BCA Research recently published an insightful observation regarding China’s potential take aways from the Russia/Ukraine conflict.

A significant share of Russia’s foreign exchange reserves has been frozen by Western sanctions since they invaded Ukraine. In March, Russia’s finance minister Anton Siluanov revealed that about $300 billion of the country’s $640 billion foreign reserves are impacted by these sanctions. This will ultimately inhibit Russian policymakers’ ability to support the domestic economy.

This event serves as a warning for China which is engaged in a strategic geopolitical rivalry with the US. Western sanctions on Russia ultimately demonstrate the impact of economic warfare against Western allies. This will likely accelerate Beijing’s efforts to protect itself from potential Western penalties in the future.

One likely implication is a reduced willingness on China’s part to hold foreign exchange reserves in US dollars. Chinese efforts to diversify reserves is unlikely to translate into an immediate aggressive sale of current USD denominated holdings. Instead, it will be a long-term process by which China tapers its accumulation of these assets.

Given that China runs a large current account surplus, the question then is how will China allocate these funds? Accumulating more European or Japanese assets will expose China to the same economic risks as US dollar assets and are therefore unlikely options. Thus, China may instead increase its purchases of real assets in other emerging markets. This outward acquisition strategy will also fit in with China’s efforts to expand its sphere of influence and will grant Beijing greater control over these assets. This process will benefit the currencies of those EM economies that will be subject to Chinese purchases and on the margin will be negative for USD/CNY and US Treasuries. With South Africa’s wealth of commodity assets, the rand is well placed to benefit from such moves.

However, there are many other factors that battle for dominance for and against the rand in the short and medium term, in addition to its sensitivity to global shocks. And so, as volatility continues to dominate the currency, the need for a carefully developed and consistently applied foreign exchange policy becomes all the more important for any business with currency exposure. You would be well advised to connect with wauko to learn how we can help.