Japan and Russia: star-crossed economic partners?

Japanese businesses are under increasing pressure. While the Abe Administration has been pushing for more ambitious deals with Russia, US sanctions have been pressing them for greater compliance, Maria Shagina writes.

In May 2016, Prime Minister Shinzo Abe offered a new approach to Japan’s stagnant bilateral relations with Russia, aiming to separate politics and business and to galvanise the potential of both economies.

While Japan hoped to use Japanese investments as political leverage to soften Russia’s stance in their territorial dispute, Russia sought to diversify its pivot to Asia from just China and to attract much-needed capital and technology for the development of its eastern territories.

The eight-point economic cooperation plan proposed joint activities in areas such as infrastructure, healthcare, and energy. Currently, there are reportedly 150 joint projects, of which more than 60 of are already being implemented.

At the moment, the plan is failing to facilitate territorial negotiations, while Japanese investments have amounted to a marginal 0.03 per cent. A mismatch in expectations is to blame. Whereas Japan originally focused on agriculture, enhancement of living conditions, and life expectancy, Russia expected an influx of Japanese investments in ambitious and geopolitically-driven projects.

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Realising that small-scale projects were not going to curry Russia’s favour, more visible deals have since been put on the agenda. Some examples include the establishment of a US $1 billion investment fund with Russian Direct Investment Fund and oil exploration in Eastern Siberia.

During the last Eastern Economic Forum in Vladivostok, Russian officials hinted at its dissatisfaction with the meagre level of Japanese investments and contrasted it with generous efforts made by China and South Korea.

Since the Forum, the Abe Administration has doubled down on its efforts to forge more deals with Russia. Japanese companies notedly raised their profiles in energy cooperation with sanctioned Russian companies. Government-linked agencies such as Japan Bank for International Cooperation (JBIC) and Japan Oil, Gas and Metals National Corporation have provided public assurances, making deals appear increasingly ambitious.

Japanese businesses were also, for the first time, involved in talks about equity participation in projects of Russian major oil and gas companies that have been sanctioned by the US and EU. In December 2018, Mitsui & Co. confirmed talks over acquiring stakes in Arctic LNG-2, the expansion of Sakhalin-2, and Baltic LNG. Itochu signed an agreement with Gazprom on the potential acquisition of a 10 per cent share in Baltic LNG. With JBIC’s support, Gazprom raised a 10-year bond worth ¥65 billion (US $574 million). The offering is reportedly the second-largest yen-denominated deal for an emerging market borrower.

Such reinforced interest from Japanese firms was triggered by Tokyo’s desire to show its full commitment to economic cooperation. Japan hopes that 2019 will be a turning point in its territorial negotiations with Russia, which has brought additional pressure from the administration upon Japanese businesses to achieve tangible results.

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The 25th meeting between Abe and Putin in January 2019 focused again on economic cooperation rather than a peace treaty. Putin acknowledged some success in Japan-Russia economic cooperation, but noted that a qualitative improvement in their bilateral relations was still absent. Putin expressed his hopes of increasing bilateral trade between both countries by at least 50 per cent or US $30 billion in the coming years, and his desire to strengthen ties in areas like the LNG sector and in technological cooperation.

However, bringing Japanese investment to Russia has always proved difficult. Japanese businesses are generally pessimistic about Russia’s investment potential, and finding profitable, ‘win-win’ projects is not easy.

Despite the creation of advanced specialised economic zones with a favorable tax regime, Japanese businesses have little inclination to invest due to the region’s undeveloped infrastructure and low population rate. For years, ineffective tariff regulations, red tape, and an opaque legal system in Russia have been the main impediments for Japanese businesses. The territorial dispute and Western sanctions were only a secondary cause for sluggish investments.

The US sanctions, however, add more uncertainty to Japan-Russia joint activities. In 2018, 67 per cent of Japanese companies reported being negatively affected by the expanding US sanctions.

Due to the centrality of the US financial system and the dominance of its dollar, Japanese companies faced difficulties in financial transactions with targeted Russian companies and were hesitant to provide them dollar-denominated loans. As a result, joint cooperation expanded in areas exempted from Western sanctions such as LNG and renewables, the nuclear power sector, and the shipping industry.

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With US sanctions intensifying and with the Abe government pushing for more ambitious deals, Japan’s private sector is caught between a rock and a hard place.

On one hand, Abe is under enormous time constraints to solve the territorial dispute during his term and Japanese businesses are being pressured to invest more. On the other, stricter US sanctions will leave less leeway for Japanese businesses to forge deals that are vital to Russia.

Despite Tokyo’s initiative to promote economic cooperation with Russia, the eight-point economic plan so far have achieved moderate results. Although the lacklustre economic cooperation was predominantly shaped by Russia’s domestic factors, sanctions have added more uncertainty.

US sanctions increasingly become a constraining factor in Japan-Russia economic cooperation, as Tokyo pushes for more ambitious joint projects. The extraterritorial nature of US sanctions will further stifle the scope of Japan-Russia economic cooperation and constrain the room for business opportunities.