China could become Russia’s economic lifeline as major economies hit Moscow with a barrage of sanctions.
On Saturday (Feb. 26), the US, the UK and the European Union increased their sanctions on Russia. They targeted Russia’s central bank, and booted major Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the global financial messaging system. The ruble plunged on Monday, prompting Russia’s central bank to nearly double its key interest rate to 20% amid concerns over runaway inflation.
While Russian banks can still make cross-border payments, without SWIFT it gets more expensive. “Payments can be done but by increased cost, at least 20%, because you need to use email, fax, etc., and there is also a certain degree of settlement risk,” said Alicia García Herrero, chief Asia-Pacific economist for France’s Natixis bank.
How far China is willing to help Russia cushion the impact of the sanctions is up for question. Fu Peng, chief economist at China’s Northeast Securities, argues that the Russia-China tie “greatly reduces the risk” for Moscow from the sanctions. But if China flagrantly breaches US sanctions, it risks jeopardising its own access to the US-dollar denominated international financial system.
“It’s not easy for China,” said García Herrero. “As sanctions tighten, say secondary sanctions are imposed or fully fledged commercial sanctions on oil imports, [China’s] room for manoeuvre will narrow.”
For now, China has said it will continue trading with both Russia and Ukraine as normal.
China also has the Cross-Border Interbank Payment System (CIPS) that targets global transactions in yuan. Analysts including Ren Zeping, the former chief economist of debt-laden property giant Evergrande, have argued (link in Chinese) that the SWIFT ban could prompt Russia to increase its reliance on the Chinese system, eventually boosting the use of the yuan globally. But given that CIPS still uses SWIFT as its messaging system, it is more likely a medium-term solution for Russia rather than an immediate one, according to García Herrero.
For its part, Russia has been building up the size of its foreign exchange and gold reserves to around $640 billion, which would in theory help it stabilize the ruble in case of market panic and volatility. About half of Russia’s reserves are held in dollars and euros, and around 20% in gold, while about 13% are in yuan.
At the same time, Russia may find a small measure of relief in the fact that it has become far less reliant on foreign loans in recent years.
Under the Chinese president Xi Jinping, China has strengthened its ties with Russia in sectors including energy, aviation, telecommunications, and media industry. In 2021, the countries’ bilateral trade hit a record high of $146.9 billion. Energy and agricultural products, including wheat, are among the biggest Russian exports to China.
Alongside that growing trade, Russia has also shifted away from the use of US dollars in its trade with China, instead increasingly preferring to use the yuan as settlement currency (included under “other” in the chart below), as well as the euro. According to Chinese state media, the yuan accounts for about 17% of trade settlements between the two countries.
Meanwhile, Russia is the biggest recipient of loans from China’s official sector institutions including state-owned policy banks, according to international research lab AidData. Those policy banks may continue lending to Russia as they are more insulated from western sanctions, say analysts.