Feb 27 - Mar 4, 20

China has continued to have significant share in global exports because of its low cost of manufacturing making the country a dominant player in export markets. In order to assist trade with other countries, China since 2008 has been implementing bilateral currency swap arrangements with its trading partners in a move to attain financial stability with trades.

China has signed agreements with South Korea, Hong Kong, Malaysia, Belarus, Indonesia, Argentina, Brazil, Ireland and more recently Singapore and Pakistan.

The benefit of these agreements for importing countries of Chinese goods to place orders in RMB rather than USD would assist countries during volatility geared through exchange rate.

China has already executed agreement in excess of $100 billion globally. The Central Bank of China and SBP jointly announced a 10 billion yuan ($1.6 billion) for Rs140 billion for a period of three years.

Pakistan has always remained in the spotlight for country risk and its ability to meet financial obligations including export payments with the dollar reserves on hold by SBP.

With current reserves at $16.78 billion and imports more than exports, Pakistan finds its challenging to hold dollar reserves. In order to meet import payments, Pakistan would arrange for dollars to meet international payments.

With such a swap arrangement, US dollar reserves could be used for other international imports whereas trade from China shall be carried out in RMB. Such an arrangement will allow Pakistan to trade in RMB and PKR to reduce reliance on holding of USD reserves. This will assist the country to enhance its diversity in currency holding used for international trade.

Another advantage to importers is that they would not have to bear additional finance cost for forward covers to ensure the PKR value for retirement of L/Cs since RMB has been stable. The imports will be safeguarded against volatility of dollar rate which would give them confidence to ascertain the cost of imports

The only pitfall of trading with China is that RMB is not traded as much as dollars. Therefore, increased trade and need for holding of reserves in RMB may pose liquidity pressures which can make the exchange rate between PKR and RMB volatile if not properly managed.

Assessing business and country risk between both countries, loss of liquidity for both RMB and PKR internationally may also be a cause of concern.

The currency swap is being viewed as financial innovation on mass scale, which may bring discomfort among banks to execute volumetric transactions and may cause delays in transaction execution increasing transaction cost. RMB is still considered a major currency in global currency trading, however, lower than USD.

Countries, which sign agreements with China, will benefit from enhanced international trade where China itself will benefit through exports and inflow of foreign currency.

Though it is in the interest of the countries, viability of trade is still a question mark incase similar imports are available from other countries at a price at par or better than what China offers. In doing so, China will stand with other developed nations e.g. USA, India and UK for volumetric trades. USA has highlighted timely to keep the dollar a global trading unit to safeguard its own interest. USA has expressed concern over devaluation of Chinese currency that is making its exports attractive in the global market. To make its local industries competitive, USA may enhance its tariffs on Chinese products.

In terms of challenges, provision in banking systems and procedures along with staff training to deal with these transactions may warrant a thought at the gradual bank operations level.

With increased trading of RMB, the currency will obtain global acceptance not only for business transactions but also for travelers from China to other countries. With RMB is competing directly with USD, the risk USA faces is that in order to trade with China in invoices denominated in RMB, the country would need to obtain RMB from the market which is only possible through exports or purchase from open markets which will pose a challenge.

In recent times, Pakistan has witnessed a devaluation of rupee against the dollar making imports expensive consequently increasing the cost of production. Dollar is currently trading in a band of Rs90.02 to Rs90.50 in light of volume of import payment and debt servicing for IMF loan amounting to eight billion dollars. Consistent devaluation may have marginal impact on exports though it will have a larger impact on imports since Pakistan is a net importer.

According to the SBP estimates, the reserves could fall as low as $11 billion by June 2012, though the position may change with future uncertainties and trading volumes. The pressure on the rupee is strong and not expected to subside in the short run. The swap arrangement with China is a good initiative. Domestic acceptance by financial institutions and the future volumes as part of the total import bill of the country is yet to be ascertained.

SBP would first need to estimate the trades with China and hold sufficient yuan deposits to ensure all trades are carried out in a swift manner. The companies importing from China will have a benefit to retire L/Cs denominated in yuan rather than USD. Diversification by SBP to hold deposits other than USD will have a positive impact on reserves.

In anticipation of trades, importers in Pakistan my carry a sentiment to import more from China substituting from other trading partners consequently increasing Pakistan's overall import bill. Despite the uncertainty, mutual trade and investment between both countries is expected to increase.

With China signing this agreement with more countries, RBM will continue to be a strong currency. Industries which will benefit to the maximum would include the consumer goods, textiles, automotive, decoration and crockery, tyre and rubber and the petrochemicals industries to name a few by procuring raw materials from China. It is also expected that industrial machineries will solely be imported from China. Once in execution, trade cooperation with China is expected to assist Pakistan with its economic development.