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FRONT OF MIND | – 4 Min

Renminbi internationalisation – The petro-yuan and the role of gold

By CHI LO 06.01.2023

In this article:

    If Saudi Arabia decides to trade its oil with China in renminbi rather than US dollars, it would add momentum to the ‘petro-yuan’ trading already happening between China and Russia. More players choosing to trade oil and other products with China in renminbi could help the Chinese currency reach critical mass internationally over time.

    Gold, however, is a key factor in the further development of a petro-yuan system. A gold-backed petro-yuan does not require full renminbi convertibility to function, so it allows China to simultaneously retain control of its capital account and boost the internationalisation of the renminbi.

    This system would enable the renminbi to become an independent asset class over time and build out both the renminbi’s internationalisation and China’s own capital markets. It could also eventually disrupt the USD-dominated SWIFT (Society for Worldwide Interbank Financial Telecommunication) global payments system.

    Petro-yuan’s momentum

    President Xi Jinping visited Saudi Arabia last December during the first China-Arab States Summit and the China-Gulf Cooperation Council Summit. China is the world’s biggest energy consumer, while Saudi Arabia is the world’s second-largest oil producer and the top oil exporter.[1] The state visit furthered China’s 2018 initiative to shift more trade in oil to the renminbi from the US dollar.

    Following US-led sanctions over the Ukraine war, Russia sought to increase its use of the renminbi, boosting the Chinese currency and the already bourgeoning Sino-Russian trade (see Exhibit 1). Russia adopted China’s CIPS (Cross-Border Interbank Payment System) for trading oil, bypassing SWIFT.

    If both Saudi Arabia and Russia work further with China, the amount of renminbi-denominated oil trade processed via CIPS could rise sharply. Note that Russia’s fourth largest oil producer, Gazprom Neft, has been settling all its crude oil sales with China (one-third of its total sales) in renminbi since 2015. Countries including Iran, Venezuela and Indonesia are already settling some of their China oil trade in renminbi.

    The volume of trade, and the scope for using the renminbi for international payments, could grow as more countries diversify out of US dollar risk. This development could challenge the US dollar-based global financial system over time as the dollar’s global reserve currency status is largely based on its importance in the energy and commodity markets.[2]

    The creeping importance of the renminbi

    Some market players initially estimated that switching the oil trade from the dollar to the renminbi could move transactions worth between USD 600 billion and USD 1 trillion out of the dollar each month.[3]

    SWIFT data show that the renminbi was the fifth most widely used global payments currency, accounting for 2.37% of the total, in November 2022 (the latest data available). That was up from 2% two years ago, though still a fraction of the payments in USD and EUR (see Exhibit 2).

    With about USD 100 trillion-worth of payment messages moving monthly through SWIFT, the renminbi’s share would currently amount to about USD 2.37 trillion. Add to that amount the USD 600 billion to USD 1 trillion of oil trade that could be settled in renminbi and the share of global payments would rise to 3% or more in the SWIFT system. That would put the renminbi ahead of the Japanese yen as the fourth most widely used global currency.

    Gold’s role

    Of course, the petro-yuan will not displace the petro-dollar and the dollar-based payments system overnight. However, China’s strategy to back renminbi oil trades by gold is instrumental for building up the petro-yuan system. Making the renminbi convertible into gold effectively turns the currency into a global investable asset for foreign renminbi owners, boosting their confidence in and demand for the Chinese currency.

    If such a strategy succeeds in getting Saudi Arabia and Russia to buy into the petro-yuan initiative, other countries may follow. This could have profound geopolitical and economic implications as it would change the dynamics of the oil trade and could tilt the geopolitical balance towards China. Countries might be able to evade economic sanctions imposed under the US dollar system by using the renminbi and CIPS, thus weakening the US’s ability to monitor and influence international trade and dollar flows.

    A renminbi asset class

    China is building the infrastructure for renminbi internationalisation. The petro-yuan system could allow Beijing to accelerate the process while retaining full control of its capital account.

    Sustaining and growing the petro-yuan network also means that China would have to accumulate more gold for a gold-backed renminbi.

    Over time, however, China will need to create more yuan-denominated investible assets besides gold to enhance the incentive to use the currency. Greater non-trade demand for the renminbi will require further development of its onshore capital markets, including renminbi hedging instruments, to accommodate large foreign fund flows.

    Disclaimer

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.


    [1] China is Saudi Arabia’s largest trading partner, with bilateral trade worth USD 87.3 billion in 2021. Chinese exports to Saudi Arabia reached USD 30.3 billion, while China’s imports from the kingdom totalled USD 57 billion. Saudi Arabia is also China’s top oil supplier, making up 18% of Beijing’s total crude purchases. Imports in the first 10 months of 2022 were worth USD 55.5 billion, according to Chinese customs data. Source: Reuters

    [2] See “Chi on China: The Renminbi’s Creeping Internationalisation: The Boiling Frog Fable”, 13 April 2022 (here)

    [3] For example, see “The Petro-yuan: A Momentous Game Changer for the Global Energy Markets, the Global Economy and Sanctions”, M. G. Salameh, International Association for Energy Economics, IAEE Energy Forum, Third Quarter 2018, pp.29-33

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.

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