IS CURRENCY SWAP DEAL WITH CHINA BENEFICIAL TO PAKISTAN?

SYED FAZL-E-HAIDER
(feedback@pgeconomist.com)

Feb 27 - Mar 4, 20
12

The currency swap deal is like a loan where one country gives its currency to another in return for an equal amount of the other country's currency at a later date. The deal gives central banks of the respective countries access to each other's currency. It is generally implemented with a slow pace. It is a transaction that allows two countries to exchange the interest and principal payments on loans issued in two different currencies.

Pakistan is in talks with Iran for currency swap arrangement. China is the second country after Turkey with which Pakistan has signed a currency swap agreement.

China has already signed currency swap deals with several of its trading partners including South Korea, Hong Kong, Malaysia, Belarus, Indonesia, Argentina, Brazil, Iceland, and Singapore.

Currency swap deal with Pakistan is actually a part of Chinese strategy initiated in 2008 to expand use of its tightly controlled Yuan abroad and reduce costs for Chinese traders mostly dealing in dollars and euros.

The swap deals could help China to boost exports by increasing the demand of Chinese goods for foreign buyers who have Yuan to spend.

Critics say that China's tight control on the Yuan keeps it undervalued, giving Chinese exporters an unfair price advantage and hurting foreign competitors. Even some US lawmakers have asked the government to impose punitive tariffs on Chinese goods in order to force Beijing to ease its controls on the Yuan.

Pakistan signed the currency swap agreement with China in December 2011, probably in a bid to shore its declining foreign currency reserves. Under the deal, Pakistan can borrow up to 10 billion Chinese yuan while China can borrow up to Rs140 billion.

There are concerns over declining foreign exchange reserves, which have declined by $1.6 billion in six months of the current fiscal year ending June 2012.

The currency swap deal is aimed at ensuring the availability of liquid foreign exchange reserves to allow the flow of foreign trade. The agreement will also allow the government to borrow up to $1.5 billion at a time when the country has to repay an $8 billion International Monetary Fund (IMF) loan this year. The deal was signed on the occasion of visit by a high-powered delegation from China headed by Dai Bingguo, China's state councilor in Islamabad in December last year. The currency swap agreement will last for three years and can be extended by mutual consent.

The signing of a bilateral currency swap deal between Pakistan and China is expected to promote investment and trade between the two countries at a time when Pakistan is nearing a default on its external and domestic debt payments. Under the deal signed between State Bank of Pakistan (SBP) and People's Bank of China (PBC), China agreed to swap 10 billion Yuan ($1.6 billion) for 140 billion Pakistani rupees. The deal has enabled SBP to purchase Chinese Yuan from PBC against Pak rupee and also repurchase rupee with the same Chinese Yuan on a predetermined maturity date and exchange rate. Similarly, PBC can also purchase Pak rupee against Chinese Yuan. The pricing is linked to interest rates' differentials between the two currencies.

The experts however believe that currency swap deal is unlikely to lower the demand of US dollars that exert pressure on the rupee in the market where importers are facing a panic-like situation finding no remedy out of the currency swap agreement.

Some industry people however believe that the swap deal could become a liability for the hugely-indebted nation, as China has not been interested in trading in Pakistani currency.

China has signed such agreements with many countries but the implementation of currency swap deal is practically limited to two or three countries.

The currency swap agreement has come at a time when Pakistani rupee (PKR) has hit a record low of Rs90 against the US dollar. Dollar is continuously appreciating against the rupee and the exporters and importers still prefer to keep dollar as their liquidity instead of Yuan, which is not tradable in the international market like dollar, pound and euro. The deal is expected to reduce Pakistan's reliance on US dollars, as it enables the two countries to do business in rupee and Yuan RMB.

The country will have increased trade margins by doing business in rupee and RMB that will also lower transaction costs and the risks related to exchange rates fluctuation. The analysts believe that the currency swap agreement with China may improve trade between the two countries but there is no chance for any ease of pressure on dollar demand, at least in near future.

Some experts fear that using the Pakistani rupee or Yuan as an invoicing currency instead of the US dollar would initially pose new risks to businesses in both countries.

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 and the Pakistani PKR has less liquidity.

The deal is beneficial to both countries in settling trade flows in their own currencies. The two counties have agreed to increase the bilateral trade to $15 billion by 2015. The volume of Sino-Pak bilateral trade was $7.4 billion last year, tilted in favor of China. Pakistan's exports to China stood at $1.6 billion compared to imports worth $5.8 billion, showing a deficit of $4.2 billion.

China is the major investor in Pakistan, though foreign investment in the country has witnessed a steady decline over the past few years.

China's public and private sector is currently involved in over 250 projects in Pakistan from mega to minor and from strategic to ordinary businesses. Chinese investments and projects in the country amounted to $25 billion, which are multiplying with each passing day. Presently, many Chinese companies are interested in making investments and establishing joint ventures with local companies in the country's different economic sectors including defense, banking, oil exploration, and mining. Analysts believe that presence of the Chinese banking giant, Industrial and Commercial Bank of China (ICBC) in Pakistan will provide financial support to Chinese companies, which are exploring investment opportunities or engaged in infrastructure development and financial business in the country.