November 26, 2015

How China Benefits From Global Sanctions

Over the past several years, major multilateral sanctions have been aimed at regimes that threaten global security, from Russia to North Korea to Iran. China has been neither the architect nor the target of these sanctions. More often, it’s a reluctant partner behind the U.S. and European Union. But Beijing has nevertheless been a significant, if unintended, beneficiary and stands to benefit even more dramatically in the future.

Last year, because of Moscow’s territorial aggression in eastern Ukraine, sanctions limited the access that Russian banks and energy companies had to U.S. and EU capital markets. This also came at a time when energy prices were collapsing. So Russia turned to China for an economic lifeline and found Beijing only too willing to play hardball, forcing Moscow to accept relatively poor terms to advance two major gas deals. The agreed price of gas for the 38 billion cubic meter Power of Siberia pipeline, for example, at $10 to $11 per cubic foot, undercut what Gazprom long considered its roughly $12 per cubic foot break-even price and only narrowly covered development costs in last year’s buoyant oil price environment.

Amid today’s low energy prices and the diminishing growth of Chinese demand, Beijing has reopened negotiations on these gas deals. But given the continued pressure of Western sanctions on Russia, China will still be able to drive a hard bargain.

U.S. and EU financial sanctions have also added momentum to China’s efforts to promote the yuan as a global currency and establish alternatives to the dollar- and euro-denominated international financial system. Multinational businesses seeking to avoid exposure to U.S. and EU sanctions can find refuge in the yuan and Chinese financial platforms.

One emerging platform is the China International Payment System (CIPS), which can function outside the jurisdiction of Western sanctions. This is a nascent alternative to the Society for Worldwide Interbank Financial Telecommunication, known as Swift, the Brussels-based global payments messaging system that also implements EU sanctions across its broad global network. Using CIPS allows payments linked to China to take place outside the jurisdiction of U.S. and EU sanctions. 

As Iran’s nuclear agreement advances and some of these sanctions are rolled back, Beijing will also be looking at new investment and trade opportunities with Tehran.

China may not have the technological edge that Western companies do and that Iran prizes, but it has capital and spare capacity to export. And while top-tier Western banks and energy companies are still reluctant to bear the risks of investing in Iran, Chinese companies may be less circumspect. They haven’t been burned by significant sanctions-enforcement actions, they have a high-risk tolerance for foreign investments, and they aren’t overly concerned about the reputational consequences of partnering with Tehran. Iran is also a target of China’s “One Belt, One Road” westward investment plans.

Even after the nuclear deal with Iran is implemented, certain sanctions will remain in place, barring the use of the dollar in trading with Iran. This gives China another financial advantage over its international competitors, because the only significant dollar-clearing business outside U.S. jurisdiction occurs in Hong Kong. This means that Hong Kong banks can clear transactions for Iranians in the world’s most coveted, convertible currency without becoming subject to U.S. jurisdiction. No other bank in the world can do that without violating U.S. sanctions.

The effects of these financial sanctions won’t catapult China into a pre-eminent position in the global financial system. Pervasive corruption, the opacity of China’s financial markets, concerns about the rule of law and a bumpy economic rebalancing make savvy investors cautious about China. The value, reliability and credibility of the dollar aren’t seriously threatened. Nor will China anytime soon undermine America’s status as the world’s largest, most stable and most liquid financial system.

But sanctions do give China’s economic ambitions an undeniable boost. This was accidental on the part of Washington, London, Paris and Berlin, but it’s likely to continue as the complexity and novelty of U.S. sanctions accelerate and spawn new opportunities for financial-system entrepreneurs and institutions outside the West.

American and European policy makers must be mindful of the unintended consequences of Western sanctions. It would be wise for them and Western financial institutions such as the International Monetary Fund to make China more of a partner in the global security architecture. This would underscore for Beijing the benefits of working within the international financial order and dampen enthusiasm for systems that may circumvent sanctions on rogue actors.

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