Sanctions Watch: Is China Already Cheating on UNSCR 2321?

On this blog, we periodically review some simple indicators that offer insight into the state of sanctions enforcement and on the part of China in particular given that it is Pyongyang’s main trading partner by a wide margin. (See previous Sanctions Watch updates here and here.) UNSCR 2321, passed in November 2016, was the first sanctions resolution to target North Korea’s commercial trade by placing a hard cap on member states’ imports, most notably on coal but on a handful of other minerals as well. By instituting a hard cap, the resolution eliminated the “livelihood exemption” in UNSCR 2270, a loophole China appeared to invoke to maintain such imports over the course of 2016. Recently released Chinese trade data suggests that the country may not be enforcing UNSCR 2321.

Any quantitative restriction requires transparency and coordination to assure the ceilings are not breached. To make DPRK coal exports are as transparent as possible, the UN Security Council website now includes a section that reports the data. Three points are noteworthy. First, China has missed its deadline to report its North Korea coal imports for December 2016. Second, as the chart below shows, both the value and volume of North Korean coal imports continued to rise over the course of 2016, certainly violating the spirit if not the letter of UNSCR 2270.

Third, however, the data appears to indicate that China has violated the terms of USNCR 2321. The resolution placed an explicit cap on North Korean annual coal imports for 2017 of $401 million or 7.5 million tons, whichever comes first. How that is distributed over the course of the year is up to China: they could front-load imports and provide North Korea some benefits early in the year or they could spread imports out. But the resolution also included a specific cap for December 2016—the first full month after 2321’s passage—of $53.5 million or 1 million tons. According to China’s own custom’s data, it failed to comply with the resolution importing $168 million in coal with a volume of 2 million tons for the month.

Should we cut China slack on this point? As Bill Brown noted in a blog piece for KEI, China’s Commerce Department stated on December 11 that as of that date it had ordered a stop to the coal trade for the rest of the month, except what had already been shipped. Perhaps all of the reported coal was imported in the first eleven days of the month and the Commerce Department decided to cut it off before the imports rose any further. It is also possible that the Chinese government is figuring out how to implement the import ceiling, which ultimately involves the allocation of quotas through administrative fiat, past imports, an auction or some other mechanism.

But perhaps Beijing turned a blind eye to contracts that had already been signed—no doubt to get in under the restrictions. Or perhaps Beijing just turned a blind eye altogether. We won’t ultimately know how China is enforcing the agreement until we get closer to the 2017 annual limits, but the amount of overage in December is not a good harbinger for enforcement of the latest Security Council resolution as Bill Brown notes.

How China allocates the right to import coal also should also affect prices, but how it does so, and how those rents are distributed between North Korean exporters, Chinese importers, and the Chinese government depends on the precise allocation mechanism. In the simplest case, the Chinese government would auction off the right to import coal and appropriate the rents for themselves. But for a variety of reasons, the Chinese government is unlikely to adopt such a simple transparent procedure, and given the pervasiveness of bribery in both the Chinese and North Korean economies, it is likely that whatever trades occur will be accompanied by under the table side payments.

Whether sanctions have material effect depends on the ability of North Korea to substitute for sanctioned trade by diversifying into non-sanctioned trade. We have noted that there has been a subtle but nonetheless steady decline in the bilateral trade, no doubt reflecting primarily the slowdown in the Chinese economy. There is a lot of volatility in the 2016 trade data, but it appears that this slowdown has stopped and that overall trade may even be turning up. Nor does there appear to be any change in the bilateral trade deficit, which we interpret as an indicator of Chinese investment into North Korea.

Finally, there is the matter of the imponderable North Korean won rate, which for the last four years has remained remarkably stable even after a barrage of new sanctions (Steph Haggard has been saying—not predicting—that if sanctions were really enforced, we should see a depreciation in the black market exchange rate). The rate we use is the unofficial Pyongyang rate tracked by Daily NK’s sources in the country. (North Korea’s official NK won rate is fantastically overvalued and therefore not a particularly useful metric for understanding the economy or balance of trade; the official rate is about 60 times higher than the unofficial rate.)

The rate is imponderable because North Korea watchers can’t figure out how the North Koreans are maintaining such a stable black market exchange rate. Normal countries—with developed markets for foreign exchange—can buy and sell foreign exchange to maintain a target exchange rate, but North Korea does not appear to have these standard monetary policy-cum-exchange rate tools. However they’re doing it, they seem to be maintaining stability just fine, thank you, suggesting that there are sources of financing that we just don’t see, perhaps for example in labor remittances. We will return to this larger topic in a subsequent post, but the main message is simple: if sanctions are supposed to impose material distress that is visible in the current account and exchange rate and prices, we are not seeing it.