In the month since Russia’s invasion of Ukraine, Beijing’s foreign policy messages have been highly conflicted, as it attempts to maintain high-level support for Moscow while distancing China from the humanitarian costs and economic collateral damage of the conflict. Those mixed messages reflect not only the difficulty of reacting to Russian military setbacks on the ground, but a real split within China’s governing system: namely, between Political China and Technocratic China.

Political China is primarily concerned with how China can use its relationship with Russia to advance its interests in a longer-term competition with the United States and U.S.-led alliances. Political China also emphasizes the importance of moving toward a multipolar world order and resists engagement with Western institutions. In this view, self-sufficiency is more important than economic and political engagement, while interdependence is defined as making the rest of the world more dependent upon China, creating points of political leverage.

Technocratic China — which generally consists of the officials at the central bank, the Ministry of Finance, and the banking and securities regulators — tempers the ambitions of Political China and reminds the country’s leadership how much it still needs active engagement with the rest of the world to fulfill Beijing’s long-term political ambitions. Two weeks ago, China’s domestic equity and bond markets were in free fall, reacting both to the economic risks of a plummeting property market and the sudden emergence of Omicron outbreaks, as well as the rising political risks of holding Chinese assets given Beijing’s alignment with Moscow. Vice-Premier Liu He had to issue a statement detailing that the Chinese authorities were aware of the market’s specific concerns, and pledging additional policy support. Technocratic China was essentially called in to manage the consequences of Political China’s choices. 

Investors are under no illusion that technocrats have the ability to set the policy agenda in Beijing. But they will increasingly view China as “uninvestable” if their influence over key policy areas continues to diminish, as has been the case over the past year with the devastating regulatory crackdowns on technology and education firms, and the elevation of “common prosperity” as a priority. The voices of Technocratic China remind Beijing both that financial liberalization provides stabilizing flows of foreign capital into China’s markets, supporting its currency and boosting the valuations of Chinese assets; and that international engagement will continue to provide the foundation for a sustainable long-term economic expansion in China, which in turn requires well-executed domestic economic policies consistent with liberalized markets.

CRITICAL POLICY DIVIDES

These two views within Beijing are set to divide sharply on a few critical issues, including China’s relationship with the U.S. dollar, technological globalization, and industrial policy. U.S. regulation and sanctions of financial transactions involving the dollar are an increasing headache for Political China. In its view, anything that could reduce China’s dependence upon the dollar and U.S. influence would be welcome, including deepening the international usage of China’s currency in transactions — take the recent reports of China talking to Saudi Arabia about paying for oil with RMB.  

But for Technocratic China, maintaining access to U.S. dollar clearing facilities is like continuing to breathe — there is no alternative. Following this view, Beijing should tread lightly regarding transactions that might court sanctions risks for critical financial institutions.  That may require downgrading economic relations with Russia, or isolating transactions with Russia through a few smaller banks. As a result, even if China promises to deepen economic engagement with Moscow, the reality may fall short. 

Investors are under no illusion that technocrats have the ability to set the policy agenda in Beijing. But they will increasingly view China as “uninvestable” if their influence over key policy areas continues to diminish…

Delisting Chinese firms from U.S. stock exchanges (and relisting them in Shanghai or Hong Kong) would be seen as a win for Political China, but technocrats regard this as creating long-term problems in attracting foreign capital. In fact, Technocratic China has been trying to deepen China’s engagement with the international financial system, opening more business lines within the financial industry to full foreign ownership over the past two years. Even though this increases China’s vulnerability to U.S. regulations and sanctions, Technocratic China would argue there is no feasible alternative to attract inward investment and maintain China’s influence within the global economy. 

Technological globalization is another key divide. China’s “dual circulation” strategy, unveiled in 2020, implies reducing China’s reliance on imports of key components in high-technology industries, particularly chips and other semiconductor components. Technocratic China reminds Political China that U.S. sanctions against Huawei have hit the company’s competitiveness, and that further courting sanctions simply to maintain limited volumes of trade with Russia could similarly jeopardize the viability of some of China’s most important companies. Technocrats also know that continued technological upgrading will be necessary for China’s long-term competitiveness, and this will require an investment environment for foreign firms where perceived political risks are falling, rather than rising. 

Political China is also far more amenable to activist industrial policy and interventions boosting investment in strategic industries to achieve self-sufficiency, while increasing the rest of the world’s reliance upon China for components such as rare earth minerals. Technocratic China is more concerned with the potential for industrial policy choices to discourage foreign investment and engagement in key sectors — given the backlash to the Made in China 2025 initiative — and with the potential waste and fraud associated with massive volumes of state-directed capital. For Technocratic China, Russia’s sudden isolation from the global economy highlights the limits of a strategy of self-sufficiency, and the obvious costs of reversing three decades of closer integration with the global economy.

POLITICAL CHINA ALWAYS WINS

Of course, this is a “contest” with little to no suspense, as Political China under Xi Jinping will ultimately frame China’s response to Russia’s actions and other vital issues. However, technocratic concerns will not be completely ignored, especially given the priority on ‘stability’ in this crucial political year. We see this balancing act already underway given Liu He’s statement to calm swooning financial markets. Media reports suggest technocratic concerns about the delistings of Chinese companies in the United States are driving a new urgency to negotiate a solution (although actions will speak far louder than leaks here). And Chinese firms appear to be treading lightly around Western sanctions, with several reports of firms reviewing business or new investments in Russia, including state-owned firms. 

Practically, Political China will be limited in its capacity to deepen the economic and financial relationship with Russia. Financial linkages are also likely to stay restrained, given the sanctions on the Central Bank of Russia. China’s own central bank can ignore those sanctions and continue to allow its Russian counterpart to trade RMB-denominated assets in China’s domestic markets. But actively adding to China’s exposure to Russia, via exchanging those RMB for dollars, or opening new swap lines, would be an entirely different matter. If Beijing’s response to Russia’s invasion appears jumbled, this is because the interests of Political China and Technocratic China are so clearly at loggerheads. The longer the war continues, China will see rising economic and international political costs from its alignment with Russia. But beyond the war, this politically important year offers a useful lens through which we can assess whether China’s technocrats remain an important moderating influence on Chinese policy in other areas. Whether or not China remains “investable” for companies and financial markets will depend upon Technocratic China reasserting some control of the narrative about China’s long-term interests.

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