Ukraine war: Russia’s Chinese yuan funding lifeline is getting too expensive

After the invasion of Ukraine isolated Moscow from the Western financial system, Russian companies have come to rely on the yuan for foreign-currency needs
But, insufficient yuan liquidity in Russia and demand for the currency from importers are contributing to higher borrowing expenses

Russia

Bloomberg

Published: 5:55pm, 5 Mar 2024

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Yuan financing is becoming costly and sparse in Russia, choking off a pathway to foreign capital for companies that are already facing much higher domestic interest rates and a wave of debt due this year.

Two years after the invasion of Ukraine isolated Russia from the Western financial system, major energy and mining companies have come to rely on the yuan for most of their foreign-currency needs.

But even as yields on China’s benchmark government bonds hover around a two-decade low, insufficient yuan liquidity in Russia and demand for the currency from importers are contributing to higher borrowing expenses.

The funding dilemma leaves companies like Russia’s biggest miner, MMC Norilsk Nickel PJSC, choosing between expensive rouble funding or the rising cost of domestic yuan debt.

Russia more than doubled its benchmark last year, saddling corporate borrowers with as much as 1.2 trillion roubles (US$13 billion) in extra debt-servicing costs, according to Moscow-based consultancy Yakov & Partners.

“Given current realities, the average cost of debt will be raising,” Sergey Malyshev, Nornickel’s chief financial officer, said in a statement sent to reporters last month.

Nornickel’s interest payments are set to reach US$1 billion in 2024 after US$800 million in 2023 – compared with US$315 million in 2021, the last full year before the war. The burden is nearly as intense for the largest oil producer, Rosneft PJSC, pushing it to accelerate debt repayments after interest consumed 50 per cent more money in the fourth quarter than a year earlier.

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After their debut in 2022, yuan bonds “haven’t yet become widespread” in the Russian market, the central bank said in a report published on Monday. It listed limited free liquidity in yuan among lenders and the need to offer higher yields as factors “restraining potential interest in such placements among investors and issuers.”

The volume of Russian corporate yuan bonds – all sold on the domestic market – almost stalled in the final three quarters of last year and reached the equivalent of 800 billion roubles, according to the Russian central bank. And although loans in the Chinese currency nearly quadrupled to a record US$46 billion in 2023, their share in corporate credit portfolios was still only in single digits.

The average yield on yuan securities for issuers went up by nearly 2 percentage points last year and approached 6 per cent, according to the Bank of Russia.

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The short-term cost of borrowing yuan on the Moscow Exchange has been so volatile that it spiked to 15.7 per cent on March 1 before dropping to 4.1 per cent three days later, according to calculations by Bloomberg Economics. The reluctance of major Chinese banks to link Moscow’s yuan market with offshore markets is most likely a key factor, according to Bloomberg economist Alexander Isakov.

“Yuan liquidity in Moscow is becoming more scarce and its costs more volatile. Yuan shortages in the Russian financial system indicate emerging problems for growing yuan lending for domestic banks – two years after the start of the war, they still struggle to attract a sufficiently large and stable yuan deposit base.”

Yuan bond issuance in 2022-2023 represented a “cheap source of funding,” according to Alexey Tretyakov, one of the founders of Aricapital in Moscow.

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Facing a worsening yuan liquidity crunch, Russian lenders have had to turn to the central bank’s Chinese currency swaps to meet their needs, resulting in a “significant increase in yuan funding costs,” Tretyakov said. “A continued deficit could lead to a further rise in yuan bond yields,” he said.

Russian companies also haven’t borrowed within China itself, according to data compiled by Bloomberg, because capital controls there complicate the repatriation of money abroad. They haven’t sold yuan securities like panda or dim sum bonds since 2018 after 11 such issues in the prior eight years.

The barriers are proving too high to overcome even for the government, which has spent years planning its own yuan bonds. Finance Minister Anton Siluanov said in a February interview with RIA Novosti that discussions with China over taking out loans in yuan also have yet to produce results.

Chinese lenders including Industrial and Commercial Bank of China Ltd. (ICBC) – the world’s biggest by assets – have been ramping up their exposure to Russia through offshore branches. ICBC’s Russian subsidiary alone saw a five-fold increase in total local assets from the start of 2022 and through October 1 last year, according to the latest data published by the Bank of Russia.

The strain on Russian corporate coffers risks depriving industries of capital in a year when refinancing needs are sharply on the rise. Despite stellar profits, companies are feeling the pinch after the government imposed new export taxes to help fund the war, further undermining the benefit of a weaker rouble that helped drive record margins.

“High rates mean that the companies will be more careful with investments that require significant debt capital,” said Dmitry Kazakov, analyst at BCS in Moscow.