CSA WITH CHINA LIKELY TO IMPROVE LIQUIDITY POSITION

SALIM AHMED
(feedback@pgeconomist.com)

Feb 27 - Mar 4, 20
12

A landmark bilateral currency swap arrangement (CSA) made between People's Bank of China (PBC) and the State Bank of Pakistan (SBP) for a three-year period is all set to boost bilateral trade.

"The bilateral CSA has been concluded in Chinese Yuan 10 billion and Rs140 billion for the purpose of promoting bilateral trade and investment and strengthening financial cooperation," sources said, adding, "The currency swap would expire in three years, but could be extended with mutual consent."

Financial experts believe that it is expected that bilateral trade and investment will grow between Pakistan and China as a result of this agreement, further augmenting the economic ties of the two countries. This agreement will make a significant contribution in further strengthening the close and special relationship between the two countries.

They said the currency swap agreement between the two central banks would give positive signal to the market on the availability of liquidity of the other country's currency on the onshore market. As a result, CSA will promote bilateral trade denominated in Chinese Yuan and Pakistan rupee.

According to them, the agreement would prove beneficial for robust trade and commerce between the two countries.

It may be noted that the volume of bilateral trade reached $5.789 billion in 2010-11 but the import from China was significantly dominant. The volume of import from China rose to $4.144 billion while export to China remained at $1.645 billion during the period. Pakistani exporters have said that China has vast scope for Pakistani products being the biggest market of the world

Experts told PAGE that currency swap would ease liquidity issues for Pakistan and conserve our dollar reserves. Additionally, it would lower transaction costs and avoid the risk of fluctuations in exchange rates.

Switching from billing our Chinese customers in US dollars to billing them in RMB would also bring opportunities to expand our trade margins, while also reducing risks and hedging costs.

However, some analysts are of the view that using the PKR or RMB as an invoicing currency instead of the US dollar would initially pose new risks to businesses in both countries that most government officials may not fully appreciate or understand.

Currency dealers believe that both the currencies of RMB and PKR are not nearly as liquid as the US dollar. The Chinese currency is not really traded outside of China except in a few countries mentioned above and the Pakistani PKR has liquidity to speak of. No doubt, it would be in the interest of both our countries to settle trade flows in their own currencies.

Although China has been working towards making its currency more convertible for the last two years, more still needs to be done, they said.

Given the robust state of China's economy when compared with the current condition of other important trade nations such as the US and the UK, it seems reasonable to assume that the RMB would continue to be robust as a currency as well, they added.

They maintained that CSA with People's Bank of China signed on December 23, 2011 represents "a significant achievement for both governments to promote, enhance not only bilateral trade but also opportunity to significantly increase investment in Pakistan going forward."

They said China's concurrent Yuan local currency settlement program is also consistent with underlying currency swap objectives. Pakistan-China CSA also reflects similar objectives of promoting trade and investment in bilateral currencies. Objective of swap is to promote bilateral trade, finance direct investment between two countries in their respective local currencies and any other 'purpose' as mutually agreed between two central banks.

Since CSA is a bilateral financial transaction, all terms and conditions apply equally to both countries. Pricing is based on standard market benchmarks, which are widely acceptable in respective domestic markets of both countries, they added.

According to them, both the central banks of China and Pakistan will have ability to draw on swap line any time during tenor of swap. SBP can purchase renminbi from PBC against its local currency PKR, and repurchase its local currency with same CNY on a predetermined maturity date and exchange rate.

Similarly, PBC can also purchase PKR against Yuan. Standard market pricing will apply on date of utilization. Like any swap, pricing is linked to interest rates differentials between two currencies. However, drawing under swap line by either central bank will be contingent on bilateral trade being denominated in local currencies, or financing of direct investment between two countries.

They said CSA is giving positive signal to the market on availability of liquidity of other country's currency in onshore market. This means that for example SBP will have ability to draw on swap line and provide Chinese Yuan to banks in Pakistan.

Banks will on-lend this liquidity to importers/exporters involved in trade denominated in yuan. At maturity, importer/exporter will repay foreign currency to lending bank; and bank will repay to respective central bank. Trade financing regulations in foreign currencies are already available in Pakistan for providing liquidity and facilitating trade. Same concept will also apply in case of PBC borrowing PKR for trade or investment in Pakistan.

On maturity date of letter of credit (LC), importer will pay off overseas supplier by borrowing in yuan. Assuming borrowing is for six months, importer will save on rupee cost and after six months importer will buy yuan against PKR and pay off yuan loan. Availability of onshore yuan financing will encourage importers to open yuan denominated LCs. Once contract is established, exporter will borrow in yuan, sell yuan against PKR and utilize PKR for its local operations. On maturity date of contract, exporter will receive yuan from overseas buyer and pay off yuan loan locally.