Is the Iran war weakening the dollar’s grip and lifting the RMB?

Following a visit to China by Crown Prince Sheikh Khaled bin Mohamed bin Zayed Al Nahyan of Abu Dhabi in mid-April, a news report out of Washington suggested that if the Iran war drags on, the shifting balance between the international standing of the US dollar and the renminbi (RMB) may accelerate further. This drew widespread attention.

Interviewed academics argue that the Iran war is undermining confidence in the US dollar, adding momentum to what they describe as “two decades of talk about internationalising the RMB”. China aims to reduce its reliance on the dollar rather than challenge the “petrodollar” system, but as global energy sources diversify and the trend towards de-dollarisation in trade settlements strengthens, the dollar’s hegemonic position is likely to be gradually weakened.

In a Wall Street Journal article published on 19 April titled “U.A.E. Asks U.S. About a Wartime Financial Lifeline”, US officials revealed that the UAE had requested Washington to establish a currency-swap line to ensure a stable wartime supply of US dollars. It added that if the UAE “runs short of dollars”, it might switch to using the RMB or other currencies for oil transactions.

Prior to this, Sheikh Khaled visited China in mid-April, during which China and the UAE signed 24 memoranda of understanding. Chinese state media did not disclose the details, but some self-media reports claimed these included provisions for long-term stable crude oil supply and efforts to normalise settlement in RMB.

Taken together, the two reports suggest that the UAE is making contingency plans on two fronts to diversify the geoeconomic risks arising from the Middle East conflict. Some analysts believe this move signals that the “petrodollar” system could loosen amid geopolitical tensions; if oil trading ceases to rely solely on the US dollar, it would create a significant opening for China to advance the internationalisation of the RMB.

Following the US-Iran war in late February, data in March pointed to increasing market confidence in the RMB.

Fortune China reported that, as of March, the share of RMB settlement in oil trade between the Middle East and China had surged to 41%, overtaking the euro for the first time to become the second-largest settlement currency in Middle Eastern oil trade, behind only the US dollar. Meanwhile, the dollar’s share of Middle Eastern oil settlements has fallen from an overwhelming dominance of over 90% in previous years to 52%.

According to data from the Society for Worldwide Interbank Financial Telecommunication, the RMB’s share of global trade finance in March exceeded 8%, a fourfold increase from its previous level of under 2%. It remains second only to the US dollar, although the gap is still substantial, with the dollar accounting for over 80%.

Key platforms China is using to advance RMB internationalisation and improve cross-border payment efficiency include the Cross-Border Interbank Payment System (CIPS), the digital RMB (e-CNY), the mBridge multi-central bank digital currency, and bilateral local currency swap agreements.

Tommy Xie, head of Greater China Research at OCBC Bank, told Lianhe Zaobao that in March, the average daily transaction volume of the CIPS rose from just over 660 billion RMB to around 900 billion RMB (US$131 billion), broadly confirming that unrest in the Middle East has helped boost the international use of the RMB.

CIPS transactions include both trade settlement and cross-border investment. Xie assesses that the sharp rise in March data may reflect a significant increase in demand for RMB among Global South countries. These countries are using large volumes of RMB for trade settlement, fundamentally because they have confidence in the resilience of China’s supply chains.

Following the outbreak of war, Iran blocked the Strait of Hormuz and imposed a “toll booth” regime, with claims that these must be paid in RMB.

The Atlantic Council’s GeoEconomics Center argues that Iran’s move has led to a surge in funds flowing into China’s financial system, as countries in urgent need of oil increasingly rely on Chinese financial networks to make payments outside the US dollar system. In fact, Iran and Russia, having been excluded from the US-led SWIFT due to Western sanctions, already conduct their oil trade outside the dollar-based system.

An article in The Economist noted that, beyond oil trade and transit fees, the surge in CIPS transaction volumes may also reflect capital outflows, with some funds originating in China being withdrawn from the Gulf region. This may be linked to turbulence in financial markets, as data from Chinese banks show that in March, the total value of cross-border trading in bonds, stocks, and other portfolio investments reached US$712 billion — 40% higher than the monthly average last year.

The article also noted that many countries, having seen Russia excluded from SWIFT following its invasion of Ukraine, have felt compelled to take precautions. A banking industry source said that even before this year, some companies had already been preparing to use the RMB, and the Iran crisis may have prompted them to “press the button”.

Markets are turning to the RMB to diversify risk, while the Iran war has highlighted uncertainty in Trump’s policies and weakened confidence in the US dollar.

Senior analyst Xu Tianchen of the Economist Intelligence Unit argues that in comparing the Chinese and US currencies, China is far from the epicentre of the conflict and has relatively strong economic resilience to shocks. As a result, the RMB is being sought after for its “stability premium”.

OCBC’s Xie concurs. He said, “When markets begin to question the US dollar, opportunities for the RMB emerge. People start asking who could replace the dollar.” In fact, since the US launched its trade war last year, many have already begun to question the US government and its policies, and “the Middle East conflict has only compounded the pressure on the dollar”.

Zhou Xiaochuan, former governor of the People’s Bank of China who actively promoted RMB internationalisation during his tenure, stressed at a forum held in Shanghai in early April that the present moment represents a “golden window” for advancing RMB internationalisation. He argued that US policies are undermining confidence in the dollar, creating external opportunities for the RMB’s internationalisation.

However, no matter how favourable the external “golden window” may be, it cannot outweigh the structural constraints at the policy level.

Capital controls — restrictions on the free cross-border flow of capital — are the biggest constraint on RMB internationalisation. They limit the currency’s appeal as a global reserve and asset allocation currency. But if China were to liberalise its capital account, its control over domestic monetary and exchange rate policy would be weakened.

Xu argued that lifting capital account controls is not necessarily desirable, particularly as the RMB’s “stability premium” is built on China’s longstanding political and policy stability. “This is hard-won, and once lost it would be difficult to rebuild,” he said. He believes China should prioritise stability, adding that there is “no need to sacrifice stability for full-scale RMB internationalisation”.

How far RMB internationalisation should go is closely tied to China’s underlying objectives. Is the goal for RMB to become a mainstream currency for trade settlement and a tool to bypass US sanctions, or to elevate it into a key currency in global capital markets, and even to challenge the US dollar’s dominance?

Xie thinks that China has no intention of challenging the US dollar’s hegemonic position, but rather seeks to reduce its reliance on the dollar. The core purpose of advancing RMB internationalisation is to serve Chinese firms by lowering the risks they face in overseas investment and trade.

However, Xie assessed that if Middle Eastern oil-producing countries adopt different pricing systems and oil settlement is no longer tightly tied to the US dollar, the foundations of dollar dominance will inevitably be weakened, as the cornerstone of US dollar hegemony is the “petrodollar”. The Iran conflict is prompting countries to accelerate efforts to diversify energy sources and reduce reliance on oil; “once greater use is made of new energy, it will also affect the US dollar’s position as a global currency”.

This article was first published in Lianhe Zaobao as “伊朗战事助推人民币国际化 能源多元化挑战美元霸权”.

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