In sanctioning the Russian central bank, the United States and its allies have delivered a substantial shock to Moscow.
The power of the decision derives not so much from the sanctioning of a central bank, but rather because of the number of participating countries. China will be watching closely.
No one knows exactly how much of Russia’s US$640 billion of foreign exchange and gold reserves are now inaccessible, but the country has effectively lost access to hundreds of billions of dollars.
The central bank surely must have thought it was protecting itself by de-dollariszing its reserves after 2014, investing more in euros, gold and renminbi.
But since all transactions with the Russian central bank have been sanctioned, Russia will find it difficult, if not impossible, to use even its $130 billion worth of gold reserves as foreign economies will hesitate to trade with a sanctioned country.
This is a serious issue for China’s policymakers since the Russian sanctions underscore the vulnerability facing any country that has tense relations with the US and whose central bank holds significant reserves for geopolitical insurance.
China has a lot of foreign reserves but also, in a sense, very few. The $3.4 trillion of reserves on the People’s Bank of China balance sheet might sound like plenty, but it is not. If it were, Beijing wouldn’t need to keep in place its controls on capital outflows.
Practically, China has three approaches should it seek to reduce its vulnerability to the kind of sanctions that Russia is facing.
The first approach is to find assets to invest in that are safer than the US dollar or the currencies of any other countries that might seek to impose restrictions on China.
Finding truly safe assets to invest in will be extremely difficult, especially as shifting away from the West may decrease returns while amplifying risks.
Russia’s current funding squeeze springs from the fact that it is not just the US, but also the European Union, the United Kingdom and Japan that have coordinated to block its use of reserves.
The second approach is to accelerate the renminbi’s, or yuan’s, international profile to reduce China’s need for foreign exchange. But the renminbi accounts for as little as 15% in settling even China’s own trade.
Beijing has strong incentives for increasing the renminbi’s use, so the limited progress suggests significant challenges. News that Saudi Arabia might accept the renminbi for some oil sales to China is of symbolic importance.
Since Saudi Arabia has a $15 billion trade surplus with China, receiving that amount in renminbi raises questions as to what Saudi Arabia would do with all that Chinese currency while the riyal remains pegged to the dollar.
While the renminbi has proved an attractive destination for the world’s bondholders, that’s hardly proof of internationalization. Foreign investors buy a lot of Indonesian bonds, but that doesn’t turn the rupiah into a reserve currency.
In any case, currency dominance in the international monetary system is characterized by inertia – things change slowly.
We may be only a few short years away from China becoming a larger economy than the US in dollar terms, but that is only one part of the equation determining the international status of the renminbi.
China’s most reliable path toward reducing its vulnerabilities may be to enhance its economic self-reliance. In fields like technology, agriculture and energy, Beijing is already doing some heavy lifting to reduce its reliance on imports and depend more on ‘internal circulation.’
Import substitution may well become an even more visible feature of Chinese economic policy. One by-product could be to keep China’s borders closed since tourism has been the largest current account drain in the last decade.
When Chinese households enjoy vacations at home rather than overseas, the economy avoids a drain that amounted to $220 billion in 2019.
A more inward-looking China suggests future challenges for the economy and certainly bad news for countries that have built up a profitable dependence on Chinese demand.
When the dynamics of geopolitics shape economic policy, growth, unfortunately, becomes a residual.
David Lubin is head of emerging markets economics at Citigroup. He is also an associate fellow of the Global Economy and Finance program at Chatham House.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of China Factor.