The physical destruction and human horrors being wrought by the Russian invasion of Ukraine are causing immeasurable devastation to Ukraine’s economy. There will be consequences for global supply chains in key sectors, from military arms sales to foodstuffs to semiconductors. And an important portion of those impacts will hit the country that has – so far – been Russia’s most important ally: China.
Ukraine, when it begins to rebuild its infrastructure and its economy, will have some difficult decisions to make in its relationship with China, and part of that calculation will undoubtedly be determined by the degree to which China continues, or not, to cooperate and support Russia while the Russian Army murders innocent men, women, and children in Ukraine.
According to The Observatory of Economic Complexity (OEC), in 2020 Ukraine was the 55th largest economy by GDP, the 46th largest in total exports, and the 47th largest in total imports. In 2020, it exported $7.26 billion of products to China; the top three were iron ore, corn, and seed oils. Ukraine’s exports to China have increased at an annualized rate of 12.2 percent over the last 25 years. And unlike many other nations, Ukraine’s imports from and exports to China have been in relative balance with one another.
However, Ukraine was only the 123rd economy in terms of GDP per capita, a ranking that indicates relative fragility and vulnerability in its economy. Other than the ethical aspects of Ukraine’s relationship with China that Kyiv may have to reconsider, there are aspects of Ukraine’s economic relationship with China that may have negative repercussions for both nations.
Military Arms Sales
Ukraine was the 14th leading exporter of major weapons in the world from 2017 to 2021. Out of over 200 countries in the world, that’s an impressive ranking.
Admittedly, however, 14th, is still a tiny portion of the market. According to Statista, Ukraine represents only 0.7 percent of total major arms exports worldwide. The top 58 percent of the market is completely dominated by two countries, with the United States in first place with 39 percent of the overall total, and Russia following with 19 percent of the market.
However, that Ukraine is even in the top 50, much less the top 20, of worldwide arms exporters, is due to one specific trading relationship: the Chinese military market.
From 2016 to 2020, 77 percent of China’s total arms imports were from Russia, according to the South China Morning Post’s report on the Stockholm International Peace Research Institute’s (SIPRI) findings.
But after Russia, the next largest sources of weapons for China from 2016 to 2020 were France (9.7 percent) and Ukraine (6.3 percent), according to SIPRI. For Ukraine, that figure represents 36 percent of its total weapons exports, equaling $80-90 million worth of weapons sold to China a year.
The numbers tell the story: China is Ukraine’s largest weapons customer.
As the Middle East Institute (MEI) reports, “Much of what the PRC knows about designing and building modern weapon systems – particularly aircraft – comes from technology, design techniques, reams of technical data and consultation with actual design engineers purchased from Russia since the late 1980s.” In the 1990s, the “low level” of dialogue developed into a “torrent” of weapon sales from Russia to China. Not surprisingly, some of those products, such as the Sukhoi Su-27SK fighter, were reverse-engineered by the Chinese and purchases from Russia dwindled and then disappeared.
The Ukrainian part of the story is an inheritance from the structure of the Soviet Union, which spread its manufacture of military equipment around the vast nation to keep the production of any single model’s critical components separated geographically in case of attack, according to MEI.
The report points out that Ukraine became “a repository for production and the location of design expertise for some of the major subsystem components that these advanced weapon systems required. Radars, electronic warfare, numerous aerodynamic weapon systems, air defense networks, repair and overhaul plants and numerous other industrial sites were located all over Ukraine.”
The key point? Ukraine’s part of the Soviet Union’s military weapons regime was not to produce new weapons, but to support existing systems. That meant that Ukraine had everything that China needed to maintain and modernize its large arsenal of Russian weapons systems.
Now, however, Russia’s indiscriminate bombing of Ukrainian cities will likely have crippled that military manufacturing capability. China can switch to other suppliers in the short term, and over time reverse engineer needed items and produce the parts themselves. But that is a time intensive process, which may in the meantime leave vulnerabilities in China’s military arsenal.
Agricultural Goods: Wheat and Barley
Only nine months ago, chances looked good for increased exports of Ukrainian wheat to China.
According to Argus Media, “The prospects for increased Ukrainian wheat exports to China have been lifted by a new memorandum… between the Ukraine grain association (UGA) and China’s association of small and medium-sized enterprises (CASME).”
Tensions in its relationship with Australia have prompted China to “diversify its supply chain” for agricultural goods, the report said. Barley shipments to China from Ukraine went from 1 million tonnes in 2020 to 2.8 million tonnes in 2021, accounting “for more than two-thirds” of China’s barley imports for the year.
Hopes were high in Ukraine that its grains exports to China could increase by as much as two to three times. The fate of that segment of the relationship remains to be seen. China produces approximately 93 percent of its own wheat, but the remaining 7 percent is still critical to its food security. China consumes all it has, has just had a bad winter wheat harvest, and is banning the sale of wheat for animal feed.
Meanwhile, the ability of Ukraine to keep even current levels of wheat exports to China stable remains an open question. Ukraine’s government has already banned exports of many staple grains, and instituted strict export licenses on the remaining products (like wheat).
Port Investment in Mariupol
The Ukrainian government’s first investment forum after the election to the presidency of Volodymyr Zelenskyy, held in Mariupol on October 29, 2019, garnered “hundreds of millions of dollars in investments and loans” for the Black Sea port city.
Among the list of significant projects announced was an investment of $50 million by China National Cereals Oils and Foodstuffs Corporation (COFCO) “to implement an investment project in Mariupol Sea Port.”
The Chinese investment project is supposed “to increase handling of agricultural cargoes three and a half times.” Together with the Ukrainian Sea Ports and private companies, the agreement includes “the development of the port’s berth infrastructure, the construction of a grain terminal in the rear of Berth No.3 and a single handling facility for food and liquid food cargoes in the rear of Berths No. 2 and 3 of the Mariupol port.” Berths No. 2 and 3 will be a transshipment complex.
In other words, China was planning to buy a lot more grain and foodstuffs from Ukraine.
As UkraineInvest hopefully put it, “Mariupol proves to be one of the key logistics centers for the export of the agricultural products, ensuring Ukraine’s place as a logistics nexus in the global supply chain.”
For now, those dreams are gone. As of March 28, CNN reported that roughly 90 percent of residential buildings in Mariupol have been damaged, of which 40 percent were destroyed. Ninety percent of the city’s hospital capacity has been damaged, with three of the city’s seven hospitals destroyed. One maternity hospital, three institutes of higher education, and 51 schools and kindergartens have been destroyed. Factories have been damaged and, ominously for the investments being made by China, the city’s port has sustained damage.
It remains to be seen how much damage the port has undergone. Did the Russian military spare the port areas and facilities in which its good friend China has promised and perhaps even already made investments?
Astonishingly, approximately half of the neon that is used in the production of semiconductor chips worldwide is supplied by just two companies in Ukraine. Both of those companies, Ingas in Mariupol, and Cryoin, further westward along the Black Sea coast in Odessa, have ceased operations since the Russian invasion began.
Neon, which is also used in laser eye surgery, is fundamental to the mass production of semiconductors for the process of lithography, which uses light to print tiny patterns on silicon. Neon’s wavelength is so short it can create patterns in the wafer chip down to 193 nanometers.
This supply blockage can impact China in several ways. First, as a customer of Ukrainian neon gas for production of the chips made in China, Chinese companies are going to be forced to either find other international suppliers or to use the neon gas that is produced in China. That Chinese domestic supply, however, has reportedly seen prices surge, with one market report showing that the price of neon gas (99.9 percent content) in China has quadrupled from 400 RMB per cubic meter in October last year to more than 1,600 RMB/cubic meter in late February. The stoppage casts a cloud over the worldwide output of chips, already in short supply due to the effects of COVID-19.
An Unenviable Dilemma
Ukraine is now in a deeply unenviable position in its economic relationship with China. If Ukraine manages to rebuild to a level of viability that allows it to continue the export of military equipment, neon, wheat, iron ore, corn, seed oils, and beyond, and if China at the same time continues unabated its deep and ever-widening economic relationship with Russia, will the Ukrainian government and the country’s manufacturers be willing to continue producing those orders for China?
This, of course, is an extreme example of the dilemmas posed by global supply chains. What happens when your neighbor becomes your enemy, destroys your homeland, and murders your people, when at the same time one of your biggest customers, and investors, is that enemy’s “best friend”?