The story so far: India and Russia are said to be considering the use of the Chinese yuan as the reference currency to facilitate oil trade between the two countries. This news comes in the backdrop of economic sanctions imposed by the West against Russia after the Russian military invaded Ukraine late last month.
Why is Russia trying to sell oil to India?
Russia has been trying to sell oil at a significant discount to India as demand for Russian oil has dropped since the U.S. and Europe imposed sanctions last month. Although there is no outright ban yet on the purchase of Russian energy exports, many energy traders have been reluctant to purchase Russian energy and sell them. Traders fear that the United States may impose further sanctions if the war in Ukraine intensifies and that this may leave them holding energy inventory that they cannot sell.
As part of Western sanctions, certain Russian banks were removed from the SWIFT payments system, thus affecting Russia’s ability to trade with the rest of the world. Russian businesses have been unable to pay for imports and Russian consumers have been unable to purchase goods. The Russian central bank’s foreign reserves were also frozen, which in turn has dented the Bank of Russia’s ability to use its foreign reserves to defend its currency. The Russian rouble has lost about a quarter of its value against the U.S. dollar since the invasion. U.S. President Joe Biden, earlier this month, also banned Russian energy imports into the United States.
Why use the Chinese yuan instead of the U.S. dollar for oil trade?
Major oil producers have for decades sold their produce to foreign buyers in exchange for U.S. dollars. Oil sellers have been willing to accept U.S. dollars for their oil because the currency is widely accepted in the global market for goods and services. It should be noted that the value and the acceptability of any currency depend mainly on its purchasing power, that is, the amount of goods and services that can be bought using it. For a long time, the U.S. has been an economic powerhouse creating valuable goods and services. So, people around the world have been willing to sell their goods and services for U.S. dollars in the hope that they can use these dollars to purchase valuable American goods and services.
The U.S. government has made use of this economic advantage to further its foreign policy goals. Since global trade that is carried out using dollars is cleared by banks located in the United States, the U.S. government has the power to freeze dollars that belong to its adversaries which then debilitates economies.
To avoid this risk, many countries have been looking at alternatives to the U.S. dollar to carry out international trade. Of late, China has emerged as a significant economic power and this in turn has boosted the value of the yuan in the eyes of people and made it an increasingly acceptable currency for global trade. However, it should be noted that only about 3% of global trade is facilitated by the Chinese yuan while almost 90% of global trade still happens through the use of U.S. dollars.
What lies ahead?
It is unclear at the moment what using the Chinese yuan as reference currency would entail. It could simply just mean that the value of trade that happens between Russia and India will be quoted in terms of the yuan without the Chinese currency actually being used in bilateral trade. Or it could mean the yuan is actually used to facilitate trade between the two countries. Since neither the rouble nor the Indian rupee is widely accepted as a global currency for trade, this can lead to problems when there is a trade imbalance. In 2021, Russia’s exports to India were valued at $6.9 billion while India’s exports to Russia stood at only $3.3 billion. This represents a trade surplus of over $3 billion in favour of Russia. If Russia were to accept the rupee instead of the dollar in bilateral trade, it would be hard for it to get rid of its excess rupee holdings. This is since the rupee’s acceptability in global trade is minuscule compared to that of the dollar. The use of the yuan, which is more widely accepted, can help solve the problem.
The use of the dollar as a financial weapon against Russia, as was evident with the freezing of dollar assets held by the Bank of Russia last month and other sanctions on Russian banks, can also accelerate efforts by countries to reduce their dependence on the U.S. dollar. Countries may want to hold fewer dollars and euros and instead opt for alternative trade arrangements that involve the use of emerging currencies such as the yuan.
This could portend a fall in the status of the dollar over time unless the U.S. manages to maintain its current status as the most dominant economic superpower.
As part of Western sanctions, Russian banks were removed from SWIFT payments and energy imports from the country have also reduced. Thus, Russia has been trying to sell oil at a significant discount using the yuan as a reference currency.
The U.S. is using its economic advantage to freeze dollars that belong to its adversaries. To avoid this risk, many countries have been looking at alternatives to the U.S. dollar.
For oil trade between India and Russia, neither the rouble nor the Indian rupee is suitable as a global currency for trade. Therefore, the yuan can become an alternate option.
- As part of Western sanctions, Russian banks were removed from SWIFT payments and energy imports from the country have also reduced. Thus, Russia has been trying to sell oil at a significant discount using the yuan as a reference currency.
- The U.S. is using its economic advantage to freeze dollars that belong to its adversaries. To avoid this risk, many countries have been looking at alternatives to the U.S. dollar.
- For oil trade between India and Russia, neither the rouble nor the Indian rupee is suitable as a global currency for trade. Therefore, the yuan can become an alternate option.