Australian iron ore unloading at Rizhao Port, one of China's major seaports, in 2010.
Source: Jie Zhao/Corbis via Getty Images

China's growing buying power in commodities and the ongoing Russia-Ukraine war have added tailwinds to the drive to internationalize Chinese currency, though hurdles remain before the yuan can become a global exchange of value.

The Chinese central government has pushed for the broader international use of its currency for years, including as part of its 14th five-year plan announcement in 2021. With Chinese imports growing to more than 70% of the seaborne iron ore market in 2021, the world's four largest iron ore producers established trading subsidiaries in China to directly sell yuan-denominated products to port markets. Russian companies, subject to sanctions after the invasion of Ukraine, started selling coking coal to China in yuan.

Mongolian mining companies have settled some coal sales in yuan, with some of the revenue applied toward expenses for infrastructure projects, an industry source said. And even Saudi Arabia, the world's top crude oil exporter, is in active talks with Beijing to price some of its oil sales to China in yuan.

However, China's strict capital controls make the yuan less likely to challenge the dominance of the U.S. dollar in commodity trade. Foreign giants, which dominate the supply side, allow yuan settlement for a small portion of sales while still using U.S. dollar-based pricing indices as benchmarks for deals.

"[Commodities] would be an easier step for the government to push forward," said Nathan Chow, senior economist at DBS Bank. "China is a huge importer of a lot of commodities, including iron ore, so they have more bargaining power [and] negotiation power."

Iron ore sold in yuan

In July, Australia's BHP Group Ltd. became the last of the top-four iron ore producers to set up a trading arm in China to directly sell yuan-denominated products in spot markets, following Rio Tinto Group, Vale SA and Fortescue Metals Group Ltd. And China's Baoshan Iron & Steel Co. Ltd., the world's largest steelmaker, plans to increase yuan settlement for iron ore imports to 10% in 2022 from 6% in 2021, the company said on the Shanghai Stock Exchange website in March.

Australian miner Fortescue, which generated 90% of its revenue from China in 2021 and 2020, established a wholly owned Chinese sales entity in 2019, known as FMG Trading Shanghai, with the intent to sell yuan-denominated iron ore direct to customers from Chinese ports. Since then, over 32 million tonnes of iron ore have been transacted through the entity.

"Fortescue's success and that of the Australian economy has been largely built on China's remarkable growth. Australia's business sector has played a significant role in forging strong, long-term relationships with business and government in China," CEO Elizabeth Gaines said in an email interview.

Diversify away from the US dollar

Economic sanctions against Russia could potentially accelerate the yuan's usage in international trade. Many countries "may start thinking about diversifying the risk" instead of relying solely on systems dominated by the U.S. dollar, said Chris Leung, chief China economist at DBS Bank.

Importers in countries such as India and China began paying in yuan for Russian coal, oil and other commodities to bypass sanctions that exclude Russia from important elements of the global financial system, such as the Society for Worldwide Interbank Financial Telecommunication, or SWIFT. Russian suppliers have shifted from SWIFT to China's Cross-Border Interbank Payment System.

The U.S. Federal Reserve's quantitative easing in 2020 and 2021 passed inflation risks on to global markets, which undermined the market's confidence in the U.S. dollar. That led some companies to turn to alternatives with stable exchange rates, according to Xie Qingwei, senior iron ore analyst at consultancy Shanghai Metals Market.

Despite the yuan depreciating against the U.S. dollar since April, it still outperforms other major currencies. In 2022, the yuan weakened by 7.8% as of Aug. 25, but the British pound, the euro and the Japanese yen have each fallen by 14% or more.

"[Companies] see the Chinese economy is slowing down, but [the government is] able to manage the stability of the currency better than others," Leung said.

Decades to go

The yuan's limited convertibility into other currencies impedes China's efforts to promote yuan usage through commodities trading.

Despite years of efforts by the Chinese central government, cross-border yuan settlement only accounts for 10%-20% of total settlements since 2016. The yuan only accounted for 2.2% of global payments in August, with little change since the beginning of the Russia-Ukraine war, data from SWIFT showed.

Experts estimated that less than 5% of iron ore deals were settled in yuan, and those deals were largely limited to portside markets. Only a few top companies can trade through yuan-denominated letters of credit.

China's capital account restrictions are the country's biggest hurdle in promoting yuan usage, and it would need to overhaul its banking and financial sector to help. "It is not something that could be done overnight," DBS Bank's Chow said.

Rocky road to boosting pricing power

When international companies settle some deals in Chinese currency, they can purchase yuan-priced goods from China to reduce exchange rate risks, said Shi Xunpeng, research principal for the Australia-China Relations Institute at the University of Technology Sydney.

What matters most is how to price iron ore.

Chinese companies are still using the U.S.-denominated Platts Iron Ore Index to price long-term contracts, which are accepted by steelmakers, traders and especially iron ore suppliers, Shanghai Metals Market's Xie said. The index is a benchmark assessment of the spot price of physical iron ore by S&P Global Commodity Insights.

International iron ore producers are also concerned about the transparency and predictability of Chinese domestic indexes. The country relies heavily on iron ore imports, but the supply side is dominated by the four largest miners. That makes it more difficult to shift away from the Platts index, Xie said.

New option

Chinese iron ore futures might become an alternative.

In November 2019, Vale signed a physical iron ore spot deal to supply Shandong Laigang Yongfeng Steel Corp. using the iron ore futures price from the Dalian Commodity Exchange as the pricing benchmark. In the past two years, the "basis trading" contracts are accepted by domestic trade between top traders and steelmakers in developed regions such as Shanghai, Jiangsu province and Rizhao port in Shandong, Xie said. Basis trading prices are less volatile compared with U.S. dollar-denominated seaborne prices.

"There is not a perfect market for iron ore because a few iron ore companies have a dominant position. But at least I think the Chinese market fundamentals will be more reflected in the futures trading index," Shi said.

As of Sept. 5, US$1 was equivalent to 6.93 Chinese yuan.

S&P Global Platts is an offering of S&P Global Commodity Insights. S&P Global Commodity Insights is owned by S&P Global Inc.

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