China and Russia: Toward an alternate financial system
Moscow and Beijing want to counter the West by reshaping global trade and payment systems.
In a nutshell
- Western sanctions have restricted Russia’s access to capital and transactions
- China balances supporting Russia and accessing Western markets
- Moscow and Beijing are working toward an alternate BRICS payment system
This report on Chinese-Russian finance models is the first in a two-part series on the mechanics of Sino-Russian relations. The second, focusing on economics, can be found here.
The war Russia has been waging in Ukraine since February 2022 has led to the United States and other Western countries imposing sanctions on the Kremlin and potentially on its enablers. One of the most important aspects of these sanctions is financial. Moscow and Beijing are constantly looking for countermeasures to get around these restrictions. However, their ambition does not end there: They are hoping that their “no limits” friendship can forge a new global order. The establishment of a payment system independent of Western oversight demonstrates their determination.
Shortly after the breakout of the war, the U.S. and the European Commission announced they were prohibiting Russia from using the SWIFT system to conduct trade, making it more difficult for Russia to obtain military goods, enhance its offensive capabilities through trade and keep its economy afloat.
However, Washington and Brussels may have underestimated the closeness of Chinese President Xi Jinping to Russian President Vladimir Putin. Mr. Xi considers the West’s sanctions on Moscow his best chance to corner the Russian market with Chinese goods, including automobiles, while also buying Russian energy on the cheap. Beijing initially sought to evade the sanctions by using the ruble and the yuan as means of payment.
Thanks to Beijing’s full cooperation, Russian-Chinese trade has skyrocketed since the start of the Ukraine war to levels that amazed even Moscow and Beijing. But this frenzied period has cooled slightly in 2024.
Xi’s dual strategy
The reason for the recent modest decline in trade has to do with the Chinese balancing act between Russia and the West. On the one hand, President Xi endorses President Putin’s efforts in creating a new world order. On the other, since Beijing came out of its zero-Covid era with an economy in the doldrums, Mr. Xi has been attempting to revive exports. In this contest, Western capital, technologies and markets have much more significance than those of Russia. He has therefore been forced to show a little goodwill toward the West.
To play nice with Washington and Brussels while simultaneously working against them, Beijing developed a dual strategy addressing both sides. For Mr. Xi to confront the West and build an alternative world order, it is necessary for him to support President Putin. At the same time, to keep the Chinese economy growing, President Xi is working to ensure Chinese relations with the West do not deteriorate too much, particularly regarding Western capital under the existing world order. This includes adherence to a few basic economic rules, including use of global payment systems.
Without using the SWIFT system, Russia has still been able to rely on the cooperation of a few so-called friendly countries. As a result, the effect of sanctions was at first not too obvious. However, over time, the U.S. has taken more stringent measures against Russia. For example, it included the Moscow Exchange (MOEX) on its sanctions list, restricting Russia’s use of the dollar and transactions in equivalent currencies, so that Russia has been forced to rely heavily on the renminbi in both trade and foreign exchange reserves. This makes the Russian economy vulnerable to China’s monetary policy and exchange-rate adjustments.
To play nice with Washington and Brussels while simultaneously working against them, Beijing developed a dual strategy addressing both sides.
Furthermore, in December 2023, the U.S. warned all countries that trade with Russia, especially China, that it would impose secondary sanctions on banks in their territories if they were found to be involved in the trade of dual-use or even military goods. This is the first time Chinese banks have been warned by the U.S. Out of caution, China’s big banks quickly withdrew from their Russia trade.
At the same time, Beijing consulted with Moscow on how to counter this measure, to implement President Xi’s dual strategy. As a result, China’s big banks have formally had to pause or limit yuan settlements and payments in Russia. However, Beijing is allowing smaller banks in the border region to continue doing business with Russian entities, hoping this enables their trade with Russia to continue.
Short-lived ‘burner banks’
Secretly, China and Russia agreed to transfer the payment business, which was previously managed by the big Chinese banks, to those small banks. These banks are also known as “burner banks,” akin to “burner phones.” Their mode of operation is such that once the banks are designated as entities of interest under U.S. sanctions, they can simply shut down their operations and have their clients move to another bank.
A burner bank can be an existing institution or one created specifically to evade sanctions. One thing they all have in common is limited interaction and connection to the larger international financial system. The catch for Mr. Xi is that even if these burner banks do not seem to be engaged in international business with countries other than Russia, they generally still maintain close ties with the big Chinese banks that rely on global trade.
Just as both Russia and China were about to celebrate the success of this little trick, in June of this year, the U.S. informed China’s large state-owned banks more explicitly that they were still facing the possibility of secondary sanctions. Larger entities that maintain cooperative relationships with these smaller banks involved in business with Russia would be targeted. In response, the Bank of China notified all banks to suspend payment business with Russia.
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The result is that Chinese banks are afraid to do business with Russia, and Russian banks have now almost depleted their yuan reserves. According to Chinese official statistics as reported by Reuters, Russian imports from China between January and July 2024 decreased by more than 1 percent annually to $62 billion due to payment problems. In March 2024, overall Chinese exports to Russia declined 16 percent annually, followed by a fall of 13.5 percent in April.
Of course, even then, there are still a few individual small banks that are prepared to take the risk and continue to serve Sino-Russian trade. That is why 98 percent, instead of 100 percent of Chinese banks, suspended accepting yuan remittances from Russia in the spring and summer of 2024. U.S. authorities are compiling a list of small Chinese banks involved in payments for Sino-Russian trade and are likely to present the list to Chinese authorities in an attempt to get Beijing to take action.
Regardless of payment systems, loopholes in the sanctions regimes still exist. Some banks may change the name of the receiving companies, the destination of the goods or the name and number of the vessel used to evade sanctions. But one thing is certain: Bank transfers for Russian-Chinese trade have become much more expensive and are becoming more complicated and tedious than ever before.
Simplified thinking in the Western media
With some large Chinese financial institutions now operating with a degree of caution, Western media is celebrating the effect of the U.S. measures, especially those related to the secondary sanctions. At the same time, it is painting the picture that President Xi is taking Washington’s side on this issue. In reality, however, President Xi is simply acting in accordance with his dual strategy.
The cat-and-mouse game is far from over. For example, China and Russia are planning to set up a Russia-China bank. Theoretically, branches of the same organization will operate on the territories of both Russia and China, and the chosen settlement bank will be able to hide information from third parties.
More importantly, Presidents Putin and Xi are determined to build a different world order, a critical aspect of which is an alternate financial system. Russia, in particular, has been deeply constrained in its trade since launching the Ukraine war. A payment platform that is independent from the existing international financial system has become an even more urgent need for Moscow.
After the Kursk incursion, Beijing is all in
President Xi’s help to President Putin goes far beyond the financial aspect. After the Ukrainian incursion of Kursk in early August, Mr. Putin was keen to get direct military support from members of the Collective Security Treaty Organization (CSTO), an intergovernmental military alliance in Eurasia consisting of six post-Soviet states, but the results disappointed him. So, Mr. Putin’s reliance on China continues to deepen.
Just ahead of Ukraine’s incursion there was a flurry of Chinese activity in Russia. In just one week at the end of July, China’s Vice Premier He Lifeng, Premier Li Qiang, Finance Minister Lan Fo’an and, more notably, Army Commander-in-Chief Li Qiaoming, each traveled to Moscow. At the same time, Russia sent its deputy foreign minister to Beijing. In Moscow, Mr. Li signed several big investment projects with President Putin totaling well over $100 billion, according to Russian news agency Interfax.
This largesse comes as China’s local governments are tightening their own belts. President Xi knows what President Putin desperately needs. Although the two sides did not disclose the areas in which China is investing, and keeping in mind Russia’s urgent need for military-industrial equipment and technology, all signs indicate that Sino-Russian cooperation in the area of defense is reaching an unprecedented peak.
On September 10, U.S. Deputy Secretary of State Kurt Campbell, during a visit to Brussels, said that China provided substantial support to the Russian military industry. As an apparent sign of gratefulness for this support from Beijing, President Putin broke with precedent and implied that Russia would assist China around Taiwan and in the South China Sea should there be an armed conflict.
Building an anti-dollar hegemon platform
Since the outbreak of the Ukraine war, Russia has been designing a payment system among BRICS countries, which was an important topic at the 2023 BRICS summit in South Africa. BRICS countries are exploring its possible use as an alternative to the system of international trade based on the U.S. dollar. Crucially, it would be a tool to help Moscow evade sanctions. What Russia would prefer is the creation of a unified BRICS currency through a monetary unit fully independent from the West. Nevertheless, all indications point to Moscow’s elites concluding that this seems unrealistic in the short and medium term.
What is more realistic, though, would be the creation of a payment and settlement mechanism that is small in scale at the outset while being independent and resistant to sanctions pressure. In June this year, Russian finance ministry officials told Russian newspaper Kommersant that a payment and settlement platform called BRICS Bridge is being developed, with three currencies based on a digital ruble, Chinese yuan and Brazilian real. The system would allow member states to transfer money directly, thereby reducing the impact of Western sanctions on payments.
At the same time, Moscow is developing a cryptocurrency. Moscow believes that through their decentralized nature and instant transactions, cryptocurrencies can bypass the traditional international banking system and provide a reliable settlement tool. In this way, states using such a system, especially China, would not have to fear the U.S. being able to trace transactions and thus imposing secondary sanctions.
As Russia holds the BRICS presidency this year, Moscow decided to more concretely outline this payment system before the upcoming BRICS summit in Kazan on October 22-24. As Victoria Panova, chairwoman of Russia’s BRICS Presidency Council, said, the proposal will be the priority of this year’s BRICS summit. This partly explains why Mr. Xi will be traveling to Russia in person for the BRICS summit in October.
Not all BRICS members on board
It is worth noting that India carries weight as one of the founding BRICS members. The Indian rupee not being included in discussions of the payment platform opens questions to the degree of consensus within the grouping, especially whether member countries will be willing to sacrifice the global marketplace for a limited Russian-Chinese trading bloc.
When Moscow was probing India on this issue, Indian Prime Minister Narendra Modi said that India must adhere to the principle of freedom in international trade. Officials in his administration said that any financial system for the BRICS group would need to allow member countries to use the currencies of their choice, on a voluntary basis. The Chinese media reaction to India’s stance was negative. According to China’s official sources, Mr. Modi’s resistance is a clear “disruption” of this year’s BRICS summit in Russia.
Separately, Beijing understands that the ongoing China-India border conflict directly affects the efforts of Mr. Putin and Mr. Xi to build a new world order. Due to tensions from an aggressive, expansionist China, India, while still maintaining military neutrality and friendship with Moscow, has been moving closer to Western nations through its cooperation in the Quad, with the U.S., Japan and Australia.
Scenarios
Probable: Moscow and China will continue pursuing an alternate payment system
On July 7 this year, while attending the 12th World Peace Forum in Beijing, Russia’s ambassador to China cheered, “We are leaving the dollar-dominated space.” Valentina Matviyenko, speaker of the Russian Federation Council, also called the envisaged BRICS payment system “a global bombshell.”
Yet the rejoicing may be premature. Launching a micro-multilateral fledgling BRICS payment system may indeed happen this year, but it is doubtful that it will work as smoothly as Presidents Putin and Xi imagine.
Nevertheless, motivations for the establishment of an alternate payment system are clear. President Putin seeks to evade sanctions, President Xi hopes to internationalize the yuan, and both want to use the system as coagulant between the BRICS member states that are accepting of authoritarian regimes.
Yet it is uncertain how long Russia’s war economy will remain “fit.” And amid China’s still slumping economy and strict control over money flows, Beijing would need to demonstrate the convertibility of its currency both within the BRICS system and with third parties in order to prove that such a payment system would be sustainable and functional. If the beta-version of this payment system is effective in sanctions avoidance, that may be sufficient for Moscow and Beijing to progress. Once its cryptocurrencies are in use, it could be harder for the U.S. to investigate whether Chinese banks are violating U.S. warnings and enabling Russian aggression.
Likely: India refuses to fully commit to a new monetary system
Whether the BRICS payment system will be successful on a large scale depends on India’s role. As things stand, India will not abandon the existing SWIFT system for this purpose. It is hard to imagine that India will join the alternate payment system as wholeheartedly as China. This limits the potential effectiveness and scope of the BRICS payment system.
Certain: Some countries seek non-dollar payments to lower costs
Certainly, there is a trend for several countries to move away from the U.S. dollar in favor of bilateral currency payments, merely to reduce payment costs and increase the speed of transactions. For example, this year, China and Vietnam signed a memorandum of understanding on cooperation aimed at promoting bilateral currency settlements as well as their own currency swaps, meaning that the two countries will bypass the U.S. dollar in bilateral trade settlements in the future.
In addition, in May this year, countries of the Association of Southeast Asian Nations (ASEAN) decided to use local currencies instead of the dollar in cross-border trade.
But the goal is primarily to reduce transaction costs when trading bilaterally: The countries involved do not necessarily intend to create or commit to an alternative system that is completely independent of the dollar, as Russia is doing. The speed at which this trend of de-dollarization develops depends on whether the economies of the West are able to maintain their leading position and dominance.
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