Mehmet Simsek, former deputy prime minister of Turkey

China’s engagement with the Middle East in real economy terms is strong – and likely to get stronger. This is a solid foundation to enhancing financial co‑operation going forward. The timing also appears to be right, in that the West is suffering from ‘Middle East fatigue’, and the US administration’s talk of retrenchment from the region is making many nearby countries much more receptive to Chinese outreach. 

Equally important, China no longer perceives the Middle East and North Africa (Mena) as a “chaotic and dangerous graveyard, burying empires”, as Li Shaoxian of Ningxia University put it. It is exactly the opposite – China now recognises the region as the key to unlocking its status as a world power. Why do China and the Middle East need financial co‑operation? There are at least five simple reasons:

1. China is the largest trade partner in the region. It is the largest trade partner of 11 Mena countries: Iran and 10 Arab League nations. Across a broader geographical area, China’s trade with the 22 Arab League nations reached US$244.3 billion in 2018; trade with Iran, Turkey and Israel totalled $72 billion. Combined, Mena accounts for more than $300 billion of trade with China.

2. China is already a leading source of foreign direct investment (FDI) and, increasingly, an important source of project financing in the region. China became the largest source of FDI in the Middle East in 2016. In 2017 alone, the country signed investment contracts worth $33 billion with Arab countries. Future projects linking China’s domestic development programme to the Belt and Road Initiative (BRI) are likely to enhance trade, investments and financial linkages. As of mid-2019, China had signed agreements with 21 Mena countries, including 18 Arab League nations, on a joint BRI project. 

3. The Mena region already hosts more than 1 million Chinese expatriates. This number is likely to increase as China ups its engagement in post-war reconstruction in Iraq, Syria, Yemen and, possibly, Libya. 

4. China is the biggest global importer of crude oil. It imported roughly 500 million tonnes in 2019, half of which came from the Middle East. Oil- and gas-rich Gulf states thus account for upwards of 80% of China’s trade with Arab nations.

5. Demand from some Middle Eastern countries for deeper financial and economic co‑operation with China is likely to grow on the back of the increasing threat of economic sanctions, and weaponisation of the US dollar and payment systems by Washington. Countries such as Iran, Turkey and Russia have publicly expressed a strong desire to use local currencies for trade and investment transactions in the future.   

In short, China’s growing economic presence in the Middle East necessitates stronger financial co‑operation.   

Swap lines and de-dollarisation

Discussions now need to be opened on what sort of financial co‑operation is likely. There are substantial differences in political, social and economic conditions across the Middle East. It would therefore be difficult to implement a single framework for financial co‑operation catering to the needs of all countries. Oil‑rich surplus countries and deficit countries have different needs. There are therefore multiple channels of financial co‑operation.

China’s rise has already led to the renminbi officially becoming a global reserve currency. It currently represents around 10.9% of the International Monetary Fund’s special drawing rights currency basket. This makes the renminbi the third-largest reserve currency after the US dollar and the euro. Central banks in Middle Eastern countries are likely to hold, in the future, part of their reserves in renminbi-denominated assets. 

One area of co‑operation, as a result, could be bilateral currency swaps to achieve a higher degree of financial stability in the region. China already has 36 bilateral currency swap lines globally, and standing facilities that are rarely used; Middle Eastern trade partners could benefit from them. 

Second, the weaponisation of the dollar – the currency being used as a weapon in imposing economic sanctions – is likely to lead to de‑dollarisation in the long term. If deglobalisation is going to be a global long-term trend, it will be partnered by de‑dollarisation.

The development of the internet and blockchain-based payment systems will probably influence multiple global systems. China and Middle Eastern countries could facilitate trade in renminbi or local currencies. Some countries are already seeking ways of reducing their vulnerability to the continuing threat of US sanctions and are considering ways of using local currencies for trade and investments. 

The Brics nations – Brazil, Russia, India, China and South Africa – are reportedly developing a new universal payment system to challenge the Swift international payment network. More recently, Kirill Dmitriev, chief executive officer of the Russian Direct Investment Fund, unveiled some striking numbers: foreign trade payments in dollars have dropped from 92% to 50% over the past few years, while international ruble transactions have risen from 3% to 14%. The Brics nations are also said to be considering a new common cryptocurrency for mutual payments as another way of working around the dollar. 

However, the use of renminbi seems a more feasible alternative for oil and gas exporters in the future, as it is hard to sustain trade in local currencies with persistent deficit countries. 

Third, the close economic integration between China and Middle Eastern countries also requires market-based financing for corporates and governments. China’s Panda bond market is another avenue for co‑operation. Panda bonds are renminbi- denominated notes sold by non-Chinese issuers in mainland China. This onshore product, which offers international borrowers a way to tap domestic Chinese investors, is likely to continue to develop and internationalise going forward. The investor base is also likely to become international. This will be a great route forward for deficit countries.

Finally, co‑operation between sovereign wealth funds in China and Middle Eastern countries is also an option. The success of any co‑operation – in particular financial – between China and the Middle East will be largely dependent on a strong policy dialogue.  

Renminbi at the top table

As previously alluded to, the world is likely to move towards a multicurrency global monetary system. The renminbi looks set to play a much stronger and more significant role in international trade and finance. This also requires China to continue reforming its financial markets, further opening up, and deepening capital markets – something the Chinese government today, and in the past, has made very strong commitments to.

Deeper financial co‑operation also requires, first and foremost, mutual trust, the existence of which is evident between the two regions. No country in the Middle East sees China’s rise as a threat, and there is already a strong strategic and political dialogue between China and almost all countries in the region. This is a good backdrop to build a win-win relationship across the border between China and the Middle East.

Arguably, the regions need each other. China’s growth has been stuttering in the face of declining returns to investments, a falling working-age population and thus declining productivity growth. China’s search for new growth drivers is going to become even more pressing. Africa – as well as the Middle East – has an extremely young population that can serve this need. Many countries, except members of the Cooperation Council for the Arab States of the Gulf, are in the growth phase. 

Middle Eastern countries also need China because they are in dire need of diversification. The International Energy Agency (IEA), in its latest World energy outlook report, foresees global demand for oil reaching a plateau around 2030. Youth unemployment rates in the Mena region have been the highest in the world for more than 25 years; in 2017, they were around 30%.

The regions are a perfect match: China is searching for growth drivers globally and the Middle East presents good opportunities. Meanwhile, the Middle East needs Chinese investments and financing to accelerate its own development and industrialisation.

Hao Pengyu, deputy general manager of the Dubai branch of the Agricultural Bank of China

The ultimate purpose of a bilateral payments system is to ensure countries can make trade and investment payments in their local currency instead of payments in that of a third country. 

Since the 1990s, China has developed cross-border trade with its neighbours, using their domestic currencies or renminbi for settlement, and allows each commercial bank to open local currency accounts to facilitate this arrangement. Since 2009, China has promoted pilot projects for cross-border settlement in which renminbi is used not only in cross-border trade settlement, but also for all general trade, including investments. 

Bilateral payments and settlement systems are developed from bilateral trade and investment. In recent years, economic and trade exchanges between China and the United Arab Emirates (UAE) have developed rapidly. In 2018, the trade volume between China and the UAE reached US$24.3 billion, an increase of 28% since 2017. The value of new contracts signed by China and the UAE reached $35.6 billion – an increase of 9% over the same period. And China’s investment in the UAE has reached $1.2 billion. These business activities have laid a solid foundation and serve as motivation for a bilateral payments system.

An exchange of visits between Chinese and UAE leaders has ushered in to both countries the best of times. China has become the UAE’s most important trading partner. And the UAE is China’s second-largest trading partner and the largest importer in the Arab region. In 2018, the bilateral trade volume reached $45.92 billion, representing a year-on-year increase of 12.1%. In the first half of 2019, the total trade volume between the two countries reached $22.66 billion – a year-on-year increase of 9.6%. Around 8% of the UAE’s imports and exports are related to China. And investment has also grown rapidly. Therefore, this economic and financial interaction demonstrates the necessity of bilateral settlement and payments.

Meanwhile, policies implemented by the two nations allow banks to open agency accounts for each other. The filing of customs records can allow the cash transfer of the two countries’ currencies. At the end of 2017, China had signed agreements on bilateral domestic currency settlement with nine neighbouring countries, and bilateral local currency swap agreements worth CNY3.67 trillion with the central banks and currency regulators of 38 countries. The UAE allows cross-border trade to be paid in any currency, including renminbi – that is, with no restrictions on currency payments.  

The strengths of the bilateral payments system

Bilateral payments systems have two major advantages. First, the settlement will be more convenient. Through the accounts of the central banks or commercial banks, the transactions can be settled directly, which is time-efficient. Second, they can reduce exchange rate risk from the third party, meaning the currencies of the two countries are directly exchanged. As a result, the transactions won’t be affected by the exchange rate fluctuations of the third party’s currency.

But what is the main basis for establishing and connecting bilateral payments systems to national infrastructure? From the perspective of commercial banks, it should be based on the current payment infrastructure of the two countries. The renminbi has its own domestic payment systems comprising the clearing systems of banks and financial markets as well as its cross-border interbank payment system (Cips). The second phase of Cips, launched in May 2018, ensured cross-border payments could be made overnight. The system’s operating times have been extended to 24 hours on working days, with four extra hours on the first trading day after weekends and holidays – effectively covering the working hours of all financial markets worldwide.1 Six continents are covered under the system. The cross-border payment of renminbi can be made through directly and indirectly participating banks.

The UAE also has its own clearing system that allows local currency payments to be made through commercial banks’ accounts in the central bank. No matter the direction of the two countries’ currency flows, they will eventually flow into the clearing system of the home country. It is therefore clear the interconnection of the payment system between the two countries must be based on their own payment systems. 

Regarding the establishment of a bilateral payments system between any two countries, from the perspective of the central bank, no country has yet reached the levels of interconnection. However, six central banks on the Arabian Peninsula – those of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE – are developing a regional dealing system, where commercial banks in these territories can conduct regional clearing through direct communication. It is inspiring that such a system has been built at the level of central banks.

The payment system will need to factor in how each commercial bank behaves, and then how the interconnection between the central banks will work. In May 2017, the Agricultural Bank of China established a Dubai branch. It has a wholesale banking licence issued by the Central Bank of the UAE and can conduct renminbi clearing, a power granted by the People’s Bank of China. The bank can also conduct deposits, transactions, clearing, trade, and financing and renminbi products. 

At present, the currency clearing between the two countries can be achieved through the commercial banks in a number of ways: 

Listing mechanism and exchange rate mechanism between the two countries

In the Middle East, China has exchange rate licences for the UAE dirham and the Turkish lira. It can exchange 62 currencies at the Central Bank of the UAE. Currency exchange is therefore viable between the two countries in terms of exchange rates.  

The liquidity of renminbi

Commercial banks can stimulate renminbi circulation by providing the currency to financial institutions in the UAE and the market composed of highly liquid assets, such as treasuries. It can also meet the renminbi demand of local enterprises through exchange remittance.   

Currency clearing

The commercial bank systems can connect with the local currency clearing system of the Central Bank of the UAE, as well as the Swift system adopted by banks in China. Therefore, dual currency clearing can be achieved.   Clearing banks have unique strengths China’s interbank foreign exchange market can be accessed, alongside the interbank lending market and the interbank bond market, as a member. The message format of the Dubai clearing branch is directly changed from the message format of Swift so the transaction can be cleared through the interbank renminbi clearing system. Straight-through processing can therefore be achieved.  

Establishing a bilateral payments system is a long process. Policy mechanisms required to achieve interconnection at the central bank level are challenging, and include the need for currency agreements signed by the two countries. But, in its early stages of development, the functional interconnection of a bilateral payments system can be achieved through the agency accounts of commercial banks.