(Yicai Global) March 1 -- Following Russia’s invasion of Ukraine on February 24, western nations have responded by unleashing severe sanctions aiming at effectively isolating the country from the global financial system, including looking to freeze their holdings of Russian Central Bank assets and expel a number of banks from the SWIFT messaging system and prohibiting them from receiving financial lending or assistance in their own currencies. In addition to this, the US is leading with comprehensive export restrictions of which will also isolate Moscow from the global semiconductor supply chain, curbing their access to components to build technology with.

Whilst these types of sanctions have been utilized before targeting smaller countries such as Iran, Venezuela or North Korea, Russia is the largest country ever subject to these kind of sanctions in history and the only major economy to be hit with such. These decisions will have profound consequences for global markets and of course China itself. Whilst this will also pose massive disruptions, in the long term, it ultimately may rewrite the global economic system in ways not seen since the collapse of the Soviet Union 1991.

Breaking Dollar Hegemony?

It is of course objectively undeniable that the sanctions being imposed now will be painful for Russia and will isolate it from the global financial economy at large. Banks are instinctive to the political risks dealt by sanctions of which can cut them off from their own lending portfolios, a weapon in which the United States has constantly pursued to its own political ends. Banks around the world who are liable in lending dollar flows to sanctioned parties face fines and sanctions themselves. For example, in 2017 Liaoning’s Bank of Dandong, a local bank, was subject to such measures because it was accused of being used by DPRK entities against US sanctions. With the war in Ukraine ongoing, the political will towards enforcement of these new sanctions in western countries is subsequently very high.

In the long run, however, the all out weaponization of western currencies to isolate a major economy will have profound consequences for already shifting paradigms in global payment systems, mediums of payment and reserve currencies. China’s Cross-Border International Payments System (CIPS), opened in 2015, is likely to rise to prominence concerning trade with Russia. Whereas India, another highly populous country and emerging major economy that has a partnership with Russia, is already looking into means of transactions in the form of Rupees. Moscow itself had already initiated its own system known as the “System for Transfer of Financial Messages” (SPFS) in 2014, but this has only connected with 23 foreign banks so far.

Critical to these shifts is how Russia will be forced to facilitate the transfer of its energy exports, key to its own economy and to the global economy of oil and gas, under another currency instead. There is a high probability this will be the Chinese Renminbi since the Pound Sterling, Dollar, Yen and Euro are all now off limits. Given that the RMB is also one of the only segments of the country’s foreign exchange reserves which are also not sanctioned, this will have a profound impact on the internationalization of the Yuan as a means of international settlement. On the first day of the Winter Olympics, China and Russia had agreed the construction of a new gas pipeline, presumably a pre-empting of the inevitable cancellation of NordStream2. This project was initially designated to be settled in Euros, but will now also have to change course.

However, this will be a long-term progress. In the short-term, China should expect that the United States will attempt to put pressure on Beijing to sever its economic ties with Russia and may apply a broader range of secondary sections, which may hasten risks of decoupling in this more uncertain world, these may be more market access and export based than strictly financial (given the US has sought to avoid financial sanctions against China out of worry for USD hegemony) Whilst Russia’s situation translates tremendous geopolitical leverage to China in dealing with the US and its allies, it also comes with such risks and challenges accordingly which are likely to surmount to a balancing act. But seen as China’s foreign policy as a whole is already shifting. The reality is consequentially likely to be a balancing act of sorts, and either way certainly places greater onus on China to further develop its strategic economic independence in points of vulnerability from the west.