The War against Ukraine – 5 Takeaways for China and Their Implications for the EU – Takeaways 1-3

On April 1st, 2022, leaders from the EU and China held their first summit in two years. The virtual meeting was overshadowed by Russia’s ongoing brutal war against Ukraine and, as expected, produced no substantial outcome. However, the consequences China will draw from the war for its national policies will substantially impact the future of EU-China relations.

Expectations for the EU-China Summit were already low due to substantial differences between the sides on several topics, and expectations were fully met. There was no joint declaration and no progress on key issues such as the EU-China Investment Agreement, the suspended human rights dialogue or – most importantly – China’s role in the war against Ukraine.

China’s diplomatic shilly-shallying in this regard has pushed its western partners to the edge of their patience. G7, EU and NATO made very clear during a summit marathon in Brussels two weeks ago what they expect from China: Stay clear from Russia, do not circumvent sanctions.

Even though China has more or less continued its balancing act of “pro-Russian neutrality,” it also has its reasons for treading cautiously in a situation that has reinforced and welded together the transatlantic alliance to an unexpected degree.

This situation, especially in regards to common western sanctions, is undoubtedly unnerving from a Chinese perspective, and China’s possible take-aways from it will shape future relations with the EU and other western nations. At least five are ready at hand. Three of them are discussed in this blog post. The other two and the implications for the EU are discussed in a second part coming next week.

1 Pushing technological (in)dependencies

China set the goal to become a global technology and innovation leader by 2049 in its industrial policy strategy “Made in China 2025” (MIC 2025), announced in 2015. Homegrown technology and indigenous innovation are at the core of this strategy, which focuses on ten key sectors, such as high-end machine tools, robotics, artificial intelligence, IT and e-mobility.

The graphs below show that China has already made huge progress in many of these technologies, as measured in the Chinese share of world-class patents. These are patents that are particularly technologically relevant and provide good insight into the innovative strength and technological development of an economy.

China’s share of these patents has increased by more than 50 percent annually on average since 2010, gaining even more speed since the introduction of MIC 2025. However, it also becomes clear from the graphs that there still is a gap between China and western countries, especially the United States, in many areas.

Among them are technologies such as artificial intelligence, energy-saving or smart manufacturing, that are especially important for the implementation of both MIC 2025 and the twin transition to a green and digital economy, which are closely interlinked.

Even before the war against Ukraine, it was a political priority for China’s government to reduce the country’s dependency on foreign know-how, especially since U.S. sanctions against Huawei nearly killed the company’s smartphone business and made crystal-clear how lethal this kind of critical dependency can be.

Western sanctions against Russia have taken things up another notch: They show that not only the United States but a larger number of – not only western – countries are willing to resort to or at least support this kind of measures to an unprecedented degree.

Consequently, the war against Ukraine will accelerate the Chinese leadership’s push for independence in key technologies, especially by reinforcing efforts to reduce the reliance on western inputs.

China will certainly also strengthen the strategic assessment of current western dependencies from Chinese inputs that could be exploited politically if the need arises and explore options to create new such dependencies regarding future key technologies.

2 Pushing alternative financial structures

China has not been happy with the USD-centric international financial architecture for quite a while and is exploring alternative structures to diversify its cross-border financial options and reduce its potential vulnerability to western financial sanctions. Western sanctions against Russia due to its annexation of Crimea were a wake-up call in this regard, and the war against Ukraine will be a powerful accelerator.

China has several options to further work on the de-dollarization of its financial system. These are the evolution of its Cross-border Interbank Payment System (CIPS) and its digital currency (E-CNY), as well as the diversification of its reserve assets.

China introduced CIPS in 2015 to establish an alternative financial structure. However, CIPS still has one major shortcoming:  it relies on SWIFT as a cross-border messaging system for financial transactions. So, for the time being, CIPS is a blunt sword to withstand financial sanctions linked to SWIFT.

To make it sharp, China would have to develop an alternative messaging system and involve a critical amount of willing participants. Given China’s economic size, this is not unfeasible, but it takes time and effort to build.

The same is true for China’s digital currency (E-CNY), which was introduced in 2021 and is currently tested for national use in some major cities. The E-CNY might be used to bypass financial sanctions in the future, but at present, it is still in its infancy. So China will certainly see to making its digital currency fit for international use in the coming decade.

China is also working on the de-dollarization of its reserve assets. Increasing gold reserves and diversifying foreign reserve currencies are two important means to achieve this. The graph below shows that China has nearly doubled its gold reserves since the imposition of Western sanctions against Russia in 2014.

However, its share of gold in total reserves (3 percent) is still dwarfed against that of the United States or some single EU Member States, such as Germany (each at around 66 percent).

As for the composition of China’s foreign exchange reserves, the USD and Euro, as the top-2 global payment currencies, are estimated to make up 60 percent and 20 percent, respectively, together accounting for a towering 80 percent of reserves.

For further diversification, the key question would be, into which currencies to diversify? Twelve of the top-20 global payment currencies are those of western democracies, 13 if Japan is included.

And it is rather unlikely for China to regard the currencies of South Africa or Mexico as an alternative, especially since, apart from the lack of scale and stability of their currencies, those countries have close economic ties with the West, too.

In the mid to long-term, China will likely instead focus on the other two options to build an alternative financial structure and continue to gradually strengthen the CNY as a global payment currency.

3 Pushing energy security

Its rise as “the factory of the world” and an economic superpower has made China both the world’s largest consumer of energy and the world’s largest emitter of carbon dioxide, as fossil fuels still make up 85 percent of China’s energy mix (see chart below). Domestic energy sources fall far short of covering domestic demands.

China has been a net importer of oil since 1993, coal since 2002, and natural gas since 2006. In its efforts to diversify its energy mix away from coal, China has, on the one hand, substantially increased its share of renewables, hydro and nuclear power from a mere 8 percent in 2009 to 15 percent in 2020. On the other hand, it has also become more reliant on oil and natural gas and thus on imports of these (see charts below.)

Heavily relying on foreign resources to fuel its economy makes China vulnerable to so-called choke points. One of them is the Strait of Malacca (the passage between Malaysia, Indonesia and Singapore), which it is estimated that about 80 percent of China’s maritime oil imports have to pass through.

The Strait is as narrow as 1.5 miles at one point and thus could easily be blocked. The unintended blockage of the Suez Canal in 2021 showed how much damage such an interruption of trade can inflict upon supply chains of goods.

A cut-off from energy sources vital for the functioning of an economy as big as China’s could do even worse. Moreover, the ongoing conflicts in the South China Sea and the unresolved Taiwan issue, which – should it come to a military escalation – could even involve armed conflict with the United States – generally make China’s reliance on fuel imports by sea a liability for its energy security.

In the wake of the Ukraine conflict, China will likely accelerate its efforts to secure its energy supply from sources that are less prone to geopolitical conflicts, such as long-term contracts with like-minded countries that can deliver fuels via a land route.

The recent gas deal with Russia is already one step in this direction. An even stronger push for the green transformation and massive investment in all non-fossil primary energy sources available as well as in green hydrogen as a key secondary energy source will be another result.

About the author

Cora is a senior expert in the Europe’s Future Program at the Bertelsmann Stiftung. Her research focus is foreign direct investment and international trade (especially the role of emerging economies).

Get Global Europe blog posts in your inbox. Sign up to receive our newsletter here.

Read more about China’s role in the changing geopolitical situation:

How the War Against Ukraine can Change the Global Economy

Caught between Russia and the West? China’s Struggle for a Position on Ukraine

China can Only Offer an Immediate Respite For the Russian Economy

Olympic Winter Games – its zero-Covid policy is a big issue for Beijing, but not the only one