Russian Railpolitick and China’s Belt and Road

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Russian Railpolitick and China’s Belt and Road

Russian economic policies and infighting with its neighbors impact China’s ambitions.

Russian Railpolitick and China’s Belt and Road
Credit: Recon Asia / Flickr

An old Chinese proverb would be best amended to go something like this: if you want China to be rich, you must first build roads. Unfortunately, a road or railway is useless unless you own and can legally operate a fleet of trucks, locomotives, and rolling stock to ply the routes.

Behind the press releases and projects building up physical linkages in Eurasia, lobby and trade wars between members of the Eurasian Economic Union (EEU) affect China’s ability to shape shipping routes. China may foot the bill, sell the machinery, and contract out construction of roads, rails, and ports to its firms but it does not yet control the often-loopy regulatory schema used to protect domestic industries and political interests along many of the Belt and Road Initiative’s routes.

Russia and other post-Soviet states present a challenge in this regard. Russian Railways (RZD) takes the lead in what could be termed the region’s railpolitick — the array of fights over economic policy and political relationships expressed through regulations in the rail sector.

Kafka Rides the Rails

Russia attempts to use regulations to promote the domestic production of locomotives and rolling stock in an often Kafkaeque display. Companies and industries frantically lobby the Kremlin before being forced to comply with costly, unrealistic requirements to replace imports and older equipment. As a rule, Russia’s industrial capacity rarely meets the resultant demand. Further, Russia’s businesses lack enough money to purchase the entirety of the theoretical boom in orders following a policy shift. Non-performing loans — nearly 19 percent of the total issued in Russia — are disproportionately in sectors that serve domestic markets such as those companies tasked with building locomotives and rolling stock. The market is wracked with uncertainty and managed according to unspoken rules.

Despite a desire to increase domestic production and replace imports, the state continues throwing its weight behind exporters in an incoherent jumble. Subsidies for export credits make exports of needed equipment more attractive financially than selling to Russian firms. Ukraine was by far the largest importer of Russian-made rolling stock, with that business another casualty of Russia’s intervention in the Donbass and annexation of Crimea. Most recently, Russia’s Export-Import Bank has begun discussing financing for the sale of 100 wagons to Zimbabwe by Uniwagon. To what end, given needs on the Russian market, isn’t clear and the loss of the Ukrainian market adds up to tens of thousands of wagons over time.

Small and medium-sized businesses are thankfully resilient and RZD spends billions of rubles procuring their services, rolling stock, and locomotives. But unlike RZD, small and medium businesses don’t have the same kind of access to cheap credit from the state. They generally go through state-owned banks tasked with supplying inefficient state firms with credit. Though bank lending to corporations is growing again, it’s unclear how much is going to private actors.

While lending begins to recover, small and medium business demand for loans won’t grow quickly since Russians make significantly less than they did in 2014 and the market is quite uncertain. State-mandated purchases will do little. China-watchers know well the phenomenon of zombie companies. A similar problem with Russian characteristics plagues RZD and Russia’s rail sector: Russia’s market for freight services, locomotives, and rolling stock can’t grow much because of low-profit margins, inefficiency, lack of credit, and self-defeating economic policies.

You Gotta Spend Money to Spend Money

As with politics, access is everything on Russia’s sprawling rail network. Of its roughly 121,000 kilometers of tracks, about 71 percent are designated as common carrier routes, meaning all companies operating on the freight market should, theoretically, have access. The rest are for non-public use and are largely connected to extractive industries, the principle wealth-creators for much of the Russian economy. Failure to comply with proposed regulations would cut off access to non-public routes for a wide array of industrial giants and resource extractors that drive the economy and sink any hopes RZD may have at profitability, growing reliance on China notwithstanding.

The Customs Union was supposed to enforce new requirements for rail carriers in 2014 that mandated a ban on the extension of locomotives’ and rolling stock’s operational lifetime. Domestic producers would ideally receive a flood of orders to replace old equipment. But the move was delayed for two years and is again being delayed this year till next August. Companies would rather not have a wave of spending forced upon them now, even as Russia’s economy enters quasi-recovery. The proposed policy exemplifies Russia’s quixotic obsession with economic sovereignty: spending induced by regulation for domestic production leads to persistent shortages, inefficiency, and little stimulus.

Private industries have consistently sought exemptions from policies RZD can better afford. Per a Kommersant article, the modernization of locomotives mandated by the legislation costs 80 percent of what it would to simply buy a new locomotive for private industries. Were the regulation delayed till next year to take effect, 73 percent of the private sector’s locomotive fleet would be forced into retirement by 2020. Modernization of the roughly 4,000 privately-owned locomotives in Russia would cost around 100 billion rubles ($1.6 billion). In the Urals, for example, only the largest companies have trains considered to have only “80 percent wear.” The oligarchs involved with firms like Transmashholding — key owner for the Kazakhstani dryport at Dostyk on the border with Xinjiang — would need several years to replace retired trains at minimum, assuming the money’s available. RZD has more than 20,000 trains and set aside money to purchase around 1,600 new ones between 2014 and 2016. With the likelihood that RZD’s fleet isn’t that much more modern than that of the private sector, it’s safe to say that the industry faces a massive deficit of supply in the near-future under the regulatory change.

Attempts to modernize rolling stock have faced somewhat similar challenges. Newer rolling stock has been shown to spend one-fourth the time under repair as wagons that have had their operational lifetimes extended. Yet simply producing new rolling stock isn’t enough. Companies need to develop supply chains to repair and maintain them as well, requiring a five-year planning horizon. That’s exceedingly difficult without consistent regulations.

Last October, there was an average of 1.08 million cars on the rails at any given time, of which about 44.3 percent were open-topped cars carrying coal or other raw materials. Between January and October last year, there was a supply of 30,600 new railway cars in total. A combined 10 billion rubles ($166 million) was directed to subsidize and compensate companies for the purchase of railcars in 2016. Because Russia relies on raw materials, the greatest deficits are showing up for open-topped cars for things like coal. As deficits grow, rental costs rise and the state may be forced to offer yet more subsidies to businesses unless it wants to open the market to more goods from China.

Production capacity for newer designs bearing heavier loads is also tapped out and purchasing such cars without improvements is uneconomical without additonal subsidies. Demand for containers — the principle indicator for Europe-China rail routes — is weak because RZD’s profit margins are low and container traffic doesn’t make much money due to the resource-centric structure of tariffs. All the same, container traffic was up 20.4 percent between January and May this year, which will lead to future deficits since Russia’s domestic market isn’t structured to profit off the types of transit rolling stock needed. Either the containers are coming from elsewhere or RZD will soon be straining to match demand generated by Chinese exporters.

Even if Russia could manufacture enough to meet demand, precluding the import of gear from China or Europe, there are still other asinine aspects of regulations that hinder cross-border trade with neighbors. Kazakhstan is a perfect example.

A Regulation You Can’t Steppe With

Not long after Kazakh President Nursultan Nazarbayev and Georgian President Giorgi Margvelashvili met in Astana and touted the Trans-Caspian transport route, Kazakhstan banned the transit of Russia’s newer rolling stock on its rail system. Kazakhstan claims that its rail network is not designed or prepared to handle any wagons that carry loads more than 23.5 tons. The move is basically a tit-for-tat over a Russian ban on 5,400 Chinese-made rail wagons Kazakhstan purchased in 2011-2012. Of the roughly 45,000 rail wagons made in Russia annually — demand picks up at the end of the year due to federal budget spending — 70 percent will be banned from entering Kazakhstan. At present, only 65,000 of RZD’s rolling stock fleet is new with the specs for heavier loads. Even if Russia’s production were to take off, the entry ban seriously hinders RZD and Russian shippers’ ability to partake in transit routes through Kazakhstan.

According to Kazakhstan’s Ministry of Transport, the country’s rail system is designed for railcars carrying an average load of 21 tons. But the fight between RZD and its counterpart in Kazakhstan, Temir Zholy (TZ), came about because there are not shared agreements on technical specifications. This kind of thing is generally ignored for shinier objects when one reads about connectivity. In this case, the design of Chinese-made wagons affects the instruments used to measure temperatures on railcar axles. Anyone who’s spent time in the region knows that come winter, such measurements are vital given the way extreme cold affects gear and imposes costs for repairs.

Unlike Russia, Kazakhstan is able to meet almost all of its freight locomotive demand domestically thanks to a joint venture launched with General Electric in 2009. TZ’s rolling stock fleet was roughly 37,500 wagons when it launched its modernization program back in 2008. Imported gear played a part in that; but unlike Russia, Kazakhstan has managed to meet its own locomotive demand. Rolling stock, however, will require more imports. With each tender announced in Astana, non-Kazakhstani producers will most likely come from China. The longer Kazakhstan maintains the ban on Russian transit for its newest rolling stock, the better China’s market position. But most importantly, these regulations and Russia’s market failures may push China to use the Trans-Caspian corridor instead of Russia over time.

The Trans-Caspian Blues

The recent Trans-Caspian Forum brought with it a spate of positive press on the outlook for the Trans-Caspian corridor. To be certain, there has been surprisingly deep commitment and political cooperation between Kazakhstan, Azerbaijan, and Georgia to harmonize tariffs, border compliance for transit, and realize the construction of various projects. As much as Kazakhstan is the “buckle” in China’s Silk Road Economic Belt, Azerbaijan is the crux of the Trans-Caspian corridor. Between January and April this year, Baku International Seaport recorded a 35 percent increase in the transshipment of non-oil goods, the best predictor for actual trade growth. Overall transshipments through Azerbaijan’s ports were up 26.1 percent year-on-year between January and March. More and more goods are transiting the route around Russia as ports in Ukraine and Romania sign on to the initiative. But China still benefits most, rather than the economies involved.

Petty trade wars between Russia and Ukraine have forced Ukrainian firms to use the Trans-Caspian corridor despite higher costs and longer transport times to reach Central Asia. Kazakhstan’s economy is more oil-dependent now than it was 15 years ago. Even as China moves factories into Kazakhstan, the country’s non-oil exports are likelier to be absorbed into the existing Customs Union and EEU than East-West trade. Azerbaijan has historically relied on oil and gas for around 90 percent of the value of its exports, an extreme case of hydrocarbon dependency. Despite positive news opening up industrial parks and supporting agricultural exports, the country dropped in most World Bank Doing Business rankings between 2016 and 2017 and has yet to tackle the structure of the state and oligarchic interests’ control over the economy. Georgia recently closed a Free Trade Agreement with China, but it’s most likely to increase Georgia’s dependency on Chinese imports because of the relative levels of development between the two economies.

Russian trade wars with Ukraine incentivized Ukraine and China — meant to be partners along China’s initial vision for the Silk Road Economic Belt — to look to the Trans-Caspian corridor. While tariffs come down and border practices are harmonized, trade will rise as freight rates fall. However, it’s considerably simpler logistically to load one train at the border of China in Russia or Kazakhstan and ship to the EU via Belarus instead of loading, unloading, and transferring goods along the way. China’s regional governments subsidize the routes now feeding the Trans-Caspian corridor. Whether or not Russia can truly tap into the Belt and Road Initiative is a question of economic reform at home, not political animosities and friction with its neighbors. China needs to look elsewhere to make sure there’s enough logistical capacity. Kazakhstan and states along the Trans-Caspian route to which it can sell that capacity make more pliant partners.

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