Crossroads Asia

Why Can’t Russia Exploit Trade Opportunities with India and Iran?

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Crossroads Asia

Why Can’t Russia Exploit Trade Opportunities with India and Iran?

Russia needs better North-South engagement to avoid dependence on China. But it isn’t well-equipped to achieve it.

Why Can’t Russia Exploit Trade Opportunities with India and Iran?
Credit: Russian Presidential Press and Information Service

Indian Prime Minister Narendra Modi’s visit to the St. Petersburg Economic Forum produced announcements that India was interested in expediting the negotiation and conclusion of a free trade agreement (FTA) with the Eurasian Economic Union (EAEU). The announcement is part of a broader attempt to show greater unity in the decades-old cooperative relationship between Russia and India.

India’s interest in the EAEU is understandable. An agreement would alleviate public strain on the relationship resulting from last year’s military exercises with Pakistan, Russian interest in Pakistan’s arms market, and the decision to back Taliban demands for the withdrawal of foreign troops from Afghanistan. More importantly, India’s public face shows more political will to realize the potential of the North-South Transport Corridor, already evidenced by India and its partner Japan’s commitment to building the port of Chabahar in Iran. Russia needs the initiative to succeed if it wants to cement its influence along its periphery and reduce the growing strategic burdens imposed by relying on China. But as always, the inertia of weak institutions, corruption, and rent-seeking threaten potential success.

A Bridge between Europe and China?

When Russia first supported the creation of the EAEU, it was geopolitically aimed at Europe. An outgrowth of the Eurasian Customs Union, the EAEU was meant to compete with the normative influence of and structures adopted by the EU on Russia’s European flank. Ukraine’s defense industries, its education and labor ties to Russia, its trade, and most importantly its elites were the prize. That dream died with former president Yanukovich’s ouster and Ukraine’s EU association agreement but the union has found new purpose. The EAEU has become one of the few means Russia possesses to affect trade flows in Eurasia, now a crucial instrument to cope with China’s rise.

Russia’s “pivot” has produced results with China. China is subsidizing east-west transit and trade has steadily deepened. By 2016, the Chinese market accounted for 15.4 percent of Russia’s exports and 20.9 percent of its imports. To underscore the point, 49 percent of Russia’s machinery imports come from Asian producers, primarily China. These increases with China parallel problems in Europe.

Chinese trade is filling a vacuum created by the effects of Russia’s import substitution policies, sanctions, and low oil prices on European trade. Between 2014 and 2015 alone, Russia’s turnover with the EU dropped 26.6 percent from 285.5 billion Euros to 209.5 billion. Of that decline, about 29.5 billion were imports from the EU. In 2016, the value of the EU’s Russian imports — driven by oil and gas prices — declined another 12.9 percent whereas exports back to Russia only declined 1.8 percent.

That may not last as China’s Customs Administration released figures placing Sino-Russian trade up 29.3 percent in the first quarter of 2017 from last year. Now that Russia’s economy has finally settled out of recession into sluggish growth, demand is growing again, if unevenly. Chinese and Russian subsidies for China’s rail routes into Russia are also driving up trade in the short-term. As long as Russia’s Central Bank and the Kremlin can maintain a weaker ruble, trade accounts in currencies weaker than the Euro will be more attractive. Given that the state owns around 70 percent of the Russian economy, politics will also buoy trade regardless of exchange rates.

Replacing German machinery with Chinese machinery doesn’t gain Russia much in return strategically if it doesn’t address structural issues in its own economy. In both Europe and East Asia, Russia is primarily exporting energy and raw materials and importing finished goods. Iran and India offer an opportunity for Russia and EAEU members to establish a beachhead in the Indian Ocean and create new trade opportunities along the Indian Ocean basin from Africa to Southeast Asia. Whether it can, even if it concludes the necessary agreements, is another story.

South of the Border

Iran is expected to reach an FTA with the EAEU by the end of the year. A 2015 feasibility study on an India-EAEU FTA was completed and endorsed during Modi’s visit to St. Petersburg and Secretary Ramesh Abhishek from India’s Ministry of Commerce and Industry has gone on record saying that negotiations would begin shortly. Though trade agreements often run into delays, there’s reason to believe that announcements from Iran and India belie progress.

Iran and Russia have already signed a customs agreement for the so-called “Green Corridor,” including information sharing on the flow of goods between customs services. The announcement comes after news in January that monthly trade turnover between Iran and Russia had nearly doubled year-on-year from 2016 to $155 million with greater Russian export growth — mostly machinery and finished goods — to Iran. The IMF found that Iran’s non-oil sector only grew .9 percent in 2016-2017, an indicator that Russian firms may continue finding new niches on the Iranian market as energy sector investment leads economic growth and consumers can spend more. Russia’s exports to Iran have been led by wheat, barley, and flat-rolled steel so the news is welcome. Positive news aside, it’s most likely that Russia’s machinery exports are led by equipment for Iran’s energy sector.

Iran’s exports to Russia have not yet shown real signs of growth. Russia’s Caspian ports showed a 48.4 percent drop off in freight turnover the first four months of 2017 despite increases for all other Caspian littoral states. Only greater two-way trade can arrest that trend with Iran, both for overall turnover figures, the limited capacity for rail, and a change of rail gauge at the border of Azerbaijan and Iran. Iran largely exports fruits and vegetables to Russia.  A comprehensive trade agreement could do much to help Iran diversify its own exports as well as tie up regulatory ends for Russian-Iranian partnership at ports in Makhachkala and Astrakhan.

Russia’s common trump cards for Asian trade partners — oil, gas, and coal — have not played a leading role in its trade relations with India in recent years. Until last December’s OPEC cuts, Russia’s Ural oil blend — its primary export blend — wasn’t very competitive against Gulf oil. Russia sold India about $480 million in oil between 2011 and 2015, trade that’s set to rise now that Russia’s Rosneft is trying to finalize its acquisition of Essar Oil’s refinery and oil port at Vadinar. Russia also exports similar small technical parts as it does to Iran, gas turbines, metals, and construction materials. Diamonds, silver, and fertilizers lead its exports and made up about 33 percent of everything exported in 2015.

India’s diamond-cutters and polishers are looking to grow and it’s expected that no new diamond supply will come onto the market before 2020. Russian ALROSA signed a Memorandum of Cooperation with India’s Gem and Jewelry Export Promotion Council during Modi’s visit on trade and market promotion, including talks on tax benefits. The more India can to lock up access to diamonds through Russia, the less it has to use middlemen in Europe or Hong Kong for its supply. Pharmaceuticals would be a potential area of cooperation given India’s rapidly growing role as an exporter but Russia’s policies are moving it towards self-sufficiency, a result of its focus on economic sovereignty. While medicaments made up 20 percent of India’s exports to Russia in 2015, Russia’s sector is expected to nearly double in value by 2021. Despite Russian policies, India’s lower production costs and rapid growth make it a better trade partner for medicines than the EU and China. It’s difficult to predict what machinery or finished goods would be traded given existing trade ties. Russian construction firms will seek contracts when possible given a perpetually sluggish market in Russian and infrastructure is a potential growth area for cooperation.

Trade turnover stood at around $6.1 billion in 2015, roughly 74 percent of which were Russian exports. To realize a trade deal, Russia has to figure out what exactly it’s going to buy from India. Repeating its habit of propping up extractive industries and the sectors that serve them won’t be enough to sustain trade. Representatives talk up an FTA with the hopes that it would increase turnover to $30 billion by 2025. That seems quite unlikely and more reasonable statements run from $16-18 billion but amidst all the talk of the NSTC playing an important role, no significant increase is possible without a change in market access for Indian firms. Better connectivity requires better legal frameworks, a weak point for Russia.

Past Isn’t Always Prologue

The EAEU has an operational FTA with Vietnam signed in May of 2015, which provides a template for future agreements. The deal stipulates that EAEU tariffs on Vietnamese goods included will drop from 9.7 percent  to 2 percent by 2025 while Vietnam’s reciprocal tariffs will drop from 10 percent to 1 percent. The deal called for the elimination or reduction of tariffs on 88 percent of goods traded between Vietnam and the EAEU within 10 years, 59 percent of which would take effect immediately. Most importantly, the deal establishes that tariff exemptions remain in effect if goods transit other states so long as they’re not consumed or otherwise undergo any change in said state, are not traded there, and must transit said state for geographic reasons. The deal also operates on the basis of turnover targets that, if exceeded before the date of the complete implementation of a tariff, are subject to safeguards to protect EAEU markets.

The language is boilerplate, but a useful reference point. Unlike trading with Vietnam, the North-South Transport Corridor would benefit most from agreements extending tariff exemptions to value-added stages of supply chains in Russia, Iran, and India rather than just an origin-to-destination clause. For Iran, preferential access for food exports would be logical, though Russia’s predilection for using phytosanitary controls as a trade weapon should give Iran pause. In the case of India, agreements to ease investment or access to the pharmaceuticals could spur joint ventures and possibly help the EAEU as it launches and improves a common pharmaceutical market.

Putin and Modi signaled interest in creating their own credit rating agency to avoid the low marks given them by S & P, Moody’s, and Fitch Ratings. It’s unclear what it would look like or what effect it would have, but it fits Russia’s interest in advancing “post-western” institutions. Further financial cooperation and integration of some kind is necessary to add transparency to investments. At present, much of Russia’s FDI into India goes through Singapore because Indian firms have regional offices there. Because Singapore has a double-taxation agreement with India, Indian investors can avoid taxes by using their money as FDI, a strategy similar to what Russian firms and oligarchs often do with Cyprus. Without transparency, investments will remain heavily politicized.

No such proposal has emerged with Iran but it’s likely that an agreement would involve ongoing work to integrate Russia and Iran’s national payments system and banking sectors to encourage investment. Both countries agreed to trade in national currencies last September. Russia’s Central Bank and the Bank Mellia of Iran — Iran’s first national bank — have publicly committed to partnership, though its contents remain unclear. There was talk of developing a joint Islamic Bank last December. However, one of Russia’s principal players for such an institution — Tatarstan’s Tatfondbank — has collapsed and Iran has shown a preference for working with Russia’s Islamic regions, when possible. Barring any sudden institutional advancements, agreements will likely mostly affect customs regulations and tariff schema.

The Vietnam FTA is not an adequate guide to address the trade issues and interests present with Iran and India. Trade could grow without deals but needs support to diversify and become sustainable. That’s where Russia has the biggest problem and an opportunity it likely can’t exploit.

The Inspectors’ General

Russia’s customs service, like so much of the Russian economy, is a source of money and power for Russia’s Federal Security Service (FSB) and those connected to the country’s intelligence and security services. For years, the Federal Customs Service has been fighting with the FSB because of its role in Russia’s plentiful smuggling operations and black market activities. Illegal smuggling aside, there are numerous ways trade filters over Russia’s borders haphazardly due to the complex, often Gogolian nature of regulations that are difficult to enforce.

For example, Russia’s counter-sanctions on Western goods weren’t upheld by Belarus. Belarus’ legal code regards smuggling as a minor offense, encouraging smugglers to transport forbidden imports like fruit through holes in Russia’s border. Russia’s accession to the WTO was supposed to help rationalize its tariffs and customs. Despite that, customs officials can still extract money out of trade by arbitrarily requiring the separate submission of documents, offering to speed up the process for a price. Taxes are applied on goods entering Russia for professional or commercial use regardless of their total value whereas personal goods are only taxed at 1,000 Euros and up in value. In the past, there have been schemes where  Russians would enter China to collect 5 or 10 of a particular good beneath the tax threshold and bring it back into Russia without paying tax. These schemes exploited visa-free regimes as they existed in border towns and now in places like Vladivostok and Kaliningrad. Considering that border guards can decide what constitutes a personal or commercial good, even clear and well-written regulations can be distorted because of the nature of Russia’s institutions.

Former Customs Service head Andrei Belyaninov was forced to resign last July in a corruption scandal engineered to replace him with someone more agreeable. Belyaninov removed FSB’s “seconded officers” — employees of state organs or firms who also work as agents for the FSB — from the Customs Service to improve its efficiency and reduce FSB influence. His replacement Vladimir Bulavin swiftly returned them while launching numerous peripheral crackdowns on corruption to project confidence that corruption would be rooted out. In the last year, the Customs Service has largely come under the control of power networks in the FSB. Reforms pushing back against corruption end up strengthening the those who benefit and control much of the economy. To cop a phrase from the Lenin: the worse, the better.

We wanted better, but it turned out as always

Reducing tariffs and simplifying trade regulations with external partners is an important tool for anyone seeking reforms within Russia’s framework of “authoritarian modernization.” Doing so adds impetus to domestic reforms and helps close loopholes exploited by traders to avoid taxation — Russia desperately needs new sources of tax revenue — while also reducing profits from smuggling. If north-south trade flows are set to grow, issues at the border such as smuggling or tariff-evasion schemes have to be taken into account. Trucks remain a better bet than rail for the foreseeable future, more easily exploited than trains. But without a change in the structure of trade, these agreements would do little to achieve that end even if they are comprehensive.

Yet because of the FSB clans’ recent victories with the Customs Service, positive developments such as universal, low tariffs for consumer goods trade may in fact signal the further tightening of economic controls in Russia by those closest to the Kremlin. These same power networks are most interested in deals pertaining to nuclear power and construction contracts. The former is a valuable sector but limited. Deals also often fall through or hit delays. The latter is an easy source of rents and does very little to sustain the kinds of trade ties necessary to develop alternative sources of consumer goods.

Russia needs these deals to work as Sino-Russian trade grows. Russian-German trade is also growing, but yields little for Russia politically. The EAEU has shown it can affect trade flows. EAEU members’ total mutual trade increased from 12.3 percent of their total trade in 2014 to 13.5 percent in 2015. Imports from each other grew from 15.8 percent in 2014 to 18 percent in 2015. Even with oil prices collapsing, commodities fluctuating, and volatile currencies in the region, the EAEU’s internal trade did grow. January-March mutual trade this year is reportedly up 31.1 percent, likely an optimistic figure but backed by renewed growth in the region. Doom and gloom coverage has been based on year-on-year comparisons that ignored overall drops in trade due to recession.

Opening the existing and evolving common market in the EAEU to Iran and India is crucial for north-south connectivity. The next trilateral summit between Russia, Iran, and Azerbaijan will focus on completing rail lines to realize the NSTC’s route. That route will do little for trade without lower tariffs and new business opportunities. Relaxing regulatory burdens may provide some more money to Russian elites and some chances for Iranian and Indian firms to compete. However, without cooperation to decentralization economic power in Russia and Iran or a decision to let firms in Iran and India sell goods at a lower price in the EAEU than native firms, agreements will likely represent the Kremlin’s constant Faustian bargain: more money for the right people and little to change the geopolitical calculus ironically due to the country’s securitization of trade.

Nicholas Trickett currently works at a think tank in Washington D.C. He is finishing an M.A. in Eurasian studies through the European University at St. Petersburg with a focus on energy security and Russian foreign policy.