Why The Yuan (RMB) Is Russia's Favorite Currency

Russia and China share a border and common political philosophies. Now they share a currency as well.  

The Chinese yuan renmibi is fast gaining preferred status within Russia. China is Russia's second-largest trading partner, so this relationship could be a big deal for the Chinese currency. Russia's largest energy company, Gazprom, has already begun accepting the renminbi as payment. The energy firm and its Chinese customers are also in negotiations to use their respective currencies for payment of energy supplies.

Additionally, the Russian Central Bank announced plans to create a new yuan-denominated funding instrument, and the Russian finance ministry said it was considering issuing state debt in yuan. Most importantly, Russia and China announced a $24 billion currency swap last year.

For Russia, the Chinese intervention could not have come at a better time.

Motivation Behind the SwapThe Russian economy has been crippled due to a combination of sanctions imposed by the West and declining oil prices. The Russian ruble's exchange rate in the currency markets has declined; as a result, its value against the dollar fell by 45% last year. The Russian Central

Bank attempted to prop up the currency by selling dollars to buy back the ruble, but its efforts have been met with little success. Given that the screws are being further tightened around Russia's economy, the situation is expected to worsen, though China's assistance to Russia is a win-win situation for both countries. (For more, see Sanctions & Oil Prices Bring Russian Economy Near Collapse.)

The Russian government is using China's currency to shore up its foreign reserves, which, considering the ruble's slide against the dollar, are depleting fast. The swap also provides a trading window for Russia, who has become an international pariah after its aggression in Ukraine. In exchange, the Chinese currency gets increased credibility and circulation in international trade. The move also enables China to access local markets because the Russian government and companies can use the yuan to buy Chinese goods and services. Russian petroleum majors have already agreed to buy equipment and services from Chinese manufacturers for their operations.  

Russia is not the first country to implement such a strategy. Last year, Argentina agreed to a $11 billion currency swap to prop up the peso after defaulting on its dollar bonds, which had negatively impacted Argentina's standing with global creditors. But the swap deal helped prop up the peso and avoid a free fall in its value. Much like Russia, Argentina also has a strong trade relationship with China; in fact, Argentina runs a trade deficit with China, with the deficit in favor of the latter. In spite of this, the Argentine President Cristina De Kirchner made a trip to China last year to court Chinese manufacturers.

Alternative To The Dollar  China is playing a long term-game in the hopes of creating an alternative to the U.S. dollar. Currently, the dollar is the world's reserve currency. This means that major transactions around the world are conducted using the dollar. For example, oil prices and transactions are set in dollars. The American economy reaps several benefits, such as access to cheap credit and a high percentage of government debt, from the world's trust in its currency.

There are no competitors or alternatives to the dollar's status presently. But China is making efforts to popularize the yuan. The nation has already signed currency swap-line agreements with 28 other countries. This will increase the currency's circulation in international trade. In addition, it provides a market for Chinese goods and services at a time when China's manufacturing prowess is under threat from a number of other countries. 

But China’s efforts may not be successful for some time. This is because the dollar is backed by political, economic and legal infrastructure – such as free markets, democratic principles and rule of law – that may be difficult to replicate in China. The U.S. also holds an enormous technological and economic advantage over the rest of the world. This, coupled with a favorable demographic outlook, makes its future growth prospects bright.  Furthermore, the trade relationship between Russia and China is a small fraction of international trade. China would need to replicate or better the U.S.’s economic, military and political clout to have the yuan replace the dollar.     

The Bottom Line

The yuan can help Russia stabilize its currency and mitigate the consequences of its current economic crisis. But the Chinese currency has a long way to go before it can provide serious competition to the dollar as the world's preferred reserve currency.