The People’s Bank of China’s decision to extend trading hours in the interbank foreign exchange market in early June was seen by Jingyang Chen, Asian FX strategist at HSBC, as a sign that China wants to give market participants more flexibility and thus encouraging the internationalization of the RMB.
China would also welcome a narrowing of the gap between onshore and offshore yuan trade.
But the development that most interests currency analysts is China’s determination to forge closer ties with Russia despite international condemnation of the latter’s invasion of Ukraine.
Trade between the two nations grew by more than a third last year, but has accelerated further since Russian forces entered Ukraine on February 24.
The yuan hasn’t done particularly well since the start of the conflict – although this is the result of other factors such as the broader strength of the US dollar and capital outflows due to weak growth prospects in China in a backdrop of strict Covid lockdowns.
Yuan shows ‘high volatility’ in 2022
It fluctuated little between late February and early March and after rising slightly, stabilized in a narrow range for another month or so. Then at the end of April, it depreciated sharply against the dollar before correcting some of its losses in the second half of May.
Galvin Chia, emerging markets strategist at NatWest Markets, observes that the CNY is now showing very high levels of volatility not seen since around 2018, with daily movements of 0.4% or more (vs. 0.1 -0.2% at the end of 2021) and is currently more likely to be influenced by global market factors like US inflation or bond yields.
China’s support for Russia has clearly had a significant positive impact on trading volumes of yuan against the Russian currency.
Yuan-ruble volumes have increased by more than 1,000% since the start of the war and the two countries find themselves in the same boat with their desire to reduce their dependence on the American dollar.
Late last month, Reuters reported that the Bank of Russia was considering imposing negative rates for dollar and euro deposits to encourage greater use of the yuan.
There’s no better reason to shift energy trading to a currency other than the US dollar, suggests Ipek Ozkardeskaya, senior analyst at Swissquote.
“We’re talking about two big economies here,” she says. “If one of the world’s largest oil and commodity reserves started trading in yuan with the world’s largest oil and commodity customer, it would have a massive effect on the dynamics of the foreign exchange market.
Petro-yuan could compete with petro-dollars and we could imagine other commodities trading moving towards yuan.
Birth of the petro-yuan?
But some analysts remain convinced. For example, Geoffrey Yu, FX and macro strategist for EMEA at BNY Mellon notes that Sino-Russian bilateral trade is dwarfed by China’s trade with the rest of the world and says it is not significant enough to make a big difference in the use of CNY.
“If there is a broader plan to increase CNY pricing for commodity trading across a wide range of underlyings such as copper, steel or coal, then that’s another story – but there is little evidence of that,” he says.
Yuan-ruble volumes on Russian exchanges were up more than 2,000% year-on-year in May, but Chinese trading volumes were down 60%, suggesting that Russia has become more dependent on China than the reverse.
“In terms of the broader picture of the global use of the yuan, it’s hard to say so soon,” Chia says. “Currency trading and settlement trends operate on the scale of years, not months.”
As for the underlying point of a Chinese “strategy”, it suggests that the Chinese approach at this stage is not convincing enough to qualify as a strategy.
Trump’s trade wars
“It has been some time since authorities pushed the internationalization of the RMB more broadly in the early to mid-2010s, and throughout the Trump administration’s trade wars and the Covid pandemic, currency interventions or capital account have remained fairly common,” says Chia.
In the medium term, the renminbi appears to be influenced more by monetary policy and economic news than larger mutual trade between China and Russia, agrees Alex Kuptsikevich, senior market analyst at FXPro.
“This can be explained by the fact that the Chinese economy and trade balance are too large to receive a noticeable impact from recent developments,” he says.
The yuan has a “zero correlation” with the conflict in Ukraine
According to Jeff Halley, senior APAC market analyst at Oanda, the yuan showed no correlation to the Russian conflict, with USD/CNY trading sideways between 6.3 and 6.4 from January to the end of April, completely ignoring the conflict. outbreak of hostilities in February.
“The yuan depreciated sharply from late April as the People’s Bank of China began to weaken it amid US dollar strength internationally,” he added.
“The weakening was a response to the sharp slowdown in China’s domestic economy as the Covid lockdowns began to bite, the logic being that a weaker yuan would boost exports and therefore actively and SMEs.”
It’s not just China that supports Russia
It has been suggested that its support for Russia has increased the likelihood of US sanctions against China, which could make major central banks more reluctant to hold the yuan.
However, Naeem Aslam, chief market analyst at AvaTrade, notes that China is not the only country supporting Russia.
“For example, countries like India are now openly buying Russian oil,” he says. “Russia is now India’s biggest trading partner in terms of oil supply – bigger than even Saudi Arabia. Does that mean central banks should also restrict the Indian rupee?”
Politically, the Sino-Russian alliance leads to a more tense relationship between the United States and China and increases the likelihood of sanctions.
Chinese sanctions “unsustainable”
However, extending sanctions to China would not be so straightforward for the West, as banning trade with China would drive inflation to unsustainable – and ultimately unmanageable – levels.
For this reason, Ozkardeskaya believes that cutting off Russia and China at the same time is not a viable option.
Halley also thinks it’s highly unlikely the US will sanction China until it starts supplying high-tech weapons to Russia.
Economically, China has far more to lose by being cut off from Western markets than it would ever gain by isolating itself from Russia, while from the American point of view, sanctions against China are not desirable because they would increase supply chain disruption and inflation.
Chinese banks reluctant to fund Russian oil deals
“Chinese banks are already reluctant to finance purchases of Russian oil by Chinese companies and Chinese insurers are also refusing to insure Russian maritime deliveries,” he adds.
“Even India – a huge buyer of discounted Russian oil – in its last terms of purchase from Rosneft included that the company bear all insurance risks.”
Chia also doesn’t think capital controls on foreigners are a likely risk.
“In this period of Covid-era capital account management, the focus has been on controlling the much larger pool of domestic capital and preventing outflows from there,” he concludes.
“China’s liberalization of bond markets to foreign participants – and thus the need for policies favorable to foreign capital – is a long-term project and should continue.”