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What does the Ukraine invasion mean for China?

Santiago Millán, CFA, Macro Strategist
2022-06-30
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THE SCALE AND BREADTH OF THE SANCTIONS ON RUSSIA have increased the uncertainty of investing in China across multiple dimensions. The decoupling of China and the West is being accelerated for the third time. The first accelerant was former US President Donald Trump, the second was COVID.

Investors now need to consider not just the risks to fundamentals but also the increased chance that China will be counter-sanctioned down the road for evading some of the Russian sanctions, despite initial signs of reluctant compliance.

The sanctions on Russia weren’t enacted until we reached the absolute worst-case scenario. So I expect the magnitude of any Western sanctions on China to be relatively small initially. However, China is likely to react by imposing its own sanctions on the West, creating a vicious cycle. In this case, investors could be forced to divest at the worst of times, so the discount rate for foreign investors needs to rise very significantly.

... I also think many investors are underestimating how disruptive serious sanctions on China could be for developed economies and markets. Besides the threat to supply chains, the US is heavily dependent on foreign savings, most of which come from Asia.

Santiago Millán
Macro Strategist

Beijing has been trying to dissociate itself from the invasion, which violates China’s own foreign policy guidelines of not interfering in the domestic affairs of other sovereign nations. Anecdotal evidence from a well-placed source I have spoken with suggests that Beijing was surprised by the invasion. When Russian President Vladimir Putin went to Beijing on February 4, he stressed Ukraine’s importance to Russia, but gave zero signal that something like this was in the works. If the invasion goes badly for Russia, China may try to distance itself further. However, it is unlikely to dissociate itself enough to satisfy the West politically.

If anything, China appears to be taking a more public pro-Russia stance. In recent days, the Chinese foreign ministry has amplified Russian claims that the US has multiple bioweapons laboratories in Ukraine, including some where bat viruses — supposedly a possible source of COVID-19 — have been studied. This claim puts China extremely close to taking sides with Russia in this conflict. If Chinese media outlets and internet platforms continue to amplify Russian propaganda, Chinese assets could soon become uninvestable from an ESG perspective.

Moreover, China’s Xue Hanqin was one of only two judges at the International Court of Justice who voted against the judgement on March 16 condemning the invasion and calling for an immediate stop to Russia’s military operations. I think this makes China’s position clear. This dissenting view provoked a negative reaction from many Western and anglophone countries. For example, a meeting of the Australian National Security Council is reported to have discussed possible sanctions on China, while the Russian sanctions bill passing through the US Congress already includes proposed sanctions on China for this reason.

Perhaps most tellingly, Chinese officials have repeatedly failed to formally deny providing military assistance to Russia. In my view, any Chinese assistance — whether of intelligence, technology or even logistics — is likely to be seen by many in the West as a very serious move.

A good test for whether people have an ideological mindset is to see if one factor can predict a person’s views on a whole variety of issues. In China and also in the West, the vast majority of the population favors one side in this conflict. Chinese support for Russia is overwhelming at the grass roots, suggesting that the response of a large part of the population (and its leaders) is ideologically based.

For this reason, I see very little chance that China and the West will find common ground, and sanction risk will likely remain high. When I consider this together with the rising risk of serious disruption from COVID, I am increasingly cautious on Chinese assets and concerned about the global supply chain.

But I also think many investors are underestimating how disruptive serious sanctions on China could be for developed economies and markets. Besides the threat to supply chains, the US is heavily dependent on foreign savings, most of which come from Asia. If the funding from Asia gets cut off, either the US will have to find another massive source of funding — and I can’t think of one — or Americans will have to cut back significantly on consumption.

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