How the war in Ukraine could boost China’s global financial ambitions

Sanctions imposed in response to Russian President Vladimir Putin’s invasion of Ukraine dealt a devastating blow to his country’s financial system and left the ruble down more than 30% this year, causing currency repercussions from Eastern Europe.

But the renminbi, the currency of Russia’s closest strategic ally and main trading partner, has remained remarkably stable.

The Chinese currency has barely budged since the start of the Russian invasion, even hitting a four-year high of around 6.31 Rmb against the dollar, extending a months-long period of resilience despite a recent slowdown in growth. of the Chinese economy.

Its relative stability has fueled rumors that the currency could become a safe haven asset, sheltered from the geopolitical turmoil that has rocked markets around the world. It would give a boost to more than 20 years of work by Beijing to globalize its currency by increasing its use in foreign trade and as a store of value in international finance.

“We are at a stage where the market no longer sees the renminbi as a highly speculative currency,” said Kelvin Lau, senior Greater China economist at Standard Chartered, adding that its recent stability was likely to bolster its reputation as a safe haven. . in times of stress.

What does this have to do with the dollar and the broader financial system?

Wider use of the renminbi across the world would theoretically make it easier for China to break through what it sees as US and Western dominance in global payments and finance – a power that has been wielded in recent days to punish the Russia.

There are signs of progress: in recent months, the Chinese currency has finally overtaken the Japanese yen in Swift’s international payments rankings to take fourth place for the first time. Meanwhile, a renminbi globalization index released by Standard Chartered showed its global position hit an all-time high.

But China’s real ambition is to go beyond reliance on Western-controlled financial infrastructure such as Swift, from which Russia has been partially excluded. That’s why it spent years developing its Renminbi-denominated Cross-Border Interbank Payments System (Cips), through which payments increased by around 20% to Rmb45.2 billion ($7.1 billion). ) in 2020.

Cips has around 1,200 member institutions in 100 countries and remains relatively light in international payments compared to Swift, which has around 11,000 members. But Russia’s own cross-border clearing system is far less developed, with around 330 institutions listed in far fewer markets, including Cuba, Armenia, Kazakhstan and Iran.

Chinese media have flagged the opportunity presented by Swift’s ejections, with state news agency Xinhua noting that “Russian financial institutions expelled from Swift may have to participate in China’s Cips” in light of the limited use of the Russian clearing system.

And as payment networks Visa, Mastercard and American Express have announced their intention to suspend operations in Russia, more and more banks in the country have also raised the possibility of issuing co-badged cards linked to both Russian international payment systems Mir and Chinese UnionPay.

Benjamin Cohen, a veteran scholar of international monetary relations, said there was no doubt that sanctions against Russia would further incentivize countries such as Iran, North Korea and Venezuela to diversify away from the dollar.

“Every time the United States and its allies weaponize access to the dollar, it creates an additional incentive for the Chinese to take advantage of it at some point,” Cohen said. “It’s not a case of Chinese wolf at the door [of US dollar hegemony]it’s more of a termite thing in the woodwork.

This corresponds to China’s long-standing ambitions.

“The events of the past few days will give a boost to countries and institutions that want to circumvent the dollar-based international financial system,” said Eswar Prasad, an economist and former chief of the IMF’s China division.

Why does China want to internationalize the renminbi?

Beijing’s desire for a global currency at par with the dollar dates back decades, but was reinvigorated in the early 2010s when US sanctions on Iran highlighted China’s own vulnerability to financial sanctions. systems of Western powers.

China launched Cips as a renminbi-based rival to Swift in 2015, after Russia was hit with sanctions for its invasion of Crimea the previous year.

“It was only after the Crimean crisis that China accelerated the pace of internationalization of the renminbi,” said Bruce Pang, head of research at China Renaissance.

Line chart of StanChart's Renminbi Globalization Index showing renminbi internationalization increased in 2022

This greater openness backfired in 2015, when a one-time devaluation of the renminbi by China’s central bank caused unprecedented capital flight and a prolonged fall in the currency. The rout only ended when Beijing implemented strict capital controls that remain largely in place.

Tommy Wu, chief China economist at Oxford Economics, said Beijing had learned from its mistakes but would feel renewed pressure to boost the currency’s global role following recent sanctions on Russia.

“Beijing will have more of a sense of urgency now,” Wu said. “But they still have to look at what happened in the past and what they can realistically do.”

How much is the renminbi already woven in Russia?

Since Russia launched its invasion of Ukraine, China has been exceptional among the world’s major economies in refraining from sanctions or even outright criticism. This is because the stakes are high on both sides to maintain cordial Sino-Russian relations.

Russia is a major supplier of oil and natural gas to China, and Moscow and Beijing have made removing the US dollar from their trade deals a priority since 2014, in response to the western backlash to the invasion of China. Crimea by Russia. The central banks of both countries signed a currency swap agreement that year, and it was recently renewed for Rmb 150 billion.

In the first quarter of 2020, the greenback’s share of Sino-Russian trade fell below 50% for the first time, according to Russia’s central bank, while the combined share of the ruble and renminbi in settlements rose to about a quarter.

That’s a big and growing sum: bilateral trade grew by more than a third to nearly $150 billion last year, according to China Customs. In February, the two countries pledged to take the total to $250 billion as Putin traveled to Beijing for the Winter Olympics, where he revealed new oil and gas deals with China worth over $117 billion.

The renminbi also takes up a large chunk of Russian foreign exchange reserves thanks in part to a 2019 deal allowing China to buy Russian gas in its own currency. A January report from the Russian central bank showed renminbi assets worth $73 billion at 13% of total reserves.

How far could China go to support Russia?

Analysts say the scope of sanctions against Russia so far could allow China to use its renminbi-based payments infrastructure to help circumvent measures intended to cut Moscow off from global finance.

China’s banks with an international presence are unlikely to rush to help from Russia, Wu said, but smaller domestic lenders not reliant on dollar-dominated Western finance could provide services in renminbi. and Russian institutions could eventually route global transactions through China’s vast state-owned banks.

However, Pang said concerns about harsh retaliation from Western countries — including possible sanctions against China itself — would seriously limit the ability of Chinese financial institutions to offer more substantial support to Russia.

“That’s why major Chinese financial institutions have complied with previous US sanctions against Iran and Russia,” he said. “China must carefully manage the pace of this operation and give Western countries no excuse for sanctions, bans or boycotts.”

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