Russian Sovereign Fund To Announce China Deals

Emerging Markets, EBRD editions, May 15 2014

Russia’s sovereign wealth fund is set to announce a series of new deals with China next week, reflecting the increased importance that Chinese investment will hold in the Russian economy as western capital stays away.

Emerging Markets has learned that the Russian Direct Investment Fund will announce the three investments – one each in infrastructure, real estate and minerals – at the St Petersburg International Economic Forum from May 22 to 24. The investments will be made through the Russia-China Investment Fund, a vehicle set up with the China Investment Corporation in 2012.

The fund was set up with $1 billion commitment apiece from the Chinese and Russian sovereign funds, and it is understood that to date, roughly 10% of that capital has been deployed, through a $200 million investment in Russia Forest Products, a forestry company in Siberia. “Including the deals that we will be announcing, we would get to another 15 to 20%” of the total assets being invested, Sean Glodek, Director at RDIF, told Emerging Markets. “We’re now fully staffed and have a full pipeline of deals.”

It is possible that the infrastructure deal to be announced may be the first bridge to join Russia and China across the Amur River, which RDIF has confirmed it is investing in through the Russia-China Investment Fund. Most deals so far have been in Russia’s Far East. “That makes sense,” said Vladimir Kolychev, chief economist for Russia at VTB Capital. “It’s the closest region to China, with the closest trade and infrastructure links.”

While these new investments have clearly been some time in the making and pre-date the annexation of Ukraine, their announcement will be a timely reminder that Russia has other sources of capital beyond the West. “The cooperation with China has been in place for a couple of years now, and the fact that we are announcing deals is more of a reflection that we have put in place the funds, resources and structure to deploy capital,” Glodek said. “It just coincides with the general mood. But I would agree there is more focus in Russia to explore opportunities with China, and with Asia in general.”

FDI between the two countries has so far been surprisingly modest. “It’s actually more words than actions so far,” said Kolychev. “If you look at FDI it’s been pretty small both ways: from China into Russia accounts for only $2 billion over the last five years, and Russia doesn’t have any meaningful FDI into Russia.” But he said many investments between the two had taken different forms, such as the $2 billion loan from China Development Bank to Rosneft in 2013, and the $270 billion supply deal China National Petroleum Corp signed last year that included a $70 billion pre-payment to Rosneft.

“I think we will see much more diverse investment flows from China to Russia,” Kolychev said. “This fund [the RDIF/CIC venture] will only be part of it, and I’m not sure it’s going to be the largest part.” Other Russia-Chinese projects besides the Rosneft deal include a potential gas supply contract and an offshore LNG project with CNPC.

Glodek agreed that investment cooperation with China was broader than the joint venture. “The relationship with CIC goes beyond just the Russia-China fund,” he said, citing the example of CIC’s investment in Moscow Exchange, which jointly bought 5.375% of the course in December 2012 with RDIF but outside the scope of the venture.

Collaboration between the two also has impacts for China’s efforts to internationalize its currency. In November 2010 China and Russia began trading in their own currencies, abandoning the US dollar as the medium of exchange in bilateral trade. Now, “on the local exchange and in China the ruble-renminbi is a tradable instrument, and volumes have been picking up,” Kolychev said. “Some trade contracts are indeed being signed in local currencies, and given the threat of sanctions on dollar payments, it does make sense, from both sides: from the Chinese given their aspirations for the RMB to become the next reserve currency, and for Russia to become more diversified in terms of the currency settlement for their trade flows. I would expect that to increase for sure.”

But it is unlikely China can fully replace the funding that has been lost from the west, particularly since the two blocs have tended to invest in different ways. “It will be hard to imagine China can replace the entire funding gap,” Kolychev said. “Some of it will be covered, mostly in the form of direct investment rather than portfolio; the institutional investor sector in China is not as developed as that in the west.”

While agreeing that “nobody wants to minimise the environment” regarding Ukraine, Glodek stressed that the environment for seeking deals in Russia has improved in recent months. “It’s not all bad,” he said. “When you look at the funding structure of RDIF, we lined up over $10 billion of investment capital in joint ventures and funds, and pretty much all of this was from China, Asia and the Middle East. Russia is not as reliant on Western Europe as some investing in public markets would expect.”

Nevertheless Kolychev said that “given the strains between Russia-west relations, this [China investment] will be given even more priority by the government now.”