top of page
  • Zongyuan Zoe Liu
    • Feb 29
    • 17 min read

China’s Attempts to Reduce Its Strategic Vulnerabilities to Financial Sanctions


Liu CLM Issue 79 March 2024
.pdf
Download PDF • 457KB

Logo of the Yuan and SWIFT

Chinese policymakers have been aware that financial security is part of national security since the 1997 Asian financial crisis. During the past decade, especially since the escalation of U.S.-China trade tensions since 2018, anxieties among Chinese policymakers over the country’s financial security have increased. In this context, China has accelerated development of an alternative global financial system with the goal of reducing its strategic vulnerabilities to potential sanctions. This article presents three primary strategies that the Chinese government has pursued to achieve this goal: supporting and expanding regional and multilateral currency and financial cooperation through various non-Western partnerships; increasing broader use of the renminbi in international trade and investment while also promoting the building of a renminbi-based international financial infrastructure; and, as the global economy is decarbonizing, improving the role of the renminbi in global commodities pricing.

Chinese State Councilor and Foreign Minister Wang Yi characterized U.S.-China relations through the course of 2023 as “having encountered severe difficulties at the beginning of the year…but eventually the bilateral relationship stopped deteriorating and achieved stabilization.”[1] As Minister Wang put it, the two sides “reestablished communications and dialogue after some hard work,” including several U.S. cabinet-level officials’ visits to Beijing and visits by Chinese delegations to Washington, which culminated in the Biden-Xi summit during the APEC Summit in San Francesco. However, there are no signs suggesting that these meetings have convinced Chinese policymakers that the U.S. government’s export controls, investment screenings, and industrial policies to promote supply chains onshore, nearshore, and friendshore are not designed to deny China’s access to advanced Western technology and to slow down Chinese growth. Viewed from Beijing’s vantage point, the Indo-Pacific Economic Framework for Prosperity (IPEF), the CHIP4 Alliance, the Inflation Reduction Act, and the Minerals Security Partnership are economic mirrors of the Quad and AUKUS, two U.S.-led security pacts that Beijing regards as anti-China coalitions. 


The escalation of U.S.-China trade tensions since 2018 and the G7’s sanctions against Russian entities and individuals since 2022, especially the decision to freeze Russian foreign exchange reserves, have motivated Chinese scholars and the policymaking community to strategize on how to immunize the Chinese economy from Western sanctions and how to strengthen China’s financial security. Some Chinese officials and academics, as well as media rhetoric, are increasingly referring to self-reliance, and they are preparing for a forced decoupling from the United States. Fang Xinghai, a vice-chairman of the China Securities Regulatory Commission, has proposed accelerating the internationalization of the yuan to prepare for the risk of a forced financial decoupling.[2] A Shanghai-based academic has argued that “the peace dividend is over,” hence, “it is time for China to prepare for a full decoupling.”[3] Even the more moderate voices have acknowledged that, behind the “decoupling theory,” there are profound changes in U.S.-China relations and they have called on China to “prepare for the worst but strive for the best.”[4] Chinese economist Yu Yongding has described the G7’s freezing of Russian foreign exchange reserves as “a blatant breach of trust” and proof of U.S. “willingness to stop playing by the rules.”[5] Jin Canrong, an international relations and strategy professor at Renmin University in Beijing, has warned that China must be vigilant about the safety and security of its overseas financial assets.[6] These assets include more than $3 trillion in foreign exchange reserves—foreign assets held by the Chinese central bank to settle international trade and to maintain exchange rate stability — and over $8 trillion in other overseas assets, such as stocks and real estate, owned by Chinese government-affiliated entities.


Since President Xi Jinping came to power in 2013, he has repeatedly emphasized a worst-case scenario to “prevent macro-risks that may delay or interrupt the great rejuvenation of the Chinese nation.”[7] From Xi’s vantage point, China’s state-owned financial institutions and enterprises must inoculate themselves in advance against even more disastrous international sanctions that might be levied against them in the event of a military conflict with the West over Taiwan. Such concerns have grown more urgent since China witnessed the collective sanctions imposed by the West on Russian entities and individuals to punish President Vladimir Putin for his war against Ukraine.


Financial security is a core aspect of President Xi’s “Comprehensive National Security.” In addressing a Politburo study group in April 2017 General Secretary Xi Jinping, emphasized that “financial security is an important part of national security. Protecting financial security is strategic and fundamental to China’s overall economic and social development.” [8]  However, it is important to note that General Secretary Xi did not suggest the idea of financial security being part of national security. But, financial security has been an indispensable part of China’s national security discourse since the 1997 Asian financial crisis. Addressing the National Finance Work Conference in November 1997, President Jiang Zemin stressed that “ensuring financial security, efficiency, and stability is a basic prerequisite for the sustained rapid development of the national economy.”[9] Jiang warned: “If the financial system is unstable, it will inevitably affect economic and social stability.” Jiang’s speech reflects the normative impact of the Asian financial crisis on the concept of national security, financial governance, and financial risk management among the third generation of the Chinese Communist Party (CPC) leaders. Awakened to the severity of the crisis, CPC leaders realized for the first time that national security cannot be narrowly defined only by military competencies and defense capabilities. It must also encompass financial security. 


Under Xi’s leadership, defending China’s financial security means not only managing market risks but also managing geopolitical risks. Developing alternative systems to hedge against the risks of sanctions and to reduce China’s strategic vulnerabilities due to its dependence on the U.S. dollar in international trade and investment have become a CPC priority. At the October 2023 Central Finance Work Conference, Xi reiterated that “preventing and managing risk is a perpetual theme in financial work” and he elaborated on the geopolitical challenges to China’s financial security.[10] He observed that “a small number of countries treat finance as tools for geopolitical games. They repeatedly play with currency hegemony and frequently wield the big stick of financial sanctions. … All these have presented new challenges to maintaining financial security under the new situation.”


Xi Jinping’s recent speech suggests that he views improvements in the international status of the renminbi as an indispensable component of strengthening China’s financial security. In January 2024, he urged leading cadres at the provincial and ministerial levels to strengthen China’s financial power and he listed having  “a powerful currency” as the top priority among several core financial issues.[11] He called on Chinese officials to promote China-governed financial infrastructures that are safe and efficient so as to improve China’s financial autonomy.


In response to Chinese policymakers’ anxieties about the country’s financial security, in recent years China has accelerated its development of an alternative global financial system that is independent of the U.S. dollar to fortify its economy against potential sanctions. The Chinese government has pursued three primary strategies to promote reform of the existing U.S.-led system while also developing an alternative strategy. The first strategy is to support and expand regional and multilateral currency and financial cooperation through various non-Western partnerships. The second strategy is to increase broader use of the renminbi in international trade and investment while also promoting renminbi-based international financial infrastructures. The third strategy is to improve the role of the renminbi in global commodities pricing, especially in the context of the transition to clean energy.

 

Promoting Non-Western Currency and Financial Cooperation


The 1997 Asian financial crisis stimulated demand for a regional currency arrangement to address the short-term liquidity difficulties of regional members and to reduce reliance on the International Monetary Fund (IMF). Japanese finance authorities proposed the establishment of an Asian Monetary Fund (AMF) but this was unsuccessful due to U.S. government opposition. In May 2000, ASEAN+3 (China, Japan, and South Korea) managed to launch the Chiang Mai Initiative (CMI), the first regional currency swap arrangement, as an incremental step to establish a foundation for continued regional currency cooperation.[12] The CMI is composed of the ASEAN Swap Arrangement among the ASEAN countries and a network of bilateral swap arrangements among the ASEAN+3 countries.


A decade later, in May 2008, and amid the 2007-2008 global financial crisis, finance ministers of the ASEAN+3 countries agreed to establish a regional foreign exchange reserves pool with a minimum amount of $80 billion, which was later increased to $120 billion with China and Japan each contributing $38.4 billion (or 32 percent each) and South Korea $19.2 billion (16 percent).[13] In December 2009, the Asian regional foreign exchange reserves pool was launched, representing a step closer to the establishment of an AMF. In March 2010, the meeting of finance ministers and central bank governors of ASEAN+3 clarified that countries could implement local currency–U.S. dollar swaps in the $120 billion collective regional foreign exchange reserves pool. In May 2012, the size of the regional foreign exchange reserves pool was increased to $240 billion.


In dealing with the economic shocks of the COVID-19 pandemic, at the G20 meeting in February 2022 PBoC Governor Yi Gang said that China would work with the Asian countries to promote the use of local currencies in trade and investment in order to strengthen regional financial security and resilience against external shocks.[14] In June, the PBoC and the Bank for International Settlement launched an RMB Regional Liquidity Arrangement, with participation by Bank Indonesia, the Central Bank of Malaysia, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, and the Central Bank of Chile.[15] This arrangement has since provided additional liquidity support for the participating central banks during times of market volatility.


The Chinese government has actively cooperated in non-Western multilateral partnerships, such as the Shanghai Cooperation Organization (SCO) and BRICS, to develop a non-dollar-based financial system and to promote the use of local currencies in trade and investment.[16] Since the West’s punitive sanctions against Russian entities and individuals because of Putin’s war against Ukraine, the Chinese government has sought to capitalize on concerns among members of the Global South about the sanctions, especially the freezing of Russian reserves. An important reason for China’s support of the expansion of non-Western regional and multilateral partnerships, such as the SCO and BRICS, has been to accelerate expansion of a non-dollar-based system. For example, at the September 2022 SCO Summit, Chinese President Xi Jinping proposed an expansion of the share of local currency settlements to promote regional integration, strengthen development of local-currency cross-border payment and settlement systems, and promote the establishment of an SCO development bank.[17] SCO members agreed on a “roadmap” to expand trade in local currencies. Iran – a regime that has been coping with severe Western sanctions and that is firmly in favor of a de-dollarization – has joined the SCO as its ninth full member[18] and Iranian President Ebrahim Raisi has made it clear that Tehran sees SCO membership as a way to help thwart American unilateralism and to bypass sanctions.[19]


China’s expressed interest in using the SCO framework to promote use of local currencies for bilateral trade and settlement had already emerged before the launch of the Belt and Road Initiative in 2013. Following the 2007-2008 global financial crisis, promotion of the use of local currencies in bilateral trade became an important issue in China’s partnership with SCO members, and this has been supported by SCO members. For example, at the 2012 SCO Business Forum, Vice Premier Wang Qishan stressed that SCO members should promote the use of local currencies for trade settlement, advance bilateral currency swaps, strengthen regional financial cooperation, and develop new financing models.[20] 


Promoting Cross-border Use of the RMB and RMB-based Financial Infrastructure


In addition to collaborating with regional and multilateral groups to pursue development of a non-dollar-based system, since the 2007-2008 global financial crisis the Chinese government has also attempted to improve cross-border use of the renminbi. In July 2009, Chinese financial regulators and central government agencies promulgated the “Administrative Rules on the Pilot Program for Renminbi Settlement of Cross-border Trade Transactions,” allowing qualified Chinese enterprises designated by the state to settle cross-border trade in renminbi.[21] The rules mark a first step in promoting greater international use of the renminbi, with the goal of ultimately establishing Chinese currency as an international reserve currency alongside the U.S. dollar and the euro.


The Chinese government has put resources into developing a renminbi-based financial infrastructure to facilitate cross-border use of the renminbi. Launched in 2015, CIPS became a proprietary financial infrastructure allowing sanctioned entities to delve into global markets, although dodging sanctions was not the original motivation for its introduction. Initially developed as a critical piece of financial infrastructure to promote internationalization of the yuan, the Shanghai-based CIPS was increasingly seen as China’s alternative to SWIFT, even before Russian banks were banned from SWIFT.[22] CIPS allows global banks to clear cross-border renminbi transactions onshore instead of through offshore renminbi clearing banks, providing a one-stop alternative to a combination of the SWIFT messaging system and the New York-based Clearing House Interbank Payments System. However, CIPS is not a complete departure from SWIFT and it still uses SWIFT standards to connect with the global system. It has adopted the ISO 2022 international payments messaging standard in order to operate with other payment systems as well as with correspondent banks around the world.[23] Adoption of the existing cross-border messaging standards serves China’s interests in making CIPS into a critical piece of financial infrastructure to promote international use of the renminbi. According to the CIPS website, CIPS currently has 139 direct participants, 100 of which are in Asia, 23 in Europe, 6 in Africa, 5 in Oceania, 3 in North America, and 2 in South America.[24] In 2023, the volume of CIPS’s annual business reached RMB123 trillion.[25] By January 2024, the volume of its average daily transactions reached RMB666.8 billion ($93.6 billion).[26] 


The PBoC has cooperated with SWIFT to receive localized services, which in theory could mitigate the impact of any sanctions. It launched a €10 million ($12 million) joint venture, called the Finance Gateway Information Services (FGIS) with SWIFT in January 2021, shortly after the United States, EU, U.K., and Canada sanctioned several Chinese officials for human rights abuses against the Uyghurs.[27] The FGIS will build a local network for financial messaging services and it will establish a localized data warehouse to store, monitor, and analyze cross-border payment messaging information.[28] Notably, the CIPS and the Digital Currency Research Institute are FGIS shareholders. Their presence suggests that FGIS is empowered to promote the use of digital yuan in cross-border transactions. Once materialized, this could be another damage- control mechanism if major Chinese banks were to be de-SWIFTed.

 

Improving the Commodities Pricing Power of the RMB


Even though the Chinese economy has struggled to recover from the shock of the Covid-19 pandemic, the Chinese government remains committed to pushing Chinese firms to use renminbi in their overseas activities. In January 2023, the Ministry of Commerce and the PBoC jointly issued a policy notice encouraging Chinese firms to engage in international trade and investment by using renminbi in their cross-border settlement and investment.[29] The policy notice also encourages Chinese banks to extend overseas renminbi loans. In doing so, China is attempting to broaden international participation in its renminbi-based financial infrastructure. Moreover, China now settles commodities trade, using the renminbi, with over 30 countries. Major Chinese oil suppliers, such as Russia, Angola, Venezuela, Iran, and Nigeria, now accept renminbi in their oil trade with China.[30]

However, the commodities pricing power of the renminbi remains limited.[31] The major commodity pricing centers are in New York, Chicago, and London, with the U.S. dollar dominating about 90 percent of the pricing of major commodities in global markets.[32] Chinese policymakers have publicly expressed their concerns about the renminbi’s limited pricing power over commodities.[33]


Chinese policymakers are correct to consider improving the renminbi’s pricing power in global commodities markets as an essential component to boost China’s financial power. China is the world’s largest consumer of fossil fuels and it dominates the supply chains of several highly sought-after minerals that are deemed critical for the transition to clean energy, such as cobalt and rare earth minerals, which cannot be easily substituted by other materials using existing technology in the clean energy transition.[34] Making the renminbi the pricing currency of major commodities powering the global economy is a crucial step to constructing a renminbi-based global commodities trading system, which could reduce China’s economic and geopolitical vulnerabilities in the global resources trade, will elevate China’s influence in the global financial system and will strengthen China’s financial security. In this context, improving the role of the renminbi in global commodities pricing is not only a critical step toward renminbi internationalization but also an essential condition for reducing China’s strategic vulnerabilities.


In this context, China has developed several commodities trading platforms, such as the renminbi-denominated futures market and the commodity exchanges. For example, China launched renminbi-denominated oil futures in 2018 and copper futures in 2020 on the Shanghai International Energy Exchange.[35] It also launched the Ganzhou Rare Metal Exchange in 2019, in which Chinese currency is used to quote prices for spot trading of tungsten, rare earth products, and critical minerals (like cobalt) that are essential to the clean energy transition.


The commodities trading platforms and financial instruments provide marketplaces with the emergence of a renminbi-based commodities trading and settlement system. When addressing the China-Gulf Cooperation Council (GCC) Summit in December 2022, Chinese President Xi Jinping emphasized that China and members of the GCC should deepen cooperation using the renminbi in oil and natural gas trading and settlement through the Shanghai Petroleum and Natural Gas Exchange (SHPGX).[36] The recent BRICS expansion supported by China, especially the inclusion of commodities majors such as the United Arab Emirates (UAE) and Iran, opens up new avenues for members to pursue use of local currency in commodities pricing and trading. This expansion provides China with opportunities to boost the commodities pricing power of the renminbi and to erode the dominance of the U.S. dollar in global commodities markets.


After Xi’s speech, Chinese national oil and gas companies accelerated initiatives to use the renminbi, instead of the U.S. dollar, in their international fossil fuels transactions through SHPGX. In March 2023, China National Offshore Oil Corporation—known as CNOOC, China’s largest offshore oil and gas field operator—used the renminbi to complete transactions to import 65,000 metric tons of liquefied natural gas (LNG) from TotalEnergies SE, a French multinational oil and gas company, through SHPGX.[37] The LNG, produced in the UAE, a member of the GCC and carried by a Liberian-flagged LNG tanker, the Mraweh, completed unloading in May at the CNOOC Guangdong Dapeng LNG receiving station.[38] This transaction was the world’s first cross-border LNG trade transaction settled using the renminbi. Since then, CNOOC has executed other renminbi-settled transactions through SHPGX.[39] In October, PetroChina, the largest oil and gas producer and distributor in China, settled the purchase of one million barrels of crude oil using digital renminbi through SHPGX, marking the first cross-border oil transaction using digital currency of the Chinese central bank.[40]  


In the near- to medium-term, China can capitalize on the current energy transition to cultivate a “gas-yuan,” emulating the petrodollar. Just as the oil-producing countries depend on dollar revenues that are not freely spendable elsewhere, gas-producing countries, such as Russia and Iran, could be become dependent on the renminbi. In China’s “World Energy Development Report (2017),” Chinese scholars propose the concept of a gas-yuan. Given the fragmented nature of global natural gas markets and China’s leverage as a leading buyer, the emergence of a gas-yuan is not a pipe dream. Russia, Iran, and China collectively produce more natural gas than the United States and they all have non-dollar financial infrastructures in place.[41] China has become the world’s largest LNG importer.[42] Iran, which shares the world’s biggest gas field with Qatar, is reviving its previously sanction-stalled LNG export plan due to President Putin’s invasion of Ukraine as the EU attempts to cut its dependence on Russian gas.[43] Although China has not provided material support to Russia and has not bluntly helped Russia dodge the Western sanctions, its natural gas imports from Russia more than doubled from 2021 to 2022.[44] The collective revisionist geoeconomic power of China, Russia, and Iran arguably is much stronger than that of OPEC. Higher global demand for natural gas as a transition fuel toward Net Zero and the decoupling of gas prices from oil prices also provide benign macro conditions for the emergence of a gas-yuan.


In the medium- to long-run, as the global economy transitions from being hydrocarbon-dependent to being mineral-dependent, China could also leverage its dominance in critical mineral supply chains and its partnership with mineral-rich countries. China’s support for an expansion of the SCO and BRICS in recent years to include major commodities-exporting countries like Iran, Saudi Arabia, and the United Arab Emirates, among others, suggests it is now eyeing new opportunities to accelerate renminbi use in commodities trading. These expansions have also given the added significance of the SCO and BRICS as political forces shaping commodity markets. Members of the SCO and BRICS include leading oil and natural gas producers and countries with significant reserves of critical minerals that will power the transition to clean energy. SCO members include major hydrocarbon and minerals exporters in Central Asia, such as Kazakhstan, Uzbekistan, Russia, and its newest member, Iran.[45] The SCO also includes major commodities importers such as China and India. Two of the world’s five largest lithium producers—China and Brazil—are members of BRICS. Iran, a member of both the SCO and BRICS, announced last February the discovery of its first lithium deposits, estimated to be the world’s second-largest after those in Chile.[46] Iran already possesses the world’s largest proven zinc reserves that are extractable using existing technology,[47] the fifth-largest copper deposits,[48] the tenth-largest uranium reserves, and the tenth-largest iron ore reserves.[49] The Iranian regime, which has been coping with severe Western sanctions for decades, is firmly in favor of de-dollarization.


As a non-Western group of countries, the SCO potentially represents a potent coalition of exporters and importers of commodities centered around using the renminbi to finance the entire commodities lifecycle from production to trade to consumption. Similarly, the expansion of BRICS to oil-rich nations bolsters the group’s collective economic power and influence in the clean energy transition, even though it introduces greater internal complexity among its members, such as regional rivalries in the Middle East and Chinese rivalry with India, as well as the rising populism and its subsequent political unpredictability in Latin America. The SCO and BRICS now share overlapping members with similar incentives for using local currencies in international trade settlement and investment. This configuration facilitates formal and informal policy efforts to implement incremental de-dollarization initiatives in energy and commodities markets, with the potential of scaling up, thus making the two major non-Western groups attractive platforms for China to create an alternative financial system as the world moves beyond hydrocarbon.

 

Still a Long Way to Go


It will not be easy for the yuan to achieve the status of a dominant currency and to pose a credible threat to U.S. dollar hegemony. The lack of attractive yuan-denominated assets and desirable high-value goods and services exported from China preclude the rise of a petroyuan or a gas-yuan anytime soon. China’s addiction to a current account surplus and a relatively closed capital account also prevents Chinese government bonds from rivaling U.S. Treasury securities.


Some recent developments suggest that Chinese policymakers are keenly aware of these obstacles to the broader use of the renminbi and they have implemented subtle but strategic initiatives to increase the utility of Chinese government bonds—a type of renminbi-denominated assets—in international finance to create investor demand for renminbi assets and to increase their liquidity. Despite hesitations about liberalizing China’s capital account to allow capital to move freely in and out of the country, Chinese authorities have worked to broaden international acceptance of renminbi bonds as collateral. In March 2021, the International Swaps and Derivatives Association (ISDA), a New York-based group composed primarily of the world’s largest banks, together with the China Central Depository and Clearing Corporation, the Beijing-based central depository for all Chinese government bonds, released a white paper detailing use of Chinese government bonds as an initial margin in derivatives contracts.[50] This past September, the Hong Kong Exchanges and Clearing (HKEX) and the London Stock Exchange began to study the use of Chinese government bonds as eligible collateral for derivatives contracts as a way of reducing Asia’s heavy reliance on cash for margins on derivatives trades.[51] Chinese institutions have also teamed up with leading resource-rich economies to make renminbi-denominated assets more attractive to international investors. Also in September, the Shanghai Stock Exchange signed a memorandum of cooperation with the Saudi Tadawul Group, operator of the Saudi Exchange, which includes collaboration on expanding equity market connections and emerging financial issues, such as cross-listings or listing stock shares on multiple countries’ exchanges to enable their interchangeability; new financial technologies; and environmental, social, and governance (ESG) issues.[52]


If implemented as planned, these initiatives can increase the global appeal of the renminbi and deepen the market depth of renminbi-denominated assets. However, there is no guarantee that this would be a smooth sail. Two mutually reinforcing factors are at play: the actual trajectory of the Chinese economy and market confidence in the Chinese economy. If global investors and domestic Chinese households are pessimistic about the Chinese economic outlook, the pessimism may become a self-fulling force and neutralize the weak government stimulus.


China’s strategies to promote border use of the renminbi and to develop an alternative financial system are defensive, rather than offensive, in nature, at least for now. The goal is to minimize the negative consequences of the West’s comprehensive sanctions against China. But in a worst-case scenario of a financial war triggered by an extreme event, such as a military clash over Taiwan, Beijing could deploy two offensive retaliatory measures: disrupting global supply chains and restricting foreign access to Beijing-controlled commercial ports.[53] Deliberate supply chain disruptions could come in at least two forms: enforcing the anti-sanctions regulatory framework to restrict access to the Chinese market and imposing export controls on critical materials. The timing of such a worst-case scenario also matters. If it were to happen after Beijing successfully deploys an alternative financial system and gathers a critical mass of participants that can complete trade within this system using the renminbi, Washington could no longer resort to sanctions to punish China.


About the Contributor

Zongyuan Zoe Liu is Maurice R. Greenberg Fellow for China Studies at the Council on Foreign Relations (CFR). Her work focuses on international political economy, global financial markets, sovereign wealth funds, supply chains of critical minerals, development finance, emerging markets, energy and climate change policy, and East Asian–Middle Eastern relations. Dr. Liu’s regional expertise is in East Asia, specifically China and Japan, and in the Middle East, specifically the Gulf Cooperation Council countries. Dr. Liu is the author of Can BRICS De-dollarize the Global Financial System? (Cambridge University Press, 2022) and Sovereign Funds: How the Communist Party of China Finances its Global Ambitions (Belknap Press of Harvard University Press, 2023).

Photo credit: public domain, Wikimedia commons

Tags:

Recent articles:

bottom of page