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Why China’s yuan-for-oil push in the Middle East is no threat to the US dollar

On December 9, President Xi Jinping said in Riyadh that even as China continues to import large quantities of crude and natural gas from the Middle East, it intends to “make full use” of the Shanghai Petroleum and National Gas Exchange as a platform to carry out yuan settlement of oil and gas trade.

There is much speculation over the implications of this statement on China’s objective of pushing yuan internationalisation to weaken the US dollar’s grip on global trade. Some perspective would help.

China has had ambitious plans for a greater international role for the renminbi since 2002, when policy steps were initiated. These accelerated after the 2008 global financial crisis.

China has permitted international investors into its capital markets, introduced a more flexible exchange rate regime, allowed offshore bond issuances, entered into bilateral currency swap agreements with about 40 countries, and launched the Cross-Border Interbank Payments System, an international yuan payments, clearance and settlement system.

Offshore yuan trading is now possible in all time zones with Hong Kong, London and Singapore as leaders. The International Monetary Fund included the yuan in the basket of currencies that determine the value of its currency, the special drawing rights (SDR) in 2016.

Nearly two decades on, where does the internationalisation of the yuan stand? Based on the latest available data, the yuan accounts for less than 3 per cent of global foreign currency reserves and about 2 per cent of global payments (the US dollar’s shares are nearly 60 per cent and 42 per cent respectively).

The yuan makes up 7 per cent of all foreign exchange trades globally compared to the US dollar’s 88 per cent. Talk of the yuan imminently displacing the dollar as the world’s premier currency is clearly premature.

Riyadh is fertile ground for President Xi to push for yuan settlement for its oil and gas trade. Saudi Arabia’s long-standing ties with the US are under strain over human rights and other issues. Countries in the Middle East are also concerned about the security implications of the US’ “pivot to Asia”.

The United States became a net energy exporter in 2019 and its crude oil imports have fallen. The freezing of nearly half of Russia’s foreign exchange reserves by the US and its allies after Russia’s invasion of Ukraine has many countries exploring alternatives to a US dollar-dominated world.

The yuan is being positioned as the alternative. The US dollar is currently the basis for the pricing and settlement of almost all of China’s oil imports. China would undoubtedly like to see greater use of the yuan in both aspects.

Saudi Arabia is reportedly considering accepting payment for its oil exports to China in yuan. Last year, China imported nearly US$44 billion of crude from Saudi Arabia and exported about US$27 billion of mostly manufactured goods to it. Saudi Arabia could choose to accept payment in yuan for some of its crude oil and use the yuan received to pay for its imports from China.

Other countries in the Middle East may also oblige China similarly. Any such shifts are likely to be marginal, as most Middle Eastern currencies are pegged to the US dollar and accepting payments in other currencies increases foreign exchange risk. A stampede out of the US dollar into yuan by the countries in the Middle East, even for settlement, is therefore unlikely.

The likelihood of the yuan replacing the US dollar as the benchmark currency for pricing is even more remote. Despite China being the world’s largest importer of oil and gas, the market is too global on both supply and demand sides for the pricing basis to change to the yuan.

China’s capital controls and the yuan’s lack of convertibility limit its usability as the global pricing currency. For now, the US dollar will remain the primary currency for pricing in the oil and gas trade.

Is there a role for China’s digital yuan in accelerating yuan internationalisation in the Middle East? No, at least not yet. The digital yuan is still a retail concept more useful for small, individual, domestic transactions rather than for settlement of large, institutional, cross-border transactions such as those in the oil and gas market.

Given the significant inefficiencies in the prevailing system of wholesale cross-border payments, the future will most likely involve digital currencies. The internationalisation of the yuan will surely benefit over time.

Even if President Xi’s audience in Riyadh goes along with his stated goal of greater use of the yuan, its impact on the further internationalisation of the yuan will be gradual.

Global commodity and financial markets will demand much more from China – liberalised financial markets, yuan convertibility, and policy certainty and transparency – before they even consider ditching the US dollar.

The yuan’s gradually increasing international role does indeed need to be watched, but it does not yet pose a clear and present danger to the US dollar.

Dr P.S. Srinivas is a visiting research professor at the East Asian Institute, National University of Singapore