As Russia is increasingly cut off, can China’s yuan find a greater role as a global currency?

  • Beijing has been trying to insulate itself from a global financial system that is heavily tied to the US dollar, but strict capital controls still hinder the yuan’s use
  • A lack of deeper financial reforms by Beijing could remain a difficult hurdle to the yuan’s internationalisation, even as Russia’s trade with China is rising

Russia’s invasion of Ukraine will have only a limited impact on Beijing’s push to internationalise the yuan, and its long-term success as a more widely utilised global currency will need to run parallel with China’s deeper financial reforms, according to analysts.

Their assessment came after US Federal Reserve chair Jerome Powell said at a US Senate Banking Committee hearing last week that the Ukraine war may “change the trajectory” of China’s moves to insulate itself from a global financial system that is heavily tied to the US dollar.

But in a note to its clients, research firm Rhodium Group ruled out the Cross-Border Interbank Payment System being a replacement for the Swift financial messaging system, with only 75 direct participants. The firm also stated that the basic constraints of China’s trade surplus and capital controls mean that the odds of the yuan’s international use expanding are “remote”.

“China is in a dilemma. On the one hand, it badly wants to internationalise its currency. But on the other hand, it is quite reluctant to open its capital account and liberalise its financial sector,” said Edwin Lai, the author of One Currency, Two Markets: China’s Attempt to Internationalize the Renminbi and an economics professor at Hong Kong University of Science and Technology.

Data from the International Monetary Fund (IMF) showed that the yuan is the world’s fifth-largest reserve currency, with central banks holding the equivalent of about US$319 billion worth of yuan reserves in the third quarter of 2021.

“The internationalisation of the renminbi still pales in comparison with the use of the dollar. Central bank holdings of the yuan are only about 2.5 per cent of their total reserves. By comparison, the dollar is over 50 per cent of reserves,” said Jeremy Mark, non-resident senior fellow at the Atlantic Council and a former IMF official, using the name of China’s currency.

He added that while the yuan is used for global trade invoicing, its use is still limited. Also, the yuan is not broadly employed for global investment purposes with a focus on Chinese securities.

Yuan – US dollar exchange rate

Price trends over time for how the Chinese currency trades against the US dollar

“The key reason for this is that China continues to impose restrictions on the free movement of capital in and out of the country, and the renminbi itself is not freely tradeable,” Mark said. “Until China liberalises its capital account and frees up controls on its currency, the renminbi’s international role will be limited.”

Information from The Observatory of Economic Complexity showed that China is the biggest trading partner for Russia. Additionally, official figures show that bilateral trade between the two rose by 38.5 per cent during January and February, year on year, marking the highest growth rate for the first two months of any year since 2010.

It was also reported that there have been enquiries from Russian firms about opening new bank accounts at Chinese state banks in Moscow, as a way to help mitigate the negative impacts on business transactions due to international sanctions.

“Even if Russia uses the renminbi more in its transactions, it will not help the international use of the renminbi too much,” Lai said. “Russia is not a very large economy at about 2 per cent of the global [gross domestic product].”

David Zweig, director at Transnational China Consulting, said the so-called new world order of China-Russia axis could reflect poorly on authoritarian rule after the invasion of Ukraine, and President Xi Jinping’s establishment of a friendship with Russian President Vladimir Putin and Russia that has “no limits” could not last long.

“An authoritarian government [is a reason that] market actors are reluctant to make use of a currency, whose issuing government cannot give assurances that property rights will be respected and contracts will be fully enforced,” said Benjamin Cohen, distinguished professor emeritus at the University of California, Santa Barbara. “The rule of the Chinese Communist Party is notably arbitrary.”

Chinese researchers have suggested that China’s digital yuan payment system could also serve to counter Western sanctions over Russia, as the development of the e-yuan may help reduce reliance on bank accounts and bypass financial intermediaries.

Lai, the professor and author, estimated in his book that the yuan could become a distant third payment currency globally by 2030, with a share of about 6 to 7 per cent compared with less than 2 per cent today, following the US dollar and Euro but surpassing the British pound sterling.

“To challenge the [US dollar], the [yuan] will need to gain trust from the global community,” said Marcus Vinicius de Freitas, visiting professor of international law and international relations at China Foreign Affairs University in Beijing, who is also a senior fellow at the Morocco-based think tank Policy Center for the New South.

“China should improve its global settlement and clearing instruments to facilitate international transactions,” he also said, adding that trust is the most critical factor, and it takes time to build.

Author: Kandy Wong, SCMP

You might also like