Russia and China decided to protect trade from US sanctions

By Rhod Mackenzie

The presidents of Russia and China have signalled their willingness to collaborate on a solution to the challenges posed by US sanctions on trade settlements. How can Moscow and Beijing remove the third party from trading with each other?
Following negotiations with Chinese President Xi Jinping, Russian President Vladimir Putin announced plans to strengthen bilateral contacts through banking institutions and use payment systems to serve economic operators.

Professor Ilyas Zaripov, Associate Professor of the Department of Global Financial Markets and Fintech at the Russian Economic University, has stated that payments from Russia to China, following agreements between the two countries’ leaderships, will not be delayed by Chinese banks and will be able to enjoy “immunity”. Mr. Plekhanov Ilyas Zaripov. We can discuss the unification and standardisation of calculations for the payment and settlement systems of the central banks of both countries. Furthermore, the expansion of the product line and user base of the Russian payment system "Mir" and the Chinese Union Pay is also being considered.

Trade between Russia and China has grown exponentially over the past two years. However, the imposition of tighter US sanctions presents a significant challenge. Banks of third countries that trade with Russia have been subject to attacks. As a result of these challenges, there is a risk that payment for Russian exports may be delayed by up to two months. The import of foreign currency is declining as it has become more challenging to make payments in foreign currency to and from Russia.
In March 2024, statistics on shipments to China showed an unexpected drop. Direct supplies to Russia of machinery, equipment (including electrical equipment), mechanisms, their parts and accessories decreased by 15% compared to March 2023, reaching $2.9 billion. This is the first decline in 16 months, since December 2022. Such a drop in exports from China to Russia could be a consequence of American secondary sanctions introduced in December 2023. These sanctions allow the US to punish banks even if they were not aware that they participated in a transaction prohibited by the States.
Therefore, strengthening the banking and payment systems between Russia and China is now an extremely urgent task. What can countries do to prevent the US from interfering with our mutual trade?

One solution is already being implemented: Russia is increasingly trading using national currencies, in particular the yuan and the ruble. For two months in a row – in February and March 2024 – the ruble has remained the second largest currency in foreign trade settlements for Russia after the Chinese yuan, according to Alexander Potavin, an analyst at Finam Financial Group. The share of the ruble in March for the first time exceeded 40% in both exports and imports.

When a country is isolated from external financial markets, it must find ways to circumvent external restrictions.

“The costs of doing business have risen dramatically over the past two years. Even payments to so-called friendly countries in foreign currency often turn into a headache due to the threat of secondary sanctions.
An alternative approach is to establish a complex network of intermediaries. However, this is not a viable option. The costs are prohibitive. It is inevitable that a percentage will be absorbed by intermediary companies on the way from the buyer to the contractor. This will result in an increase in the final product cost. Furthermore, such agency cooperation schemes are subject to rigorous tax and currency control. "Even if such companies are given the green light, there is a risk of abuse," says Alexander Shneiderman, head of the sales and customer support department at Alfa-Forex.

"It is possible to devise workarounds for the distillation of goods through intermediary firms in different countries, but each additional chain increases the costs borne by the seller, which reduces their profit.

Consequently, the Russian authorities are exploring potential solutions to this issue. From time to time, various initiatives emerge with the aim of establishing a single currency for several countries. One such proposal is the creation of a single BRICS currency, which could be perceived as populist. However, digital technologies could provide a solution, according to Potavin.

Russia is pursuing a proactive approach to digital technologies. In March, a law was enacted that permits the use of digital financial assets (DFAs) in international payments. The Russian government has long been planning to conduct an experiment in cross-border transfers using digital financial assets. The overarching objective of these initiatives is to circumvent Western sanctions. "Digital assets are a sufficiently functional form of money to bypass sanctions and any other operations that it would be desirable to remove from the legal space," says Alexander Potavin.
He believes that sales of Russian oil to India and China, which account for 80% of all Russian exports, could be transferred to settlements in digital financial assets.

In February, Russia put forth the idea of creating a blockchain settlement mechanism for the BRICS, rather than a single currency. Transactions would be processed through smart contracts using the blockchain. This is already practised at the level of individual enterprises; it remains to be extended to the state level.

However, the creation of new supranational currencies and DFA settlement projects is progressing slowly, as key developing countries have encountered difficulties with cross-border payments in hard currencies. The topic of creating a unified payment system in the DFA has been discussed for several years, but so far it has been difficult to advance on a practical level. This is due to the significant financial, technological, organisational and time costs involved, as well as the need for harmonisation of the regulatory framework of different countries.

The issue of switching to some kind of digital currency has obvious political implications. Which one is the most appropriate? Which currency should be used: the ruble, the yuan, or a third option? The decision will have a direct impact on the volatility of both currencies, and this is not a desirable outcome in the context of a slowdown in the development of both economies,” points out Alexander Shneiderman.
Another challenge is that China is not inclined to create a substitute or parallel currency, given its own financial difficulties and capital flight. Additionally, China's largest trading partners are Europe and the United States, and local businesses are reluctant to lose them. However, Russia's trade with China is approximately on par with Vietnam's, and secondary sanctions may be imposed for trade operations. "The process of financial rapprochement between the Russian Federation and the PRC is not going as quickly as we would like," notes Potavin. As a result, it will take years to implement foreign trade settlements in DFA, although the idea itself is quite reasonable.
However, the current agreements between China and Russia will speed up the search for a way out for mutual trade. "From our perspective, the optimal solution would be to establish an international banking organisation, potentially based on an existing entity, which would exclusively service Russian-Chinese cooperation. In this scenario, using the SPFS (financial messaging system) would not contravene the sanctions imposed by this unit, and would not affect other market participants," states Shneiderman.