Russia’s growing reliance on China’s yuan, which was initially seen as a lifeline after Western sanctions cut off its access to U.S. dollars and euros, is now becoming a significant economic headache. In a rush to survive economically after its 2022 invasion of Ukraine, Russia shifted its trade and financial transactions to focus on China, one of the few major countries willing to maintain a relationship. However, as Moscow’s dependence on the yuan deepens, it faces serious consequences that are unraveling the country’s financial stability and exposing the risks of doing business with China.

The Yuan Takes Over Russia’s Economy

After the U.S. and its allies imposed severe sanctions on Russia in response to the Ukraine invasion, Russia was largely shut out of Western markets and the global financial system. Cut off from the U.S. dollar and euro, Russia turned to the yuan. Trade between Russia and China surged as Moscow sought to replace its former Western trading partners. By June 2024, the yuan accounted for a staggering 99.6% of the foreign exchange market in Russia, according to data from the country’s central bank. The rise of the yuan in Russia was not only in international trade but also in domestic financial transactions. Russian banks issued corporate loans in yuan, and many businesses relied on the Chinese currency for cross-border payments.

At first glance, the arrangement seemed to benefit both countries. Russia could continue financing its war effort and pay for essential imports, while China gained significant influence over Russia’s economy. But this arrangement wasn’t without major risks.

Running Out of Yuan: A Currency Crisis Unfolds

Recently, these risks have come to light as major Russian banks, including Sberbank and VTB, have run out of yuan. “We cannot lend in yuan because we have nothing to cover our foreign currency positions with,” said German Gref, CEO of Sberbank, during an economic forum. The root of the problem lies in the secondary sanctions imposed by the U.S. These sanctions expanded the definition of Russia’s military industry, which now includes Chinese firms that could face penalties for doing business with Russia.

This has left Chinese banks in a difficult position. They are increasingly reluctant to transfer yuan to their Russian counterparts, fearing U.S. retaliation. Transactions between the two countries are often left in limbo for months, with yuan liquidity drying up. In response, Russian companies have turned to their central bank for help, tapping into yuan reserves through currency swaps. In early September, banks raised a record 35 billion yuan from Russia’s central bank to try to keep their operations afloat. However, the central bank was quick to warn that these swaps were not a long-term solution.

In fact, the Bank of Russia has urged banks to curb corporate loans in yuan, signaling that it can only provide temporary assistance. “The increase in yuan lending was partly caused by the replacement of loans in ‘toxic’ currencies, but 41% of the increase was down to new currency loans,” the central bank said in a report. The deeper reliance on yuan loans has become unsustainable, with no long-term solution in sight.

The Hidden Cost of Doing Business with China

Russia’s reliance on China is beginning to look more like economic entrapment. Beijing’s government-controlled currency exchange system allows China to set the rules in a way that benefits its own economy, often at the expense of its partners. While Russia once celebrated its ability to pivot away from the Western-dominated financial system, it now finds itself vulnerable to Chinese manipulation.

For example, Chinese banks have been taking advantage of Russia’s dependence on the yuan by manipulating exchange rates. As the ruble weakens under the weight of sanctions, Chinese banks have hiked the yuan-ruble exchange rate to capitalize on the situation. While Russia’s central bank sets the exchange rate at 12.07 rubles per yuan, Chinese banks are charging Russian businesses up to 13 rubles per yuan. This premium makes it more expensive for Russian companies to do business with China, further squeezing the country’s already-strained economy.

“Everyone takes advantage of the opportunity to make money on our difficult situation,” said an analyst at Sberbank CIB, a Moscow-based investment bank. This manipulation highlights one of the core risks of doing business with China: its government tightly controls the currency, and foreign partners often have little recourse when Beijing decides to shift the rules in its favor.

A Fragile Partnership

While Russia hoped that its relationship with China would shield it from the worst effects of Western sanctions, it is clear that China’s priorities lie elsewhere. Although Chinese President Xi Jinping and Russian President Vladimir Putin have frequently met and spoken of a “no-limits partnership,” China has been careful not to cross the line when it comes to U.S. sanctions. In practice, China has complied with many of the restrictions, refusing to process transactions for Russian entities tied to its military industries.

As a result, Russian exporters are struggling to get paid, even when dealing with supposedly friendly countries like China. A survey conducted by the Russian central bank found that a quarter of Russian exporters faced problems with foreign transactions, including blocked or returned payments. Nearly half of the exporters surveyed reported that these problems had worsened in recent months.

Russian businesses are left with few alternatives. The days of easy transactions in dollars or euros are gone, and attempts to switch to other currencies have proven problematic. The yuan, which was supposed to replace the dollar as the backbone of Russia’s foreign trade, has instead become a source of frustration and economic instability.

An Unsustainable Economic Path

The broader Russian economy is being propped up largely by government spending on the war effort and revenues from oil exports to China and India. However, the combination of busy factories and labor shortages, due to military mobilization, is pushing inflation higher. Researchers from Yale, led by Jeffrey Sonnenfeld, have warned that Russia’s seemingly strong GDP figures mask deeper problems. “Simply put, Putin’s administration has prioritized military production over all else in the economy, at substantial cost,” Sonnenfeld and his team wrote. The defense industry may be expanding, but Russian consumers are increasingly burdened with debt, setting the stage for a potential economic crisis.

The overreliance on military spending has crowded out productive investment in other sectors of the economy, stifling innovation and long-term growth. The yuan shortage is just one symptom of a broader economic malaise that has taken hold in Russia. Without access to reliable foreign currency reserves, Russian banks and businesses are struggling to keep their operations running smoothly.

Moreover, Russia’s dependence on China’s currency and its financial systems leaves it vulnerable to Beijing’s manipulations. Should relations between the two countries deteriorate, Moscow’s reserves and payments could be left hanging in the balance, dictated by China’s needs and not Russia’s. The yuan, despite being a minor player in the global financial system, has become a critical lifeline for Russia. But that lifeline can easily be pulled away if China chooses to prioritize its own geoeconomic interests.

A Lesson in Economic Vulnerability

Russia’s pivot to China, driven by necessity, may have temporarily helped it avoid a complete economic collapse after Western sanctions. But as Russia’s reliance on the yuan deepens, it is becoming increasingly clear that this relationship has significant costs. The lesson for other countries is stark: dependence on a single country—especially one with a tightly controlled economy like China—can come with serious risks. Russia is now paying the price for putting too much faith in its “no-limits” partnership with China. Instead of finding a reliable alternative to the Western financial system, Moscow has traded one form of dependency for another, and the consequences could be devastating.