Russia’s economy is facing a moment of truth from China

That would threaten a critical lifeline for Russian businesses, which have become heavily dependent on the yuan as trade with China intensified after President Vladimir Putin ordered the invasion of Ukraine in 2022. The war triggered Western sanctions that have largely excluded Russia is part of the global financial system. .

In June, the US expanded its sanctions, forcing the Moscow Stock Exchange and its clearing agent to halt trading in dollars and euros. A Treasury Department license, which allows time for some transactions to close, will expire on October 12.

While Russia has already moved away from Western currencies in favor of the yuan, additional US sanctions could have ripple effects on Chinese banks that engage in yuan transactions with Russia.

“The situation may change after October 12,” a source told Reuters. “A sudden shortage of yuan or a complete refusal to accept payments from Russia by Chinese banks is possible.”

This is because all conversion operations, including for Chinese bank subsidiaries, will stop and all currency positions opened through the Moscow Exchange will be closed, the report also states.

“As a result, the situation with the provision of yuan liquidity will become even more difficult,” the source told Reuters.

In addition, the Russian unit of Austria’s Raiffeisen Bank began refusing to make payments to China earlier this month, the report said.

Liquidity in Russian yuan was already under pressure after the US expanded its definition of Russia’s military industry earlier this year, widening the potential scope of Chinese firms that could be hit with secondary sanctions for doing business with Moscow.

As a result, Chinese banks have been reluctant to transfer yuan to Russian counterparts while servicing foreign trade payments, leaving transactions in limbo for months. With liquidity in China’s yuan drying up, Russian companies have turned to the central bank for yuan through currency swaps.

But the Bank of Russia dashed hopes for more liquidity, saying the swaps are intended only for short-term stabilization of the domestic foreign exchange market and are not a source of long-term funding.

Russian banks more than halved their swap loans, which fell to 15.4 billion yuan ($2.19 billion) on Wednesday from a high of 35.2 billion yuan in early September, according to Reuters.

“We cannot borrow in yuan, because we have nothing to cover our foreign currency positions,” German Gref, CEO of major Russian lender Sberbank, told an economic forum earlier this month.

For the time being, Russian wartime spending as well as oil exports to China and India helped support the overall economy. But the combination of busy factories and labor shortages due to military mobilizations fueled more inflation. Meanwhile, Russia is suffering from a spiraling population crisis.

Researchers led by Yale’s Jeffrey Sonnenfeld warned in August that the seemingly solid GDP data was masking deeper problems in the economy.

“As the defense industry expands, Russian consumers are increasingly burdened with debt, potentially setting the stage for a looming crisis,” they wrote. “An excessive focus on military spending crowds out productive investment in other sectors of the economy, stifling long-term growth prospects and innovation.”