Unlike the Brics summit in Johannesburg in 2023, which was waved off by western observers as no real threat to the dollar, October’s summit in Kazan, Russia is set to be ground-breaking for two reasons.
First, there have been major changes since the last summit. Brics – comprising Brazil, Russia, India, China and South Africa – has been expanded by five important new members: Saudi Arabia, United Arab Emirates, Iran, Egypt and Ethiopia. Saudi Arabia, the world’s main supplier of petrol, has also joined Project mBridge, the Bank for International Settlements’ digital currency arrangement. The country has made comments about considering alternatives to the present dollar-based oil payments system and being open to using the petroyuan for oil settlements.
Second, there is Russia, a country at war with Ukraine and engaging in economic conflict against the whole western alliance. It will use the Kazan summit as a means to push Brics members to join this endeavour. Russia is planning a new denomination for oil, – the petroyuan – its own mBridge system to pay for oil and even a common Brics currency to reduce dependence on the dollar.
How feasible is the petroyuan?
A fully-fledged currency needs to fulfil three functions: denomination, a means of payment and storage of value. Anything short of these is not a currency and the petroyuan is struggling to meet these requirements.
Denomination can be done at the drop of a hat; just put a price label in renminbi on every barrel of oil. Achieving a means of payment, however, is more complicated.
The Johannesburg summit communique proposed using the antiquated correspondent account system to avoid US-controlled Swift. This has already run into trouble as participating Chinese banks face scrutiny elsewhere and thus may be subject to US sanctions. Problems have also cropped up as there are imbalances among Brics countries using national currencies. For instance, there are piles of Indian rupees at Russian banks paying for Russian oil imports.
The main challenge for the petroyuan will be putting enough renminbi at the disposal of major oil-importing countries such as India. As they do not run current account surpluses with China, these countries do not earn enough renminbi to pay for their oil imports. They must be provided with renminbi through other channels.
The BIS-led Project mBridge could be a solution. mBridge is a modern payments system that uses central bank digital currencies to replace the outdated correspondent account settlement system. It allows for immediate settlement among partner central banks in China, Hong Kong, UAE, Thailand and now Saudi Arabia. Transactions conducted on this platform avoid scrutiny by outsiders such as Swift and the US.
The third function of money is storage of value. The oil-exporting countries will earn massive amounts of renminbi. A mechanism must be designed to recycle these surpluses to countries in need. In the dollar-based system, this was efficiently managed by global banks. Any surpluses that were added to the foreign exchange reserves of oil-exporting countries were attracted by foreign banks that lent them to countries in need. With the exception of the Mexican crises in the early 1980s, this process worked smoothly, mainly through the eurodollar market.
In the case of petroyuan, this process will be far more difficult as surplus renminbi has to be either spent on trade with China or added to foreign exchange reserves – now deemed acceptable by the International Monetary Fund since the renminbi is in the special drawing rights basket. Brics financial intermediaries will face the task of recycling the surpluses to countries in need. This will be testing as China tightly controls the offshore renminbi market.
Great benefits await from the enhanced role of the renminbi. China has laid down the infrastructure (the Cross-Border Interbank Payment System and the Shanghai Petroleum and Natural Gas Exchange) but it is not well developed. China had previously proposed to link petrol sales in petroyuan with renminbi gold futures but this plan was dropped as China would have been the only supplier of gold in a thin market.
The main beneficiaries of the renminbi’s greater role will be Chinese banks, making badly needed profits out of the recycling process. Western financial intermediaries can join them by arbitraging between the dollar-denominated oil market and the renminbi-denominated oil market. However, the introduction of a petroyuan will only further the fragmentation of the global financial system.
Herbert Poenisch is Senior Fellow, Zhejiang University, and former Senior Economist, Bank for International Settlements.
