China has been actively seeking to reduce its reliance on the US dollar for over a decade, driven by concerns about risks stemming from the US economy and its aspiration to expand its sphere of influence. However, in recent times, the impetus to insulate China’s economy from dollar-based sanctions has emerged as a crucial factor for decoupling from the dollar, particularly as tensions rise between China and Taiwan.
The West’s sanctions on Russia following its invasion of Ukraine inadvertently benefited the Chinese yuan. By limiting Moscow’s access to US dollar transactions, the sanctions led to a significant increase in the use of yuan for Russian imports. In fact, the share of Russian imports paid for in yuan surged from 4% to 23% in the previous year. The yuan even surpassed the dollar as the most traded currency on the Moscow exchange for the first time in history.
China’s efforts to internationalize its currency predate the conflict in Ukraine, but the importance of boosting the yuan’s global presence has grown. Between March 2021 and March 2023, the yuan’s share in the trade finance market, which underpins 80% of world trade, more than doubled, as per data from Swift. China is also actively encouraging other countries to adopt the yuan for international transactions. Agreements have been reached with countries like Argentina and Brazil to settle Chinese imports in yuan rather than US dollars.
Furthermore, China has taken steps to protect itself from potential sanctions by diversifying its currency use. In a landmark move, a Chinese company used yuan to purchase liquefied natural gas (LNG) from a French multinational, marking the first international LNG transaction conducted in China’s currency. By reducing dependence on the dollar for essential imports like energy, China aims to enhance its energy security and insulate itself from potential economic repercussions of sanctions.
In its pursuit of financial self-reliance, China has developed alternatives to traditional systems. It has created an alternative to Swift, the international interbank messaging platform, and introduced a digital currency called the e-CNY. These technological advancements are part of Beijing’s broader campaign to position the yuan as an attractive alternative to the dollar.
However, China faces challenges in fully internationalizing the yuan. The government’s control over capital flows and its desire to maintain domestic financial stability limit the market’s role in determining the currency’s value. The Chinese Communist Party sees a prominent state role in the economy as vital to maintaining political control. While China aims for a more significant international role for the yuan, it must balance this with domestic financial stability to ensure the country’s ongoing economic functioning and political stability.
In summary, China’s use of the yuan as a means to insulate against sanctions and reduce reliance on the dollar has gained momentum. By expanding the international use of its currency, China aims to protect its economy and increase its influence on the global stage. However, challenges remain in fully liberalizing the yuan due to the government’s control over financial markets and its priority of maintaining domestic stability.