[RMB]How far away from China and Saudi Arabia settling oil in yuan?

Author: Wang Yingliang

Unofficially Translated from https://mp.weixin.qq.com/s/glNw71vGJGJc6rhQKpjUI

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During President Xi's visit to Saudi Arabia earlier this month, the two countries signed a number of cooperation agreements, including a huge energy deal, which yielded fruitful results, but the much-hyped media agenda of settling oil trade in yuan did not achieve a breakthrough. Previously, China and Middle Eastern countries have mostly used currency swaps to implement cross-border energy transactions. The summit, where China advocated the use of RMB for oil settlement, will have a certain demonstration effect on other countries in the Middle East, signalling that the Chinese government is seeking to enhance the RMB's status in international commodity settlement, which is expected to usher in a new situation for RMB internationalisation. Although there has been no breakthrough in the settlement of oil in RMB, the initiative has important implications.

1. This initiative sends a positive signal

Saudi Arabia is already China's largest exporter of oil and China has long settled its energy transactions with Saudi Arabia in US dollars. Against the backdrop of the US dollar currency still being pegged to oil, China's initiative to use the RMB as a means of settlement in its meetings with Saudi Arabia, despite not achieving a breakthrough this time, is a rich signal in itself. 

Firstly, as one of the major global demanders of fossil energy, the Chinese legal tender, the RMB, has the potential to gradually replace the US dollar in international commodity trade to some extent.

Secondly, in the bulk trade, China's attempt to achieve a breakthrough in the internationalisation of the RMB could help to provide other oil exporters with a means of settlement in addition to the US dollar and could achieve some positive signals. 

Thirdly, at a time in history when energy prices have skyrocketed as a result of the Russia-Ukraine conflict, China would prefer to use its local currency as a settlement to hedge against energy price volatility, and attempting to peg the RMB to some oil products could help to maintain its energy and financial security. 

Fourthly, China has become aware of the potential risks of US dollar-based oil trading, and its attempt to seek a shift in trading currency in commodities is an important signal to the world as the US continues to strengthen domestic legislation to expand its intervention in international trade and commerce. 

2. Renminbi internationalisation indicators are generally positive

The Renminbi Internationalisation Report 2022 released by the People's Bank of China in September shows that the indicators of RMB internationalisation are generally positive. 

Since 2021, the central bank has adhered to a market-driven approach based on the independent choice of enterprises and prudently promoted RMB internationalisation, which has provided strong support for the smooth operation of the real economy. In 2021, cross-border RMB receipts and payments for major commodity trades such as crude oil, iron ore, copper and soybeans totalled RMB 405.469 billion, up 42.8% year-on-year. 

In May 2022, the Executive Board of the International Monetary Fund (IMF) completed its five-yearly review of the Special Drawing Right (SDR) fixing. This was the first review since the RMB became an SDR basket currency in 2016. The Executive Board unanimously decided to keep the existing SDR basket currency composition unchanged, i.e. composed of USD, EUR, RMB, JPY and GBP, with the RMB weighting remaining third and the RMB weighting raised from 10.92% to 12.28%. All these show that the internationalisation of the RMB is gaining momentum. 

As a major global oil producer, any attempt by Saudi Arabia to abandon the use of the US dollar in oil trade could have complex spillovers. If Saudi Arabia were to settle its oil transactions in yuan, it would certainly be seen as a "rebellion" by the US. A Saudi source previously told Reuters that the decision to settle oil exports to China in yuan was "not the right time". Despite Saudi Arabia's disagreements with the US, its active development of strategic partnerships with the EU, Russia, China and India in recent years, and its apparent domestic anti-Americanism, the conflict is far from a need to repudiate the dollar currency. 

Typically, the issuance of an international currency can bring enormous political and economic gains, and the major global powers have actively mobilised at the international level to compete for a higher order of international currency status. 

Through the Defense Production Act of 1950, the U.S. Foreign Corrupt Practices Act of 1977 and the newly launched U.S. Anti-Corruption Strategy by the Biden administration, there have been increasing channels and opportunities for the U.S. to intervene in international trade and economic activities that are settled in U.S. dollars, making cross-border settlement of RMB in strategic items such as oil and gas, which are of national economic security, a must for China's sustainable development and security. The process is challenging but worthwhile.

3. A challenging but rewarding process

The promotion of RMB settlement for commodities is a rational approach by China in the context of the US-China game, but the process is challenging but worth the wait. 

The internationalisation of the RMB is fundamentally dependent on China's comprehensive national power and international political leadership. Historically, the replacement of the pound sterling by the US dollar was not entirely a free-market exercise, but rather a process that saw the UK's international political leadership greatly weakened by two world wars, the US becoming the world's largest gold reserve after World War II, and the direct pegging of the dollar to gold through the Bretton Woods system, with other currencies pegged to the dollar. It was only through the Marshall Plan that the dollar was established. 

In an era of general global peace, the replacement of the dollar by the renminbi will depend even more on China's international political influence, particularly in terms of gaining monetary allies and creating international monetary regimes and regional monetary and financial norms. Of course, breakthrough points will fall on specific countries. Iran, for example, has been decreasing the status of the US dollar in payments for oil exports since 2006 as an expression of its opposition to its status, and in recent years has made a number of breakthroughs in the settlement of oil trade between China and Iran in RMB. 

China's commitment to 'non-alignment' makes the use of the RMB as a settlement more of a requirement for China to shape the currency dependence of particular countries on China and for China to provide certain public goods in the long term. This makes the use of the RMB as a bulk currency for settlement by specific countries somewhat random. Of course, the "Belt and Road" friendly countries are the focus of China's efforts to promote the internationalisation of the RMB, and China could try to promote its own international currency strategy to provide a counterweight to the hegemony of the US dollar. 

From a domestic perspective, some Chinese scholars have suggested that, on the one hand, China should maintain a normal fiscal and monetary policy for as long as possible to ensure that the economy operates within a reasonable range and to maintain the stability of the real purchasing power of the local currency; on the other hand, it should prudently promote institutional financial opening, accelerate the marketisation, rule of law and internationalisation of the financial market, and create an increasingly convenient, transparent and predictable market environment for institutional investors, including foreign central banks. On the other hand, we will prudently promote institutional financial liberalisation, accelerate the construction of financial markets, rule of law and internationalisation, and create an increasingly convenient, transparent and predictable market environment for institutional investors including foreign central banks. 

However, China's economy has been disrupted by the three-year-long epidemic, with new economic adjustments and large fluctuations in the RMB exchange rate, and the reform of China's domestic financial system is still at a critical stage. Of course, the international community still has a path dependence on the US dollar, which is a real obstacle to the internationalisation of the RMB. 

Currency dominance is a complex systemic game. China and Saudi Arabia have great complementarities in the economic and trade fields, but the Saudis have shown caution in using the RMB as the oil settlement currency, reflecting the fact that the traditional path of "oil-dollar" is still highly stable. 

As a currency catch-up country, China needs to strengthen its comprehensive national power and international political leadership in order to promote the RMB as an "anchor currency" for international trade in bulk commodities.