Will China stand with Russia?

A new state of play

Samy Chaar began by discussing the macroeconomic context. The war in Ukraine has created an irreversible “new state of play” in which Russia faces a future of political isolation and continued sanctions, while China and India remain key trading partners.

China’s domestic agenda will be its highest priority in 2022, to ensure stability ahead of the Party Congress. “Right now, China faces huge domestic challenges: rising Covid cases, an ailing property sector and ageing demographics,” he said. The US has started to tighten its monetary policy while China continues to accommodate and even intervene in capital markets.

In addition, making the shift to a consumer-based economy is a huge task that only a few countries have accomplished. It is in China’s interests to maintain smooth trading relations globally.

A ‘no limits’ alliance?

Both agreed that China is unlikely to provide direct support to Russia. “Beijing is trying to take a dignified position on the fence,” Carrie said. “It cannot afford to provoke the West by supporting a pariah state at a time when Xi needs to allay a growing sense of unease ahead of his controversial re-election.” China owes its economic success to years of global prosperity and order, and the development of a global financial system. It cannot afford to decouple yet.

However, Russia may not be completely isolated. Although it has avoided recognising the independence of the separatist-held Ukrainian regions, China has not explicitly condemned Russian aggression. China’s ‘no limits’ alliance with Russia has strengthened in recent years and the current internal narrative is distinctly anti-Western. China was quick to blame Nato’s expansionism for the current conflict.

“It’s important to get a sense of the scale of China’s antipathy to what it perceives as US hegemony,” Carrie said. Anti-western sentiment can be traced back almost two hundred years to the humiliation suffered in the Opium Wars, and actions in the name of western democratic values are typically dismissed as realpolitik.

The ‘unipolar moment’ when the USSR collapsed in 1991 was a devastating blow to China and the global communist movement. “For China, its alliance with Russia is founded as much on ideology and its anti-western agenda as it is on trade and military power.”

Lessons in failure

Carrie believes that any imminent attempts to reclaim Taiwan are highly unlikely, citing China’s current domestic problems and the need to establish a sense of stability, both politically and economically.

However, China will be watching and learning from Russia’s protracted and costly land invasion of Ukraine. It will be assessing the potential costs of a seaborne invasion of Taiwan and whether it can protect itself from western sanctions. “The extraordinary resistance demonstrated by ordinary Ukrainians against a much larger foe will be a shock to the Chinese authorities,” Carrie said. “That level of autonomy is simply anathema to China.”

Conversely, Taiwan will be very encouraged by Ukrainian resistance, and will be watching for lessons on how they can deter Beijing by increasing the cost of any invasion.

Does the likelihood of any action by China increase over the next ten years? “Xi has made it very clear that Taiwan is ‘coming back to the fold.’ He simply does not accept US dominance of the western Pacific and he needs a legacy. Rhetoric and military spending suggest Beijing could be ready for an invasion by 2030,” Carrie said.

Spending to avoid recession

The impact of the war will be felt through several channels of transmission, including reduced trade, lower investor and consumer confidence and higher energy prices. However, despite the inevitable price shock, particularly in Europe, Samy remains confident that the worst economic outcomes can be averted.

“Our base case scenario is that recession will be avoided despite all that is happening,” he said. Economically, the West is now less reliant on oil than it was in the 1970s, and the strong post-pandemic global recovery will likely buffer any slowdown.

EU plans to allocate significant resources on updating defence systems and increasing energy independence could also help to avert a recession. “This is their Hamiltonian moment, the moment when they have to come together to be ambitious. You don’t find a solution to energy independence and defence with billions, you find it with hundreds of billions. And the more ambitious they are, the more likely we are to avoid recession.”

Our portfolios are now neutral risk assets, such as equities, with a tilt away from assets with high interest rate sensitivities, including investment grade credit and US government bonds. Conversely, we are overweight commodities, cash and selected Chinese assets including renminbi-denominated government debt, which offers attractive relative yields and portfolio diversification.

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