As the Central Bank of Russia (CBR)’s prime rate approaches 20%, lending in rubles has become nearly impossible for Russian businesses. Companies are already spending one ruble in four on servicing interest payments, according to the regulator, and raising long-term investment capital at these prices is not viable.

Cheaper loans in yuan have provided a lifeline for some companies, but access to yuan has become harder to obtain as the so-called US strangulation sanctions introduced in December increasingly target banks and Russia’s currency exchange and clearing infrastructure. There is already a dearth of liquidity in the foreign exchange markets, largely affecting the Chinese currency since the yuanisation of the Russian economy after the US cut Russia off from the dollar after the SWIFT sanctions were imposed only days after Moscow’s invasion of Ukraine in 2022.

With demand rising, there is not enough Chinese currency to go around. Russia turns over more than $240bn in mutual trade with China each year, but the trade is well balanced, so most of that is settled in national currencies; without a large trade surplus, most of the yuan Russia earns from exports to China are used up paying for imports.

Another source of yuan liquidity could be swap agreements or interbank loans, but Office of Foreign Assets Control (OFAC)’s threat of secondary sanctions on international banks doing business with Russia led most of the important Turkish and Chinese banks to close their Russian client accounts at the start of the year. Now Russian exporters have to send their payments through slow and expensive roundabout routes to pay their bills and are unable to tap their former partners for trade financing deals, the norm, to ease the shortage of cash problems.

This summer, the market yuan liquidity shortage became much more noticeable, The Bell reports.

In theory the CBR has plenty of yuan. Half of the central bank’s non-frozen currency reserves of around $300bn predominantly comprises yuan (with the other half being the goal). In early 2022, yuan demand on the Russian currency market was negligible, but by May 2024 its share of trading on the Moscow Exchange had soared to 54%.

However, the liquidity problems started in earnest in June when OFAC slapped sanctions on the Moscow Exchange (MOEX), causing the CBR to immediately halt trading in dollars and euros, sending demand for the yuan soaring to 99.8%. Before the war, more than 80% of transactions were conducted in dollars, with euros making up the remainder. Another factor contributing to the yuan shortage is US sanctions against Russia’s National Clearing Centre (NCC) in addition to MOEX. These restrictions have led to speculative trading on the yuan’s exchange rate, further exacerbating demand.

Another factor leading to a shortage is that the extremely high domestic overnight interest rates – currently at 19% but expected to end the year at 20% – have made yuan loans very profitable for Russian banks, due the low borrowing costs, but high margin banks can change, similar to the set-up in the early 90s when dollar loans were cheap but cash was hard to find.

The average interest rate on corporate ruble loans in 2024, excluding SMEs, was 17.17% for loans under a year and 14.74% for longer terms, The Bell reports. By comparison, yuan loans carried significantly lower rates at 7.11% and 8% respectively, with 79% of loans issued for under a year and almost exclusively used in foreign trade.

“For businesses with yuan-denominated expenses, it’s easier to borrow in that currency than take out ruble loans, convert to yuan, make purchases, then reconvert revenues back into rubles to repay,” economist Sergei Skatov told The Bell. Previously dollars and euros were the currencies of choice for trade for the same reasons.

The spike in demand for the Chinese currency has far outstripped supply. Russian banks have faced difficulties lending in yuan because they lacked enough currency to close open credit positions, according to Sberbank CEO German Gref at the Eastern Economic Forum in September, and that is acting as a drag on loan volume growth.

The state-owned giant VTB has a branch in Shanghai and is trying to find a work-around, targeting Chinese and Russian trading companies, to persuade them to open accounts so they can collect pools of deposits to ease the pressure, but without much luck so far.

The yuan liquidity crunch reached its peak in September, when the rate on one-day repo agreements in yuan (a transaction involving the sale of currency with an obligation to repurchase it) surged more than fourfold in a single day, hitting 212%. Such figures were unprecedented on the Moscow Exchange, The Bell reports.

Phantom problem

Yet the yuan liquidity problem is not as bad as it appears, as the CBR maintains that there is no genuine shortage of yuan liquidity. The issue lies with the banks, which did not issue yuan loans to clients because they needed the currency to balance their own foreign exchange positions. Simply put, banks have been using yuan to align their balance sheets rather than lending it out, adding to the shortage.

The CBR has tried to remove the problem by offering currency swaps, a tool designed to sell yuan for rubles with a commitment to repurchase. This alternative to the currency repo was introduced in early 2023 to stabilise money market rates during periods of imbalance, such as the current currency shortfall.

Initially, the CBR raised the swap limit from CNY10bn to CNY30bn but later increased the cost of borrowing through swaps to discourage reliance on this facility. In September, Deputy Chairman Alexey Zabotkin clarified the regulator's stance: banks should not use swaps to solve funding problems disguised as liquidity issues. He stressed that banks need to ensure their lending aligns with their capacity to raise foreign currency deposits.

The FX related operations have been a real boon for the banking sector, which is currently earning its highest profits in at least five years. The profits of the Russian banking sector in August increased by 42% compared to July, to RUB435bn ($4.6bn), according to the Central Bank's data, which also recently improved its net profit forecast for the sector in 2024, now estimating earnings between RUB3.3 trillion and RUB3.8 trillion, up from a previous range of RUB3.1 trillion to RUB3.6 trillion, with a return on equity expected to be around 22-25%.

Zabotkin was telling banks to source yuan themselves and not rely on the CBR’s loans that were intended to solve liquidity problems, not make them profits.

Raising more yuan deposits would be the classical solution to these problems, but there is still little demand for yuan savings in Russia, unlike for dollar savings account pre-war. As a result, the yuan often flows out of the country via arbitrage, say experts.

The Central Bank’s recent Financial Market Risk Review explicitly blamed banks for the surge in yuan borrowing rates, citing their increased foreign currency lending, coupled with a reduction in liquid yuan assets. Corporate deposits, a primary funding source, have proved volatile, and when outflows occur, banks turn to swaps to balance their positions, The Bell reports.

The yuan liquidity issue was further aggravated by Rosneft’s CNY15bn bond redemption, due on 20 September. Banks scrambled to accumulate yuan ahead of this deadline, causing a spike in demand. Once the bond was settled, the rate for yuan lending on the Moscow Exchange dropped from 17.76% to 13.54%.

Experts don’t think the situation will improve anytime soon and the CBR could chose to halt yuan trading completely, potentially after October 12 when the US sanctions licence for the Moscow Exchange and NCC expires, The Bell reports.

Suspending yuan trading would increase costs for all parties involved in export-import operations. However, The Bell’s source insists that solutions will be found, as Europe continues to buy Russian exports such as gas, despite sanctions.

“The shift in Russia’s foreign trade towards the East has made the yuan its main settlement currency. But the yuan is not yet fully equipped to replace the dollar in this role, and similar imbalances are likely to emerge periodically,” The Bell commentated.

These problems affect not only businesses and currency traders but also ordinary Russians. The ruble has depreciated by 15% against the yuan since late August, making Chinese imports more expensive – a significant issue given China’s role as Russia’s leading trading partner in recent years.