serve to shift more bargaining power to China, much to the annoyance of Putin and the Russian economy.
Devaluation of the Yuan
During August 2015, the yuan’s single-largest drop in 20 years, along with the two consecutive devaluations that followed, knocked over 3 percent off its value. While the People’s Bank of China (PBOC) claims the devaluation was the result of allowing the yuan to float more freely as part of the government’s move towards a more market-oriented economy, many interpret it as a signal that the Chinese economy is growing more slowly than expected.
There is no doubt that China’s economy has been slowing over the last few years as its targeted growth rate was set at 7% for 2015, which would make it the slowest pace in a quarter-century. But recent manufacturing activity data indicates that things may be worse than anyone thought as the sector shrank at its fastest pace since 2009 in July 2015. The Chinese government reported in August that exports declined 8.3% in July from a year earlier. Some economists are predicting growth rates as low as 4% for the Chinese economy this year. (For more, see China's Economic Indicators.)
With oversupply already plaguing oil markets, the price of oil fell to a six-year low on the news of the devaluation of the yuan. While the devaluation is a warning sign of slower-than-expected economic growth, the weak yuan makes oil imports more expensive for China, resulting in even lower demand for Russian oil exports.
Implications for Russia
Diminished demand for oil hurts Russia’s economy in two separate but related ways. First, less global demand for oil means that there will be less demand for Russian oil exports. The weaker demand and depressed oil prices result in lower oil revenues. Second, weaker demand for oil hurts Russia through the ruble as there is also less demand for the ruble, which causes it to depreciate. While the ruble was trading at 36 to 1 U.S. dollar just last year, it continues to depreciate and recently fell to 71.65 to the dollar as a result of depressed oil prices being driven lower over China concerns. (For more, see What to Expect from Russia's Oil-Dependent Economy.)
The weakened ruble is having severe inflationary effects on Russia’s economy as it makes imports into Russia significantly more expensive. Inflation is now above 15% as prices of many imported goods, including coffee, tea and children’s clothes, have shot up. Car sales have fallen 36% in just the first half of this year and international air travel has dropped nearly 20% from last year. The Russian economy entered its first recession since 2009 after contracting 4.6% in the second quarter of 2015 compared to the same period a year earlier.
The Bottom Line
The effects of the devaluation of the yuan and the weaker Chinese economic growth that it suggests are devastating for a Russian economy already reeling from low oil prices and Western sanctions. Weaker demand for oil exports and the attendant depreciation of the ruble that makes imports significantly more expensive are having immediate depressing effects on Russia's economy. But the economic realities in China are more than a momentary blip that Russia can simply wait out. Many see slower Chinese growth as a symptom of an economy that needs to make structural adjustments if it is ever to move from a middle-income country to a high-income one. Slow growth and its implications for global demand are the new normal for the world economy moving forward. This is a reality that not just Russia, but the rest of the world, needs to accept.
