World Economy
The Yuan as the Leading Foreign Currency in the Russian Market

It is the Chinese yuan that is becoming the most popular “friendly” currency among both Russian entrepreneurs and citizens, who are converting their dollar savings into yuan. Demand growth is trending, and the position of the yuan in the Russian foreign exchange market is strengthening month by month, writes Alexander Losev,  financial expert, Member of Presidium of the Council on Foreign and Defence Policy (SVOP).

Hard and soft currency

The world, including Russia since the early 1990s, has been accustomed for decades to the fact that there are only two types of currencies: hard currency and soft currency.

A hard currency is a strong currency with a stable exchange rate, a currency that is freely convertible globally and is used in international settlements; it is used for reserves and savings. Its purchasing power demonstrates long-term stability; it is a currency with low inflation issued by a country with reliable legal and government institutions, ensuring the predictability of monetary and fiscal policy. It is also the currency of a country where politics are stable and unchanging.

Conversely, a weak or soft currency is a currency that is expected to fluctuate or depreciate erratically against other currencies, and its lightness or softness is usually the result of weak legal institutions, as well as political or fiscal instability.

In 2022, this unshakable currency dichotomy collapsed.

Now, no currency in the world, including the US dollar, is "hard" anymore in the sense of the original definition.

The large-scale unsecured issuance of major world currencies, record inflation and sharp changes in monetary policy, social and economic instability, political risks, and the weaponising of the EU and US financial systems through the use of sanctions and hybrid war have put an end to the firmness and strength of the dollar, euro, British pound and Japanese yen. Meanwhile, the once “soft” currencies are gaining strength because they are backed by real industrial capacity (Chinese yuan) or commodities (Russian ruble), as well as politically stable regimes.

Friendly and unfriendly currency

The events of 2022 divided all currencies of the world into “friendly and unfriendly” for Russia’s government, banks, businesses and citizens. At the end of May, against the backdrop of new sanctions and an attempt to engineer an artificial default on Russian Eurobonds, Finance Minister Anton Siluanov called the dollar and the euro toxic currencies for Russia. Following the Ministry of Finance, representatives of the Central Bank also spoke about the toxicity of the dollar and the euro. The dollar, the euro and the Western financial system as a whole were being used as a weapon of economic warfare against Russia. This led to the freezing of Russian assets and the disconnection of banks from the SWIFT payment system. This made it impossible not only to conduct a significant volume of settlements in dollars, yen, euros and other European currencies, but also store these currencies in accounts without the risk of them being blocked, frozen or confiscated. The growing escalation of the conflict around Ukraine, including support by NATO countries for the actions of the Armed Forces of Ukraine in the Donbass and further threats against the Russian financial and energy sectors, launched a real avalanche of “devaluation” of the balance sheets of Russian banks. Threats of sanctions against the National Clearing Centre indicated the risks of a complete cessation of trading in dollars and euros on the Moscow Exchange.

With the closure of Western markets and the blocking of export-import operations with Europe, the United States and a number of Asian states, trade with countries that did not support anti-Russian sanctions and the transition to settlements in national currencies, primarily in Indian rupees and Chinese yuan, began to grow rapidly. India became the first major economy in the world to return to a practice of mutual trade, similar to one that worked out in the days of the Soviet Union. But given the scale of trade between Russia and China, and (according to forecasts, the Russian-Chinese trade turnover will reach $190 billion this year and a wide range of mutual trade goods), it is the Chinese yuan that is becoming the most popular “friendly” currency among both Russian entrepreneurs and citizens, who are converting their dollar savings into yuan. Demand growth is trending, and the position of the yuan in the Russian foreign exchange market is strengthening month by month. In August 2022, for the first time, the yuan overtook the US dollar in terms of trading volume on the Moscow Exchange, and a month earlier, the euro lost its honourable second place in the Russian currency market.

The Bank of Russia, in its reports, notes “in the current geopolitical conditions, the growth in the trading volume in the currencies of friendly countries is a positive trend, which reflects the general desire of economic participants to reduce sanctions risks, as well as the reorientation of exports and imports to counterparties from friendly countries.” Even the structure of cross-border transfers of individuals began to change in favour of the yuan in the summer, which also reflects the reorientation of the Russian economy towards friendly countries.

De-Dollarization of the Economy as a Way to a New Economic Order
The change in monetary policy of China and Russia is the most dramatic turn since the Bretton Woods Conference in 1944.

Currency is currency

Years of ruble weakness and instability have led to the significant dollarization of the Russian economy and savings structure. The presence of foreign currency in the accounts of banks, companies and citizens was considered a prudent practice, hedging the devaluation risks of the ruble and simply, comme il faut, of proper investment behaviour. The Western sanctions war has changed the attitude of Russians towards "toxic" currencies, but has not changed their attitude towards the foreign exchange market as a whole.

In its July report, the Bank of Russia wrote, “sanctions risks associated with the storage of significant foreign exchange liquidity in the perimeter of the Russian financial system remain high. In order to reduce the vulnerability of market participants, it is advisable to diversify the placement of foreign currencies" and implement measures to decrease dependence on Western currencies. In August 2022 the “Overview of the risks of financial markets” was published. There, the Central Bank of the Russian Federation noted another important aspect of the demand for the yuan among Russian market participants: “Buying yuan allows professional market participants to manage a position in unfriendly currencies, primarily in US dollars, since there is a high correlation between the yuan/ruble and dollar/ruble rates. On the long-term horizon, these currency pairs change in the same direction, insignificant differences in the movement of rates are observed only in certain short-term periods. With the expansion of the analyzed range, the correlation of the two currency pairs increases, which indicates the possibility of replacing US dollars with yuan as a hedging asset.”

The threat of correspondent accounts in American and European banks being blocked and the impossibility for Russian banks and large exporting companies to manage currency positions and hedge currency risks using financial derivatives force them to completely replace dollars and euros in accounts with yuan, as well as convert a significant share of current foreign exchange earnings into yuan.

Foreign exchange reserves

The Bank of Russia and the Ministry of Finance have recognised the need to create reserves in yuan and gold, as well as the currencies of other friendly countries with which there is active trade turnover. Indeed, the central banks of various countries are trying to accumulate reserves precisely in the currencies of countries which are home to companies engaging in international trade and borrowing via foreign capital markets. This is necessary to balance the trade balance or current account in case of unfavourable external economic developments or in the event of imbalances in the foreign exchange market.

The Bank of Russia indicated in one of its reports that since 2014, it has taken into account two possible types of crises in its policy. The first type is a traditional financial crisis: reserves were created in the stable currencies of the G7 countries, because most trade and external borrowing were carried out in these currencies. The second type is a geopolitical crisis: the CBR had to mitigate the consequences of a situation where reserves are needed and where there is a minimal risk them being frozen due to Western sanctions. Eight years ago, after the “Crimean Spring”, the Bank of Russia began to increase the share of the yuan and gold in its international reserves, bringing these “geopolitical” reserves in alternative currencies and gold to almost half of the total reserves by the beginning of 2022.

In the next few years, the yuan is likely to serve as the basis for the international reserves of the Russian Federation, but we can expect a larger range of "friendly" currencies, including the currencies of the BRICS and the Persian Gulf monarchies.

Unfortunately, it is impossible to fully rely on the yuan as a reserve currency, given that the Chinese economy can also suffer from imbalances and capital outflows. Most importantly, the People's Bank of China is trying to manage exchange rates and protect its financial system, which means that it is not going to follow the path of the US Federal Reserve and flood foreign markets with yuan to completely replace the dollar in world trade.

Capital markets

Russian citizens now save their money via ruble deposits, but investors are looking at the yuan as an investment currency as well. The growth of yuan in bank accounts dictates the need to place them in financial instruments to receive investment income. The transition of large exporters not only to settlements in Chinese yuan, but also to borrowing in yuan began to form a new yuan segment of the capital market. The largest Russian companies have already begun issuing bonds in yuan for circulation in the domestic market.

What is surprising here is that Chinese banks are not yet in a hurry to lend to Russian companies, and Chinese investors are not yet even theoretically going to buy the bonds of the Russian Ministry of Finance denominated in yuan, if they are issued. The external borrowing market is still closed for Russian issuers due to high geopolitical risks. Thus, Russia is forming its own investment market for the yuan, which is minimally connected with the capital market of China itself, although the potential interest in the Chinese exchange market can be very high.

There are also movements in the share segment. SPB Exchange, the traditional trading platform for foreign stocks, plans to start trading the shares of four Chinese companies: PetroChina, Sinopec, Chalco and China Life. But you need to be patient. Opening correspondent accounts in Chinese banks and accounts in depositories and clearing centres as well as creating "bridges" for cross-border settlements and infrastructure for accounting for Chinese securities could take a long time.

Ruble or yuan?

"All happy families are alike, but every unhappy family is unhappy in its own way." These words from Leo Tolstoy's novel "Anna Karenina" could be applied to both economies and national currencies. Currencies do not exist outside their economies and outside the financial market. Economic imbalances and risks of recession, lots of debt, high inflation and low or negative real rates can create negative dynamics even for once-“hard” currencies, while the dynamics of the currencies of emerging economies are even more unpredictable. The strength and weakness of the currency depends on both economic prospects and geopolitics. Nevertheless, the backing of the ruble with energy exports, metals and other resource commodities forms the basis for expanding the use of the ruble in international settlements, which may make the ruble a competitive currency against the yuan in some segments of alternative currency settlements. One can not rely on past models of currency strategies in a changing world. The ruble also has a chance to become a "hard" currency.

World Economy
National Currencies in International Settlements
Alexander Losev
Geopolitical risks that were unimaginable just a few years back are turning the idea of reliable currencies and global financial centres upside down. The countries that created and controlled the existing global financial system in mid-20th century, receiving global rent or seigniorage in the process, have dealt the most devastating blow to their own system, writes Valdai Club expert Alexander Losev.
Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.