Close Russia Ties Could Worsen China's Financial Woes

Western sanctions imposed on Russia in response to its invasion of Ukraine look set to accelerate the economic decoupling underway between the United States and China, especially if Beijing seizes the opportunity to enhance the global appeal of its currency and financial architecture, Diana Choyleva, chief economist at Enodo Economics, argued in an essay for Foreign Policy.

Photo Insert: Washington's demonstration of how much raw financial power still remains in the hands of the West can only strengthen China’s determination to stick to its own ideological path and carve out a sphere of geopolitical influence.

By blocking Moscow’s access to nearly half of its $630 billion in foreign exchange and gold reserves, Washington has offered a demonstration of how much raw financial power still remains in the hands of the West.

That can only strengthen China’s determination to stick to its own ideological path and carve out a sphere of geopolitical influence. Given that about 75 percent of China’s goods trade is still invoiced in dollars, being barred from the dollar-clearing system and SWIFT would have unfathomable consequences for both Chinese banks and the global economy.

China’s maintenance of capital controls is one of the main obstacles to the yuan becoming a rival to the dollar. But that could change if a cross-border digital currency system structured around the yuan and operating on standards set by Beijing came to be used in China’s putative sphere of influence.

In that case, the People’s Bank of China (PBOC) would have such clear visibility and control over payment flows that China would probably consider making the yuan fully convertible.

China set about internationalizing the yuan in response to the shock of the 2008 global financial crisis. The yuan’s use in cross-border trade increased, central banks started holding it in their reserves, and it was added to the basket of currencies that make up the International Monetary Fund’s reserve asset: the special drawing right.

Yuan internationalization initially seemed to be working—albeit very slowly.

However, the process peaked in 2015 when the PBOC bungled a change in the mechanism for setting the renminbi to US dollar’s daily central parity and a nearly 3 percent decline in two days caused the market to scream devaluation.

So as the yuan declined and renminbi internationalization began to reverse, it became clear that success up to that point had been driven by foreigners’ willingness to hold an appreciating currency.

China was forced to reassess. Beijing needed give foreigners a better reason to hold onto the yuan rather than simply counting on the currency to keep appreciating.

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