Coins and banknotes of China's yuan are seen in this illustration picture taken February 24, 2022. REUTERS/Florence Lo/Illustration

Analysis: Amid sanctions, Russia's emerging market allies, including Brazil, explore alternative solutions

The willingness of emerging market giants to trade with Russia could lead to a split over Europe's biggest crisis since World War II.

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As western governments ratchet up sanctions against Russia over its invasion of Ukraine, Moscow’s emerging markets allies are exploring channels for trade and financing to continue.

The other members of the erstwhile BRICs group – Brazil, India, and China – are treading cautiously for fear of tripping on the sanctions, but the beginnings of a parallel financial system centered on Beijing are becoming detectable.

The United States and Europe have banished big Russian banks from the main global payments system SWIFT and announced other measures to limit Moscow’s use of a $640 billion war chest.

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So the willingness of the emerging market giants to sustain business relations with Russia highlights a deep rift over Europe’s biggest crisis since the World War II, and threatens to chip away the dominance of the U.S. dollar in global trade.

Chinese businesses and banks are now scrambling for ways to limit the impact of sanctions on their relations with Russia, with settlement of transactions in yuan seen rising at the expense of the dollar. The western curbs, which aim to cut Russia out of the global financial system, could also deepen commercial links between Moscow and Beijing.

In India, as concerns mount over sustaining supplies of Russian fertilizer, government and banking sources say there is a plan to get Russian banks and companies to open rupee accounts with a few state-run banks for trade settlement as part of a barter system.

Brazil‘s President Jair Bolsonaro said his country will remain neutral in the conflict. The supply of fertilizers is also an issue for the Brazilian government.

Brazil depends on imports for around 85% of its fertilizer needs. Russia is its most significant supplier of raw materials for fertilizers.

Even before the conflict in Ukraine, fertilizer prices were rising due to global logistics problems, US sanctions on Belarus, and China’s absence from the market since October.

The crisis in Ukraine means that Brazilian producers of soybeans and other agricultural commodities are potentially about to face a difficult time.

China's President Xi Jinping, left, and Russia's President Vladimir Putin during the BRICS emerging economies meeting in Brasilia, Brazil November 14, 2019
China’s President Xi Jinping, left, and Russia’s President Vladimir Putin during the BRICS emerging economies meeting in Brasilia, Brazil November 14, 2019. Photo: Pavel Golovkin/Pool via REUTERS

Deng Kaiyun, who heads Zhejiang’s chamber of commerce that represents Chinese private businesses that trade with Russia, said doing transactions without SWIFT was not a big issue, as the two countries both started de-dollarisation five years ago.

“Yuan-rouble settlement has become a normal business at major banks nowadays … We business people are already accustomed to that,” Deng said, adding yuan is increasingly popular with Russians.

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The effects of pulling Russia out of SWIFT

The sanctions are prodding Russian and Chinese companies to open accounts at Chinese banks that have subsidiaries in Russia, said a Moscow-based lawyer who represents Chinese businesses.

“SWIFT is not the only payment system. If you block this channel, business people need to find alternatives,” said the lawyer, who declined to be named due to sensitivity of the topic.

A source at a Chinese state bank who declined to be identified says “exporters are now in favour of using yuan to settle their payments” with Russia. Some of those trades were settled in euros or dollars until last week.

A source at another state lender said that, given a lack of details in the Western sanctions, the bank is closely monitoring the situation while encouraging clients to use yuan in trade settlements with Russia.

Yuan settlements already accounted for 28% of Chinese exports to Russia in the first half of 2021, compared with just 2% in 2013, as both China and Russia step up efforts to reduce reliance on the dollar while developing their own respective, cross-border payment systems.

The current crisis could accelerate the trend.

Dang Congyu, analyst at Founder Securities writes that SWIFT sanctions against Russia are “a milestone event that will accelerate the process of de-dollarisation.”

“Although it’s hard to replace SWIFT in the short term, this incident is very beneficial to yuan’s globalization over the long run.”

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Efforts on de-dollarisation are not limited to trade. Investment firm Caderus Capital said it has been working to promote cross-border investment between Russia and China.

Managing director Andrei Akopian also hailed Russia central bank’s move to increase investment in yuan assets as “the best way to increase the popularity of the Chinese RMB among Russian investors.”

Yuan accounted for 13.1% of the Russian central bank’s foreign currency reserves in June 2021, compared with just 0.1% in June 2017. Dollar holdings dropped to 16.4%, from 46.3%.

“If we talk about trade and investment, it makes a lot of sense for both countries not to trade in the in U.S. dollars, because then you have double conversion, in addition to other difficulties recently,” Akopian said.

But the pain for many Chinese businesses is immediate, with a volatile rouble and trade contracts not being honoured.

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“Everyone is focused on maintaining or cutting existing business right now. No one is talking about new business. That’s what I’m hearing from all quarters, including Chinese clients,” said a lawyer who declined to be named.

Han-Shen Lin, senior advisor The Asia Group and an ex-banker, also cautions that Chinese banks could face tougher scrutiny in the face of western sanctions against Russia.

“All the Chinese banks know that the U.S. dollar clearing global banks will be asking Chinese banks about involvement in sanctions-related counterparts transactions,” Lin said.

“What will be of interest is how Chinese banks can segregate the sanctioned transactions versus non-sanctioned”, such as energy-related businesses.