The Russia-Ukraine war will change the world of cross-border payments, which are considered the engine that facilitates global trade, finance and investments.
The consequences of unplugging Russia from SWIFT, or the "Society for Worldwide Interbank Financial Telecommunication", and the news of Visa, Mastercard, American Express and PayPal suspending operations in Russia are poised to alter the geopolitics of international payments.
The consequences of Russia’s exclusion from the global financial artery, SWIFT
Sweeping financial sanctions and stringent export control imposed by the West, including the SWIFT ban, will damage the Russian economy right away, but it can also have unintended effects for European countries. It can negatively impact major European Union (EU) economies, particularly Germany and Italy, which are heavily dependent on Russian natural gas.
Russia’s SWIFT exclusion will also hurt European commercial banks because they are barred from doing business with Russia, and given that French and Italian banks have the largest cross-border exposure to Russia, that may mean higher loan loss provisions by these banks.
Russia and China’s alternative to SWIFT
In 2014, Russia set up the System for Transfer of Financial Messages (SPFS), its equivalent of SWIFT. China built its cross-border interbank payment system (CIPS) and SWIFT alternative in 2015 to promote yuan internationalization.
CIPS is designed to help cross-border transactions in yuan (RMB or renminbi-denominated) as trade and investment with the rest of the world grows. It also serves as an avenue or alternative payment system for any country to bypass the SWIFT dollar-denominated payment and settlement system should they be cut off from SWIFT.
In response to the recent disengagement from SWIFT, Russian banks have immediately turned to China, primarily China’s state-owned UnionPay system, to issue cards. This move can accelerate cooperation and transactions between Chinese and Russian payment systems. In addition, the U.S. embargo on Russian oil imports will push Moscow closer to Beijing and expand their economic ties. If Russia can’t sell its oil to the U.S., it may sell it to China. China in turn can export more of its technology to Russia and also leverage its financing power to invest in Russian hydrocarbon projects.
China has been Russia’s largest trading partner for over a decade, according to Russia’s commerce ministry data, with energy and mineral products making up the bulk of Chinese imports. “Russia buys about 70% of its semiconductors from China,” states the Peterson Institute for International Economics. It also imports computers, smartphones and auto components from China.
The Sino-Russian desire to reduce dependence on the dollar has also strengthened their relationship. According to Atlantic Council, “China shares convergence of interests with Russia on finance and dedollarization. Russia and China shifted further away from using the dollar in bilateral trade in 2018 following the US imposition of heavy tariffs on Chinese goods and the onset of the US-China trade war.”
“While Moscow had previously spearheaded the dedollarization initiative, Beijing quickly modeled Russia’s strategy when it perceived its own risk to punitive US financial measures. This made way for a 2019 agreement to replace the dollar with national currencies in international settlements between them. Such financial coordination helped Russia reduce its reliance on the greenback in trade. While 80% of Russia’s total exports were denominated in US dollars in 2013, only a little over half of its total exports today are settled in dollars. Most of the decrease was absorbed by its trade with China.”
Apart from reducing its share of trade conducted in dollars with China, Russia has begun replacing its dollar reserves with yuan and euros to offset the negative impact of financial sanctions and to reduce the dollar’s hold over its economy. There might be more – alternative payment channels to keep payments flowing to Russia.
The long-term consequence of barring Russia from SWIFT may be China and Russia establishing an alternative payment system (RMB denominated) that is impervious to unilateral economic sanctions and will facilitate trade payments between Russia and China without using SWIFT, even though for now, China has shown little interest in sticking its neck out to back Russia and is quickly distancing itself from the beleaguered economy.
Central bank digital currency (CBDC) and China’s digital yuan
Almost 100 countries are actively evaluating central bank digital currencies (CBDCs), according to the IMF, and some have already started rolling them out.
The U.S. President, Joe Biden, signed an executive order last week directing agencies across the federal government to examine the risks and benefits of CBDC, as well as other cryptocurrency issues. India (digital rupee) and Russia (digital ruble) plan to launch CBDCs in 2022 as well. However, China’s central bank digital currency (CBDC) is perhaps the largest, most advanced and futuristic CBDC project to date.
The rollout of China’s digital yuan (digital legal tender), dubbed e-CNY, can be leveraged to promote their own sovereign digital currency as an attractive medium of payment for cross-border trade and finance and to challenge the dollar’s hegemony.
The home-grown digital yuan enables concurrent and efficient payment and settlement with a reduced dependence on financial intermediaries and lower cost of liquidity management. This will help the digital yuan reduce the cost of cross-border payments significantly. It aims to achieve real-time cross-border transactions in the near future to boost renminbi internationalization.
China is uniquely positioned to popularize the use of a CBDC due to its trade prowess, primarily as the world’s leading exporter and also as a colossal infrastructure investor. China’s Belt and Road Initiative (BRI), a trillion-dollar international infrastructure program that seeks to connect Asia with Africa and Europe, can give China the opportunity to increase its use of digital yuan through facilitating cross-border payments along the BRI. This will also augment its financial clout in the global arena and make it the key architect of a new payment system that facilitates the complete digitization of money.
Cryptocurrency and conflict
Another cross-border payment recourse that is emerging out of the Russian invasion of Ukraine is cryptocurrencies. The acceptance of cryptocurrencies within the mainstream global financial system is growing and is now a part of the conflict too. Millions of dollars in crypto have flowed in to support Ukraine’s army and hacktivist groups.
Cryptocurrency is being viewed as an alternative currency exchange for cross-border transactions that Russia could use to circumvent the international banking system and pay for imports of goods and services that it might otherwise struggle to access because of the severe economic sanctions.
The regulatory challenges are significant, and even as many governments explore the issuance of CBDCs, we may see different scenarios play out. It is difficult to predict how cryptocurrency will shape international conflict. Either CBDCs may shut out cryptocurrencies as was predicted in 2018 by the prominent economist, Nouriel Roubini, or the conflict may become a turning point for crypto, leading to its rise in popularity within conflict zones. For now, cryptocurrency is giving people a way to work outside of traditional financial institutions, and that may not change anytime soon.
In conclusion, the Russian-Ukraine war is hurting Russia, but it will also have global economic ramifications. In the days ahead, it can drive China, Russia and others into seeking alternatives to SWIFT, and that would mean that the U.S. dollar, the world’s reserve currency, may lose some control over the global cross-border payment network. In addition to being a significant humanitarian crisis, this conflict may prove to be the defining moment that alters global payment flows.
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