BRIC through a window | Rebecca Harding (author) | 14th July 2014
Why Russia’s attempt to decouple from the dollar is a defensive strategy | Gazprom’s decision to price oil trade with China in Roubles or Yuan rather than US Dollars effectively demonstrated the power that the BRIC countries want to exert over world trade. It has profound implications for trade finance, not least because a cry for decoupling emerging currencies from their dollar-dependency resounded across emerging Asia, and France, last week. The issue is that, as global pressure on interest rates in the US build and as tapering continues, the threats to Emerging Economies of US Dollar-denominated debt increases. It has not been a great year so far for Emerging Market currencies and the signals for a stellar recovery in the second part of 2014 are not strong.
France worries about this because of its increasing reliance on countries like Brazil for oil, and perhaps because it wants to bang the drum for the Euro. But Russia’s decision is arguably a defensive one – it is protecting its own oil trade interests with China as its relationships with Europe and the US become more strained. The value of the Rouble against the US Dollar is barely correlated with world trade, Chinese trade or even the oil price and, as a result, it is seeking to integrate itself into the world trade system through closer ties with China. The effect will be the strengthening of the Yuan, and ironically the Euro, as trade finance currencies and while it might serve to weaken the hegemony of the US Dollar in trade terms, it will have little impact on the value of the Rouble.
The reason for this is simple. There are two currencies that are very strongly correlated with world trade: the Yuan and the Euro, as shown in Figure 1.
Figure 1 | World export trade values (USDbn) versus USD-Yuan, Last Price Monthly, June 2001-June 2014
Source | DeltaMetrics 2014, Bloomberg
The correlation between the value of the Yuan and world exports is -0.91: in other words, as it weakens against the US Dollar, world exports increase and vice versa. This is of little surprise to any observer of world trade: the Yuan is a managed currency and it has been a bone of contention in trade negotiations between the US and China that its artificial weakness has kept Chinese exports strong. Indeed, as the currency has been allowed to strengthen over the past couple of years, world trade has slowed. This is not just simply a reflection of the dominance of Chinese exports in world trade. China’s trade is highly currency elastic – it exports intermediate manufactured goods that are very price sensitive and so trade will also be highly influenced by the value of its currency.
But there is more than just global trade at stake from Russia’s point of view. Russia needs to secure markets for its oil exports if it is to undermine the effects of first, any sanctions that may arise from the continuing crisis in Ukraine and second, the reduced dependency of Europe on Russian oil and gas. Its obvious trade partner is China and, indeed, Russian exports of oil and gas to China are forecast to grow annually by around 9% each year to 2020. China is resource hungry and, as a result, its trade is highly correlated with the oil price as well as with the value of its currency, as illustrated in Figure 2.
Figure 2 | Value of Chinese exports versus NYSE Arca Oil Spot Last Price Monthly, June 2001-June 2014
Source | DeltaMetrics 2014, Bloomberg
The Rouble-Yuan currency spot is highly correlated with Chinese trade (0.75) and this potentially helps to explain why Russia is so interested in building up the ties between the two currencies through oil trade in particular. It strengthens the likelihood of the Yuan increasing its importance as a currency for trade finance and protects Russian trade interests against the weakness of the Rouble-USD exchange rate in other markets.
The only other currency where the correlations with Chinese trade, world trade and oil are as strong is the Euro, as Figure 3 suggests.
Figure 3 | Correlations of major currencies with world exports, Chinese exports and the NYSE Arca oil spot price. June 2001-June 2014
Source | Delta Economics analysis, 2014
Apart from the strong correlations with trade and oil prices of the Yuan-US dollar price, the table also shows how important the Euro is as a trade currency. Past trade views have commented on the fact that the Euro is a trading currency that responds to economic fundamentals and not a currency that is used for speculation. Russia’s move towards the Yuan and away from the dollar will not strengthen the rouble, since its value against the dollar is barely correlated with trade and only weakly correlated with oil prices. However, it could serve equally to serve the purpose of strengthening the Euro as a trade finance currency.
The reason for this is because of the strong correlation between the Real-USD value and both world trade and Chinese trade and the oil price. While not as strong as the Euro value alone, there is something important that is emerging in terms of Brazil’s role in the trade finance system. Brazil’s exports to China are forecast to grow at above 11% for the next four years, and much of this trade is commodity-based – soya and oil in particular. Similarly, France’s imports of oil and gas from Brazil, for example, are set to increase in double digits annually over the next five years and exports to Brazil from Europe are forecast to grow at similar rates to exports to China over the next five years.
This helps to explain, perhaps, why there was a call from France in the last week to loosen ties with the US Dollar as well. Figure 4 shows that France’s trade is, in comparison with German trade, weakly associated with the value of the Euro versus the USD.
Figure 4 | Correlations of key currencies against French and German exports, June 2001-June 2014
Source | Delta Economics Analysis, 2014
Perhaps more importantly, French exports are more correlated with the value of the Yuan versus the US Dollar, albeit more weakly than German exports. A logical conclusion is that it is in the interests of all exporters from the Eurozone for the Yuan to be a more dominant trade finance currency as it will help their trade, and hence the value of the Euro.
Russia’s move away from the US Dollar has a deep resonance across the trade finance system. First, it will encourage the Chinese government to decouple the currency from the dollar and allow it to trade in currency markets more freely which, in and for itself has to be a good thing for the global trading system. Second, it means that trade, and hence trade finance, will increasingly be denominated in Yuan, and arguably Euros as well, reducing the importance of the Dollar as a trade finance currency. Again, this is welcome on the grounds that it supports free trade.
And third, given the fragile relationship geo-politically between Russia and the US at the moment, it also makes it more important that the US engages in trade talks with Asia. If the Yuan and the Euro become more important as a trade finance currencies, then the US cannot afford to be isolationist in the way it handles its trade negotiations. Whichever way this is looked at, Russia has just thrown a BRIC through the window of the US’s current trade stance.