China’s currency has suffered some pain since Russia invaded Ukraine. The yuan was trading at around 12.6 roubles on February 24, since when it has dropped as low as 7.85 and was bumping along at 8.86 on July 13.
“The performance of the yuan since the start of the conflict in Ukraine is skewed to the downside, and we think that is likely to be the case in the short term,” says Naeem Aslam, chief market analyst at AvaTrade.
This is of course good news for any Russian firm buying goods or services in yuan. But it is not just Russian firms that see value in paying this way – at the end of June, Reuters reported that India’s biggest cement producer was importing a cargo of Russian coal and paying using yuan.
The report quoted sources who suggested that other companies that have placed orders for Russian coal were also paying with yuan.
There has been concern in the Chinese media about the potential for wide-ranging sanctions on that country given the relatively low probability financial markets had initially ascribed to the possibility of Russia being sanctioned.
Central banks
Galvin Chia, emerging markets strategist at NatWest Markets, believes sanctions have made central banks think more about diversification and alternatives to the dollar.
Sanctions on Russia have clearly weakened the dollar appetite of many central banks as they figure they could lose a big chunk of their FX reserves in the blink of an eye if their country’s relationship with the US deteriorated.
The dollar’s share of allocated reserves has fallen steadily over the last six years, albeit it is still the most widely held reserve currency.
A survey of 30 leading central banks conducted by UBS between April and June 2022 found that 85% had invested or were interested in investing in the yuan, compared with 81% last year. These findings prompted UBS’s head of strategy for global sovereign markets to refer to a gradual erosion of the dollar and the emergence of a multipolar currency system.
BNY Mellon reckons the softness in the yuan since the start of the Russia-Ukraine conflict is largely due to broader strength in the US dollar and capital outflows owing to weak prospects for growth in China amid the lockdowns there.
The Sino-Russian financial and trading relationship is not large enough to make a big difference to CNY usage
Geoffrey Yu, BNY Mellon
“The yuan has, however, performed better now that mobility restrictions appear to be easing,” says the bank’s FX and macro strategist, Geoffrey Yu. “Furthermore, the apparent loosening of certain regulatory restrictions on tech companies could boost sentiment in equity markets and encourage inflows. Our custody data suggests stabilization in both equity and fixed income flows in recent weeks.”
He refers to anecdotal evidence of higher CNY-RUB volumes, but also notes that most CNY-related flows pertain to much larger trading relationships and capital inflows into China.
“The bottom line, in our view, is that the Sino-Russian financial and trading relationship is not large enough to make a big difference to CNY usage,” adds Yu. “However, if there is a wider project at hand to boost invoicing in CNY for the commodity trade then that is a different story.”
Dynamics
If one of the world’s largest oil and commodity reserves started trading in yuans with the world’s biggest oil and commodity client, it would have a massive effect on FX dynamics, acknowledges Ipek Ozkardeskaya, senior analyst at Swissquote.
“In this sense, China’s close ties with Russia could help weaken the dollar’s hand as a global base currency,” she says. “If Russian oil is traded in terms of yuans, petro-yuans could compete with petro-dollars – and we could also imagine other commodities’ trading shifting to yuans.”
History teaches us that confidence in a currency rises and falls much more slowly than a country’s economic power and is a process that lasts years or even decades.
Alex Kuptsikevich, FXPro senior market analyst, says the movement towards regional currencies and the dollar decline started a few years before the pandemic when the larger emerging economies were actively negotiating a mutual settlement in local currencies.
This year’s sanctions have shown countries such as China and Saudi Arabia why using the dollar outside trade with the US can be risky, especially if you are not a perpetual political friend, Kuptsikevich says.
“For now, it seems that imposing sanctions on Russia and freezing foreign exchange reserves in dollars and euros will accelerate the formation of broader diversified baskets of currencies,” he adds. “The weights in these baskets could be closer to a country’s or region’s share of mutual trade, moving away from the previous peg to debt market depth, which gave disproportionate weight to the dollar as well as the euro, yen and pound.”
