The rising yuan? Why Iran's yuan oil payments won't catch on, just yet…

The rising yuan? Why Iran's yuan oil payments won't catch on, just yet…

While the yuan should play a bigger role in the world's energy settlements by the end of the decade, Iran's shift won't be the catalyst says Una Galani.

May 9, 2012 4:24 by kippreport

Iran’s yuan-for-oil payments won’t catch on, yet. Tough sanctions from the United States have pushed the Islamic Republic to accept the Chinese currency as part-payment for crude exports to the People’s Republic. But while the yuan should play a bigger role in the world’s energy settlements by the end of the decade, Iran’s shift won’t be the catalyst.

It makes sense for China to use its own currency to pay for oil imports. The move transfers foreign exchange risk away from the world’s second largest oil consumer and supports the government’s long-term drive to establish the yuan as an alternative global reserve currency to the dollar.

For Iran, the yuan trade is more a matter of necessity than desire. Sanctions have made it hard to deal in freely convertible dollars or euros – the currency of Chinese oil payment to Iran since 2006 – so it has been forced to let its largest customer pay in its own non-convertible currency, just as it let India pay in non-convertible rupees.

The Chinese might like the Iranian deal to start a trend in the Middle East, but less politically squeezed producers will be reluctant to follow Tehran’s example. While China might be more willing to buy oil denominated in yuan, Gulf producers have other considerations.

They peg their currencies closely or entirely against the dollar and hold most of their foreign reserves in dollar assets. Although the tie to U.S. monetary policy is not ideal, the choice is rational for economies dominated by a single commodity mostly priced and traded in dollars – and for governments which still rely on U.S. military support.

The yuan’s status is rising, very slowly. China and the UAE have a yuan currency swap agreement, but it covers less than a quarter of the value of two-way trade between the countries. The pace will pick up as Chinese GDP increases and its currency becomes more convertible. The yuan-denominated sales to Iran constitute a small step on the yuan’s long road to becoming a global commodity currency.