China balances dollar reliance with sanctions hedging amid US threats

Chinese financial institutions face a complex strategic dilemma as the United States threatens to disconnect entities facilitating Iranian sanctions evasion from the American financial system. While Beijing has vowed to protect its interests, major Chinese lenders retain a strong incentive to maintain access to U.S. dollars, creating a tension between geopolitical alignment and economic necessity. This friction arises against the backdrop of a looming summit between U.S. President Donald Trump and Chinese President Xi Jinping, where both sides are navigating the delicate balance between confrontation and cooperation.

U.S. Treasury Secretary Scott Bessent announced on Monday that any entity involved in money laundering or sanctions evasion on behalf of Iran risks being cut off from the U.S. financial system. This move forms part of a broader initiative described as an economic D-Day against Iran. When specifically questioned about Chinese banks, Bessent stated that those facilitating transactions that convert Iranian oil into funds for repression would be targeted. In response, a Chinese Foreign Ministry spokesperson said on Tuesday that China would take all necessary measures to protect itself, reiterating its firm opposition to unilateral sanctions that lack a basis in international law or United Nations Security Council authorization.

The economic stakes are significant given that China purchased approximately 90 per cent of Iran’s exported oil prior to recent conflicts, which accounted for about 12 per cent of China’s total crude imports. Analysts from the U.S.-China Economic and Security Review Commission noted in March that this made China Iran’s largest trading partner. The expanded U.S. sanctions, dubbed Operation Economic Outcast, identified several China-based companies and individuals as having allegedly assisted the Iranian military. Although the U.S. indicated it would provide a timeline for countries to shut down identified activities, specific dates have not been made public. China’s Foreign Ministry stated it is closely monitoring the situation.

Despite the tough rhetoric, analysts suggest that China will strive to remain within the U.S. dollar financing system while simultaneously diversifying its financial infrastructure. Peter Alexander, managing director of advisory firm Z-Ben, noted that China’s Cross-Border Interbank Payment System, or CIPS, illustrates an effort to diversify away from dollar-centred finance without fully abandoning it. The People’s Bank of China began developing CIPS in 2012, the same year the U.S. Treasury sanctioned China’s Bank of Kunlun over illicit Iran-related activities. Transaction volumes on the system have increased since the Russia-Ukraine war began in 2022 and have generally grown this year, according to official figures. The system currently lists 210 direct participating institutions globally, most of which are affiliates of state-owned Chinese banks.

Further evidence of this hedging strategy includes the recent renewal of bilateral currency swap agreements between China and both Argentina and Australia. These agreements enable the exchange of tens of billions of dollars’ worth of yuan between the countries’ central banks. Alexander described this emerging financial system not as a complete abandonment of the U.S. dollar, but rather as a geopolitical hedging instrument. Data from Swift, the secure bank messaging system, shows that the U.S. dollar still accounted for more than half of global payments in July, while the Chinese yuan ranked fifth at 3.1 per cent, down from more than 4 per cent in early 2025. In trade finance, the dollar held nearly 80 per cent of the market, with the yuan in second place at 8.4 per cent.

Tianchen Xu, senior economist at The Economist Intelligence Unit, observed that China wants to stay in the dollar system to benefit its trade engine, but this does not imply full compliance with expanding U.S. sanctions. He expects China to use rare earth controls and other measures to retaliate against sanctions on major Chinese businesses. However, the U.S. also seeks access to critical minerals held by China, which incentivises maintaining a stable relationship. Dan Wang, China director at Eurasia Group, noted that the U.S. does not want to derail the upcoming summit. She added that the core of the China-U.S. relationship revolves more around the Taiwan situation, and that the China-Iran tie is not as close as outsiders might imagine, citing Beijing’s halt of state-backed infrastructure investment in Iran since 2018. Wang warned that removing a major Chinese bank from the SWIFT system would significantly increase devaluation pressure on the yuan, a scenario she described as unacceptable to Beijing. The U.S. dollar index has strengthened by about 1.5 per cent since the Iran war began on 28 February, while the yuan has gained nearly 2 per cent against the dollar and more than 3 per cent against the euro in the same period.