Russia’s strategy of relying more on China’s yuan is the opposite

After the US and its allies sanctioned Russia in 2022 for invading Ukraine, Moscow moved away from the dollar and euro in international transactions and relied more on China’s yuan.

This coincided with more trade between the two countries as Russia was largely shut out of Western markets as well as the global financial system.

By June, the yuan accounted for 99.6 percent of the Russian foreign exchange market, according to Bloomberg, which cited data from Russia’s central bank. And Russian commercial banks have stepped up corporate loans denominated in yuan.

But that reliance on the yuan is now reversed as top Russian banks run out of the Chinese currency, Reuters reported on Thursday.

“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.

That’s because 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. As yuan liquidity dries up in China, Russian companies have turned to the central bank for yuan through currency swaps.

Earlier this month, banks raised a record 35 billion yuan from Russia’s central bank through these swaps, according to Reuters. And the banks expected more help.

“I think the central bank can do something,” Andrei Kostin, CEO of the second largest bank, VTB, said on Thursday. “Hopefully they understand the need to increase the supply of liquidity through swaps.”

But on Friday, Russia’s central bank dashed those hopes, asking banks to reduce yuan-denominated corporate loans.

The Bank of Russia also said in a report that the swaps are intended only for short-term stabilization of the domestic currency market and are not a source of long-term funding, according to Bloomberg. But rather than simply filling the roles that the dollar and euro had, lending in yuan has expanded.

“The increase in yuan lending was partly caused by the replacement of loans in ‘toxic’ currencies, but 41% of the increase was due to new foreign currency loans,” the bank said.

The central bank also released a survey that showed a quarter of Russian exporters had problems with foreign counterparts, including blocked or returned payments even when trading in supposedly friendly countries. And about half of exporters said problems got worse in the second quarter compared to the previous quarter.

The story continues

The overall Russian economy was supported by wartime government spending as well as oil exports to China and India. But the combination of busy factories and labor shortages due to military mobilizations fueled more inflation.

Researchers led by Yale’s Jeffrey Sonnenfeld warned that the seemingly robust GDP data masks deeper problems in the economy.

“Simply put, the Putin administration has prioritized military production over everything else in the economy, at substantial cost,” they wrote. “While the defense industry is expanding, Russian consumers are increasingly burdened with debt, which may set the stage for a looming crisis. The overemphasis on military spending crowds out productive investment in other sectors of the economy, stifling long-term growth prospects and innovation. .”

This story was originally featured on Fortune.com