In order to reduce dependency on the greenback gradually over time, Pakistan has decided to use Chinese yuan for bilateral trade. The yuan attained the status of a global reserve currency, the third one after the US dollar and the euro, on Nov 30, 2016. For Pakistan, the rupee-yuan settlement of trade with China is important because it would reduce need for US dollars to a significant extent as Pakistani imports from China are in excess of $10 billion. Initially, even if 25 percent of our imports from China are to be financed in yuan, our dollar requirements would decline by $2.5 billion within a year. Through this move, the two countries aim to promote monetary cooperation between the central banks, implement existing currency-swap arrangements, research to expand the amount of currency and explore to enrich the use and scope of bilateral currency swap and assign the foreign currency to domestic banks through credit-based bids to support the financing for projects along the China-Pakistan Economic Corridor (CPEC).
This means Pakistani and Chinese banks will, in the course of time, be able to open import letters of credit in rupees and yuan (also known as renminbi, or RMB). Moreover, Pakistan will be able to pay for imports from China in yuan rather than in dollars, and Chinese companies investing in CPEC projects will bring in yuan-denominated funds here and remit back their profits and dividends also in yuan instead of dollars or other foreign currencies. The two countries have not signed Free Trade Agreement (FTA) as yet but they have signed Currency Swap Agreement (CSA). The FTA may benefit exporters from Pakistan as the country critically needs to improve its exports due to huge trade deficit.
Industrial and Commercial Bank of China Ltd (ICBC) Pakistan has been allowed to establish a local yuan settlement and clearing setup in Pakistan enabling it to open yuan accounts of the Chinese banks operating in Pakistan and to facilitate settlement of yuan-based transactions such as remittance to/from China.
With the opening of Bank of China in Pakistan, the access to Chinese markets will strengthen further. Considering the recent local and global economic developments, particularly with the growing size of trade and investment with China under CPEC, yuan denominated trade with China will increase significantly and will yield long term benefits for both the countries.
The main issue is that the Chinese banking system is used to handling transactions in yuan and other regional currencies (of the countries with which direct settlement of transactions are going on) but Pakistani banks are not. The challenge is to make them used to such transactions, explain them how the rupee-yuan settlement of transactions would work and how the businesses would benefit from it. The next step is promoting the clearance and settlement of claims of financial institutions through a cross-border interbank payment system. Once concrete developments are made in this regard, the free flow of capital and cross-border transfer of legitimate funds between the two countries would become easier.
Basically, RMB trades in two markets. One is the offshore RMB market where the People’s Bank of China (PBC) has no control and the other is the onshore market within China, which is regulated by the PBC. Hence, RMB has two types of exchange rates. While offshore rate moves freely, the onshore rate floats within a narrow band allowed by the PBC.
If RMB becomes operational in Gwadar, China has two major advantages. First, it will be able to monitor the impact of RMB on Gwadar Free Zone and draw lessons for its currency reforms within China. Secondly, it can promote RMB internationally without any effect on its capital account whatsoever. Similarly, Pakistani exporters can accept payments in RMB from Chinese importers and then exchange the cash into PKR at a high open-market rate, which will increase their returns in PKR terms. However, speculation between the two currencies may increase which could prove to be quite disruptive for private businesses.