Russia's Loss Is China's Gain

The same day in February that forces loyal to Vladimir Putin swept into Crimea, drawing international outrage that has since isolated Russia and diminished the ruble, China's yuan surpassed the Swiss franc as the seventh-most-used currency in the world.

It was another victory for Chinese President Xi Jinping in his bid to make the yuan an international reserve currency, and it was an economic retreat for Putin. After proclaiming in 2007 that the ruble was poised to become a haven for global investors, the Russian leader has watched it fade, a victim of his nation's stagnating economy since the land grab in Ukraine. Now so much money is leaving Russia that its central bank is considering temporary capital controls, according to two officials with direct knowledge of the discussions.

The ruble's share of global trading dropped to 0.4 percent from 0.6 percent since 2012, falling five places to rank 18th most-traded in the world, while the yuan tripled to 1.5 percent, according to the Society for Worldwide Interbank Financial Telecommunication, or SWIFT. Even as protests in Hong Kong this week challenged China's leadership, direct trading began between the yuan and the euro, capping a year in which trade with European Union nations grew 12 percent.

“If Russia is serious about internationalizing its currency, it should mend its relationships with the West first,” said Banny Lam, the Hong Kong-based co-head of research at Agricultural Bank of China International Securities Ltd., a unit of China's fourth-largest lender. “You have to let people believe that by holding your currency, they aren't going to suffer great losses.”

In the contest to reshape the world's economic order after the 2008 financial crisis, Russia and China are headed in opposite directions. Xi, 61, is carrying out China's most sweeping economic changes in more than three decades by opening up capital markets, expanding trade links and setting up overseas hubs to make the yuan a store of value.

Capital flow into China totaled $108 billion through the end of August, about triple the amount during the same period two years ago, according to data compiled by Bloomberg. The yuan, whose spot rate the government largely controls, has weakened 1.4 percent against the dollar this year, trimming its gain since 2005 to 35 percent.

Putin, 61, is more interested in territorial expansion. He told Ukraine President Petro Poroshenko that if he wanted to, within two days Russian troops could arrive not only in Kiev but also in Riga, Vilnius, Tallinn, Warsaw, or Bucharest, Sueddeutsche Zeitung reported this month, citing EU documents.

Asked about the report, Putin's spokesman Dmitry Peskov said, “I don't comment on signs of mass psychosis.”

Capital Flight

In a signal that economic sanctions imposed after the Feb. 27 invasion of Crimea are hurting Russia, capital flight from the country in 2014 could reach as much as US$120 billion, almost double last year, Interfax cited Russian Deputy Economy Minister Alexey Vedev as saying Sept. 22.

The limit on outflows under discussion at the central bank would be imposed only if they rise significantly, said the people, who asked not to be identified because no decision has been made. They didn't give a timeline or a level that may force such a move, saying they are looking at all possible scenarios. The central bank denied it was weighing controls.

The ruble is down almost 17 percent against the dollar this year and weakened to a record this week. The dollar-denominated RTS stock index is in a bear market, and yields on government ruble bonds due in 2023 have jumped 1 percentage point since June to 9.42 percent, more than the yield on similar-maturing debt securities sold by Greece. Net outflows from Russian assets totaled US$75 billion in the first half of 2014, compared with US$61 billion in all of last year, central bank data show.

When the Russian president took the stage at the St. Petersburg International Economic Forum in June 2007, there was a “new balance of power” in the world, Putin said. Russia was at its zenith in the post-Soviet era. The economy was posting a second straight year of growth of more than 8 percent; oil, the country's signature export, was about to top $100 a barrel for the first time; and the ruble had soared to its strongest level in almost a decade against the dollar.

“It's the right time to consider a transition to ruble payments for Russian exports,” Putin said.

A year later, during the global financial crisis, Russia drained $200 billion from its $598 billion foreign-currency reserves to slow the ruble's slide.

Today, none of the major central banks holds the ruble in its foreign reserves.

“I don't know anyone who takes the idea of the ruble as a reserve currency seriously,” Barry Eichengreen, an economics and political science professor at the University of California-Berkeley, and author of a book on global reserve currencies, said via email. “Holding financial assets in Russia is risky business.”

While Russia opened up its local bond market to foreigners last year and is easing its control over the exchange rate, sanctions are pushing the US$2.1 trillion economy to the verge of a second recession in five years. Gross domestic product will probably grow 0.3 percent this year, the worst performance since shrinking 7.8 percent in 2009, according to economists surveyed by Bloomberg.

Ruble-denominated assets have been anything but a store of value. The ruble has lost 14 percent against the U.S. dollar over the past three months alone, more than any other currency tracked by Bloomberg, and reached a record low of 39.852 per dollar in September. It has weakened 26 percent since the end of 2008 compared with an 11 percent gain for the yuan. Russia hasn't had any annual net inflow of private capital since 2007, the year after it lifted its last capital controls.

Doubled Range

While snubbing the ruble, central banks hold US$19 billion of the Chinese currency in their stockpiles, according to Societe Generale SA estimates. The yuan, also known as the renminbi, accounts for 4 percent of the reserves in South Africa and Hong Kong, and 2 percent of the holdings in Chile and Nigeria, the third-largest French bank said in a report in July.

“Chinese policy makers are serious when they say that enabling Chinese banks and firms to do cross-border business in their own currency is a source of convenience and competitive advantage,” Eichengreen said.

Over the past 13 months, the authorities doubled the range of prices at which they will the allow the yuan to be traded, liberalized the lending rate, and established a free-trade zone in Shanghai. This month, mainland and Hong Kong individual investors will be allowed to buy stocks in one another's markets for the first time.

Such efforts have paid off. In the first seven months of this year, about 13 percent of China's global trade was settled in the currency, compared with less than 1 percent in 2009, according to HSBC Holdings Plc. The yuan accounted for 1.39 percent of global market share in January, compared with 1.38 percent for the Swiss franc, La Hulpe, Belgium-based SWIFT reported on Feb. 27. Yuan payments rose 30.6 percent that month while growth for all currencies was 4.8 percent, SWIFT said.

Yuan-denominated debt sold by companies in the international market surged to 350 billion yuan ($57 billion) this year, from 16 billion yuan in 2009, data compiled by Bloomberg show.

“They are all small and consistent steps,” Sacha Tihanyi, a Hong Kong-based currency strategist at Bank of Nova Scotia, said in a phone interview. “That helps the renminbi to play a bigger role internationally.”

For its part, Russia is embracing the yuan, as Putin seeks to end what he has called the “dollar monopoly” and improve trade ties with his nation's largest trading partner.

Growing Faster

Yuan-ruble trading is growing faster than any other pair of currencies on the Moscow Exchange, and Russia's central bank said in an email that increasing the Chinese currency's role in local money markets is a main priority.

All that said, world markets are still dominated by the dollar and euro. As of June, the U.S. currency made up 61 percent of the US$6.3 trillion global foreign reserves that the central banks reported to the International Monetary Fund. The euro had 24 percent, followed by 4 percent in the yen and 3.9 percent in the pound. The shares of the ruble and the yuan are too small to break down.

“While it'll be hard for the yuan to be a reserve currency in five to 10 years, it's even more difficult for the ruble,” Jimmy Zhu, an economist at FXPrimus Ltd., a Singapore-based brokerage, said in a phone interview. “Russia is getting so isolated from the Western economies.”

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