Amid growing condemnation of Russia’s invasion of Ukraine, Chinese Foreign Minister Wang Yi issued what is arguably his country’s strongest statement of support for Moscow since the beginning of the crisis.
Wang declared ties with Russia to be “rock solid,” noting that no matter how precarious the situation may be, “China and Russia will maintain a strategic focus and steadily advance our comprehensive strategic partnership and coordination.”
Wang’s remarks on March 7 can also be seen as efforts by Beijing to step up support for Moscow and its push to challenge U.S. dominance, especially as Russia’s economy becomes increasingly isolated because of international sanctions.
However, while Moscow is likely to rely more heavily on China as a financial and trading partner, Beijing will have to perform a balancing act, as any breach of U.S.-led sanctions would jeopardize its own access to the dollar-denominated international financial system.
Sanctions imposed by the Group of Seven wealthy nations, as well as the European Union, range from penalties on Russian assets and government entities right down to companies and individuals.
These include sanctions against Russia’s central bank and sovereign wealth funds, aimed at effectively freezing their foreign reserves, banning transactions with Russian financial institutions, blacklisting prominent Russian individuals and imposing export controls on several types of dual-use equipment such as lasers, semiconductor sensors, computers and communications equipment.
Moreover, Japan, the United States, Britain, Canada, and the European Union have agreed to exclude Russian banks from SWIFT, the international messaging system used for bank transactions.
‘There is little China could do’
Against this backdrop there has been speculation that China, which has refused to support the Western-led sanctions on Moscow, could potentially help lessen Russia’s economic pain.
But many of these U.S.-led measures also put significant constraints on China’s dealings with Russia as they include ‘secondary sanctions,’ which penalize individuals and companies from third countries for dealing with sanctioned countries or companies.
For instance, a Chinese institution dealing with a sanctioned Russian company could end up having its assets in the U.S. frozen or be barred from operating there. This means that continuing to do business with such Russian entities would not pay off for Chinese firms with substantial commercial interests abroad, as it would jeopardize their access to the U.S. financial system.
“There is little that China could do… to soften the impact of these sanctions without damaging its own economic and financial position,” says Mark Williams, Chief Asia Economist at Capital Economics.
In terms of bank payments, Williams says that oil and gas, which made up two-thirds of China’s imports from Russia last year, have not been sanctioned, meaning that trade in those areas can continue as long as a replacement for SWIFT can be found.
Russia could, in principle, use the Cross-Border Interbank Payment System (CIPS) – a Chinese international bank payment and clearing system launched in 2015 – to sidestep SWIFT. The drawback is that Moscow can currently only use this system for transactions with China as it uses the yuan.
Around two dozen Russian banks are currently connected to CIPS through a clearing bank, ICBC Moscow. But a second issue it that, because CIPS is a payments processor, it is also subject to Western sanctions on transactions involving Russian banks.
For example, the U.S. Treasury has barred Sberbank, Russia’s largest financial institution, from processing any payments through the U.S. financial system. Although CIPS, which is backed by the People’s Bank of China, does not involve the U.S. banking system, payments through it that are deemed intended to circumvent U.S. sanctions could trigger sanctions from Washington for those involved, effectively limiting the use of CIPS to bilateral transactions between Russia and China, Williams says.
Even bilateral trade through CIPS may not be possible immediately, as CIPS is not currently set up as a SWIFT alternative. In fact, the Chinese system still uses SWIFT to communicate orders between banks outside China and the clearing banks, which function as nodes for CIPS overseas, Williams notes.
Moreover, it is unclear how rapidly CIPS could switch to using its own messaging system or to utilizing that provided by Russia’s own alternative to SWIFT, the System for Transfer of Financial Messages.
Beijing unlikely to flout sanctions
While CIPS may support transactions between Russian banks and Chinese correspondents, it does not necessarily protect China from at least some potential sanctions from the U.S. or EU, says Nicolas Veron, a senior fellow at the Washington-based Peterson Institute for International Economics (PIIE).
“It will be increasingly hard for China to have it both ways, keeping or intensifying their economic relations with Russia while at the same time maintaining its much more significant economic relations with the rest of the world,” Veron says.
“What is clear is that China’s economic relations with Russia are dwarfed by those with the rest of the world. From an economic standpoint, Beijing has no interest in siding with Russia, which is rapidly being decoupled from the rest of the world. But of course, not all will be about economics.”
The main issue for Beijing is that, although it has a growing strategic partnership with Russia, completely siding with Moscow on Ukraine and breaching international sanctions would further worsen its already strained political and economic ties with the West.
China could buy more oil and gas, as well as find other ways to bolster its trade and financial ties with Russian companies. After all, Beijing bought one-sixth of Russia’s total exports last year and two-thirds of that was oil and gas. However, Moscow would not be able to immediately deliver more of these energy resources, as pipelines linking the two countries are already fully loaded. The two countries signed a 30-year supply deal last month, but the pipes meant to carry that gas won’t be completed for at least three years.
All of this suggests that the leadership in Beijing is unlikely to approve a large-scale circumvention of sanctions. This means that China will likely have to perform a difficult balancing act between its geopolitical and its geoeconomic interests, thus putting the strength of its ties with Moscow to the test.
China’s bank payment system likely to expand, but no SWIFT replacement
As Russia gets cut off from the global financial network, China’s own international bank payment and clearance system – the Cross-Border Interbank Payment System (CIPS) – is getting a windfall.
Although the CIPS does not currently provide Russian banks with a way to bypass Western sanctions and trade with the world beyond China, the move to ban some of them from SWIFT is likely to speed up the expansion of CIPS as well as the internationalization of the yuan.
For comparison, SWIFT is a much larger, member-owned cooperative with more than 11,000 financial institutions in more than 200 countries and territories.
CIPS says that overseas indirect participants accounted for 54.5% of the total business volume last year, with the system processing around 80 trillion yuan (sabout $12.65 trillion based on current exchange rates). However, with about 15,000 transactions processed per day – and an average volume of 437.68 billion yuan – CIPS is also much smaller than the dollar-based Clearing House Interbank Payments System (CHIPS), the latter of which processes over 240,000 transactions with a daily volume of $1.8 trillion in domestic and international payments.
Nevertheless, some analysts argue that the importance of CIPS may not necessarily lie in its ability to directly compete with SWIFT, but rather in the fact that it can insulate China from financial pressures as well as increase its autonomy, “giving the country control over all information that passes through its network, the power to help others bypass sanctions, and the ability to one day cut others off from the RMB-denominated system,” according to a 2019 report by the U.S China-Economic and Security Review Commission. CIPS, it stated, “has been attractive for banks in countries targeted by U.S. sanctions, such as Russia and Turkey, which have sought to reduce their reliance on the U.S. dollar.”
The expansion of CIPS comes as global trade is increasingly denominated in currencies other than the dollar, as Carlos Casanova, senior Asia economist at the private Swiss bank Union Bancaire Privée (UBP), pointed out. For instance, the yuan accounted for 3.2% of global payments in January, according to SWIFT data.
While this is a new record – in line with China’s growing role in international trade –, it only accounts for a small fraction of global payments. In fact, the yuan only ranks fourth in terms of the most widely used currencies, following the dollar, the euro, and the pound.
Despite all the speculation about the Chinese currency in recent weeks, CIPS is unlikely to become a serious competitor to SWIFT or CHIPS anytime soon. Casanova noted that “the sizeable inflows into U.S.-dollar denominated assets indicates that the U.S. currency remains a preferred safe haven asset in times of heightened geo-political risks.”
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