Can the Yuan ever replace the Dollar for Russia?

Vita Spivak

Testing the possibilities of internationalizing the Chinese currency in Russia is a tempting prospect for both Beijing and Moscow, but agreements on paper simply aren’t enough to change reality.

The Russian and Chinese leaders regularly discuss increasing the use of their national currencies in bilateral payments, most recently in a phone conversation at the end of June. Moscow hopes to become less vulnerable to US sanctions this way, while Beijing, in its most recent Five-Year Plan, outlined its intention to construct and advance the security of yuan cross-border payment systems while steadily promoting the currency’s internationalization.

In practice, however, these top-level statements of friendship against the US dollar are thwarted by the lack of practical incentives to develop financial ties. When it comes to money, it seems that the lofty ambitions of political leaders are no match for the insufficient liberalization of the Chinese financial system and the unwieldy Russian economy beset by sanctions.

In March 2018, Russia’s central bank made global headlines when it reported that 14 percent of its reserves were now held in yuan. Yet the trend of increasing that proportion has reversed. In 2018–2019, the yuan lost 6.4 percent of its value (partly because of the China-US trade dispute), while Russian reserves contracted by an estimated $3.4–$4 billion, so by the end of 2019, the proportion of central bank assets held in yuan had decreased to 12.2 percent.

Despite the International Monetary Fund adding the Chinese national currency to its Special Drawing Rights (SDR) basket back in 2016, the latest data showed that in the final quarter of 2020, the yuan only made up about 2.25 percent of international reserves. Even the enormous size of China’s economy isn’t helping to increase the global profile of its national currency. China is currently the world’s biggest trader—accounting for about 13.5 percent of global exports and 11.4 percent of global imports—but the yuan accounts for only 1.7 percent of international settlements as of June 2021 (compared with the dollar’s 38.4 percent share and the euro’s 39 percent). The US dollar, euro, pound sterling, and the Japanese yen are all more popular than the yuan as currencies in international settlements.

One of the main reasons for the yuan’s lack of progress is that it is not freely convertible. Instead, the People’s Bank of China sets a daily reference rate for the yuan against the dollar, from which trading via interbank currency markets cannot diverge by more than 2 percent. There are also restrictions on moving capital out of China, including for foreign companies. Beijing toyed with the idea of loosening the capital repatriation rules in 2015 amid the yuan’s introduction to the IMF’s SDR basket, but that led to record capital flight (up to $1 billion) out of China.

Beijing may wish to promote the yuan’s greater internationalization, but periodic crises have shown that a nonconvertible currency makes it easier to control the impact of economic shocks on domestic financial markets. At the outbreak of the coronavirus pandemic, for example, the People’s Bank of China stopped the yuan from depreciating by selling foreign exchange reserves. In January–April 2020, China’s foreign exchange reserves decreased from $3.115 to $3.091 trillion.

To try to make the yuan more international without losing control over the exchange rate entirely, the Chinese authorities have created the offshore renminbi (CNH), which has been traded since 2009 on the Hong Kong exchange. It has a more free-floating rate than the onshore renminbi, and its purpose is to make it easier to invest in China and move money outside of mainland China.

Still, the offshore renminbi channel is not a solution to all the problems in dealings between Russian and Chinese companies. Western sanctions have frequently impeded Russian companies trying to do business with China via Hong Kong. There have been cases when the Chinese bank accounts of Russian companies in both Hong Kong and mainland China have been frozen, and Russian entrepreneurs have been refused loans because of the sanctions risks.

In 2014, Russian companies gained another instrument for attracting financing from China: through the bilateral swap agreement between Moscow and Beijing. The swap agreement sum between China and Russia amounted to 150 billion yuan (about $24 billion), but its real-life application was limited to a few test deals conducted by the Central Bank of Russia and the People’s Bank of China. Companies on either side of the swap deal appeared to be uninterested in taking advantage of it, once again because of sanctions fears and the difficulties of capital repatriation from China.

In June 2019, after lengthy negotiations, Beijing and Moscow signed an agreement on moving over to bilateral payments in their national currencies, and talked—not for the first time—about “de-dollarization.” The agreement contained mutual promises to broaden the use of the yuan and the ruble, including in foreign trade contracts. Yet the choice of currency for payments between specific Russian and Chinese companies remains at their own discretion. Despite the agreement and top-level rhetoric, the role of the ruble and yuan in Russia-China trade is growing slowly. In 2020, the ruble accounted for just 5.7 percent of the total volume of Russian-Chinese payments, and the yuan accounted for only 6.3 percent. There is a pattern of growth, but it is sluggish: the figures for 2013, for comparison, were 2 percent for the yuan, and 1 percent for the ruble.

The de-dollarization process in bilateral trade between Russia and China is, however, under way—but largely through switching to the euro. In the last four months of 2020, Beijing and Moscow conducted 83.3 percent of their deals in euros. This also impacted on the process of de-dollarizing Russia’s export operations with the rest of the world, in which the dollar’s share dipped below 50 percent for the first time ever in the final quarter of 2020, to 48.3 percent.

Yet even the switch to the euro in Sino-Russian trade does not mitigate the risk of Western sanctions. Any correspondence bank facilitating a Russia-China transaction is likely to touch US dollars to some degree and, therefore, be subject to secondary sanctions. Certain euro-nominated cross-border payments rely on the SWIFT international payment system, which makes them a potential target for US sanctions. To get around this problem, Beijing and Moscow could have used China’s version of SWIFT: the Cross-Border Inter-Bank Payments System (CIPS), or Russia’s System of Transfer of Financial Messages (STFM). Yet so far, only one Chinese bank has joined STFM, and only twenty-three Russian banks have joined CIPS.

Since 2015, the Chinese government has actively promoted “panda bonds”—currently the only kind of debt security that foreign entities can issue on the markets of mainland China—as a way of internationalizing the yuan. Yet panda bonds remain expensive for the issuer: yield to maturity on the three-year bonds is 3.5 percent, which is significantly higher than similar securities fixed in dollars or euros on Western markets—not to mention the difficulty of then moving the yuan-denominated capital raised from such a transaction out of the country.

The first (and so far only) Russian company to issue panda bonds on the Shanghai Stock Exchange was the Russian aluminum giant Rusal in 2017, with an initial tranche priced at 1 billion yuan (about $145 million) and coupon rate of 5.5 percent. In doing so, the company set a successful precedent and invested in its reputation in China, though it has not followed through on plans to repeat the issuance. Other Russian companies and banks are not in a hurry to follow Rusal’s lead. Instead, companies including VTB Bank and RusHydro have made use of the Hong Kong capital market and “dim sum bonds,” which are denominated in the offshore renminbi. Another method of making the yuan international is through loans from Chinese development banks, and Russia is one of their biggest borrowers. According to Boston University, in 2000–2020, Russian companies borrowed more than $44 billion from Chinese financial institutions—most of it from banks directly under the control of the Chinese government.

Large Chinese loans to sanctioned or likely-to-be-sanctioned Russian businesses are often denominated in the yuan, especially if Chinese companies are involved with the project for which the loan is required. The sanctions risks for Chinese creditors are often hedged through high-level support for such deals from the Chinese and Russian leaders. This privilege, however, is only extended to projects that are strategically important for Moscow, such as Novatek’s Yamal LNG project in the Russian Arctic.

In other cases, therefore, it’s worth remembering that talk of using national currencies in bilateral payments is all well and good, but it cannot magic away anti-Russian sanctions, the risks of the Russian business climate, or the limitations of the Chinese financial regulators’ policy. Facilitating the improvement of bilateral economic ties through the greater internationalization of the yuan is a tempting prospect for both Beijing and Moscow. For China, it’s important to mitigate the risks of US sanctions to payment rails while steadily advancing the yuan’s internationalization on the global stage. For Russia, it’s essential to reduce the currency risks it faces amid economic sanctions.

Yet agreements on paper aren’t enough to change reality: at a time of global turbulence, Russian and Chinese companies that should theoretically be implementing de-dollarization and increasingly using the yuan will be inclined to use the most stable means of payment available to them. A combination of the yuan and the ruble is simply not capable of being that tool.

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