Ukraine crisis: yuan’s emergence as a safe haven a win for China’s economy

• The Chinese economy is the world’s manufacturer but it needs to import a vast amount of energy, raw material and food
• With commodity prices spiking due to Russia’s invasion of Ukraine and growing risks of imported inflation, the yuan’s resilience is a positive sign

The resilience of the Chinese yuan last week was noteworthy as the foreign exchanges reacted to unfolding events in Ukraine. While sensitive to the tragedy and human cost of war, forex markets necessarily reacted by adopting a risk-averse approach, seeking out currencies that are held to have safe-haven characteristics.

The renminbi would now appear to be one of a select group of safe haven currencies, and in present circumstances that is no bad thing for China.

News of Russia’s invasion of Ukraine initially triggered equity market sell-offs around the world, while in the currency markets, investors sought to secure currencies traditionally regarded as safe havens in times of major uncertainty, such as the Japanese yen, the Swiss franc and, of course, the US dollar.

This time, the yuan was also sought after. Indeed, it “has been trading like a safe-haven currency during the Ukraine crisis”, Khoon Goh, head of Asia research at Australia & New Zealand Banking Group in Singapore told Reuters, adding, “Prospects for further easing [in China] should see growth recover, hence keeping Chinese equities resilient even as US equities have sold off”.

Investors will surely have taken into account that Beijing has been extolling the virtues of yuan stability.

At the same time, with nominal yields on Chinese government bonds above the consumer price index in China, investors will have computed that their safe haven yuan was also offering a real renminbi-denominated return on government bond investments, an attractive proposition given that other traditional safe haven currencies such as the greenback and the yen don’t currently offer an equivalent inflation-adjusted positive return.

But if the foreign exchanges sought out some currencies, others were shunned.
Russia’s rouble tumbled in value as investors rationally exited Russian exposures, correctly anticipating broad international condemnation of Moscow’s actions and the imposition of meaningful financial and economic sanctions.

The presumption has to be that the Kremlin would have factored the negative impact of its invasion of Ukraine on the Russian currency into its wider calculations. But unless the rouble’s slide is fully reversed, the depreciation effect can only add to inflationary pressures in Russia at a time when the Russian central bank is already faced with an inflation rate near 9 per cent.

If the rouble plummeted in value, the euro edged weaker. The European Union’s proximity to the conflict zone, and its dependency on energy imported from Russia, surely lessened the allure of the euro as the crisis in Ukraine erupted.

Looking further ahead, the currency markets may yet conclude that prospects of future economic growth in Europe may now be crimped if EU policymakers ultimately conclude that the bloc’s continued dependency on Russian energy imports is untenable.

Energy prices spiked with Russia’s move into Ukraine, but it is important to remember that those same prices had already been elevated for months, as gas and oil production has struggled to keep pace with resurgent post-pandemic global demand.

Similar price spikes were also evident in the wider commodities space, from grains to metals, but, in each case, prices were already high before the latest moves.

It’s impossible to ignore the fact that both Russia and Ukraine are key suppliers of a large number of commodities that the world economy requires, and that the eruption of armed conflict following Russia’s advance into Ukrainian territory will impact commodity prices.

Russia and Ukraine are important suppliers of grains, such as corn and wheat. Russia is a major producer of oil and gas. Russia also supplies a substantial percentage of the aluminium, cobalt, copper, nickel, palladium and platinum essential for the world economy, as well as gold.

And that brings us back to China. The Chinese economy is the world’s manufacturer but that economic heft depends on a vast amount of imported energy, raw material and indeed food.

With commodities generally priced in US dollars, spiking greenback-denominated commodity prices will translate into elevated risks of imported inflation, but those risks become even more pronounced if the move higher in raw material prices is accompanied by local currency weakness.

Consequently, a stable to stronger renminbi mitigates some, if not all, of that risk of importing inflation.

Last week’s flight-to-safety approach, adopted by the currency markets, included the renminbi. That shows the confidence of the foreign exchanges in the yuan as a store of value and it also erodes the risk that China imports inflation via elevated commodity prices.

Author: Neal Kimberley, SCMP