Feb 27 - Mar 4, 2012
Pakistan's economy is under pressure mainly because of two key factors: trade deficit and continuous depreciation of Pak rupee against all the major currencies. Pakistan's trade balance with its 53 trading partners is in deficit for the last five years. Persistent trade deficit is not a healthy sign for an economy like Pakistan.
Negative net trade balance with major trading partners including China, Japan, Kuwait, Malaysia, Saudi Arabia, UAE, and India was recorded during the last fiscal year (2010-11). The country recorded a trade deficit equivalent to USD1025 million in December 2011 alone.
Exchange rate plays a significant role in an open economy for the policymaking. Over 50 per cent depreciation of Pak rupee against US dollar since the beginning of 2008 has nearly halted the economic growth, hitting all the important areas of economy from agriculture to industry, manufacturing to import of goods, etc.
Fluctuations in exchange rates are affecting a number of variables like investment decision, FDI (foreign direct investment), trade flows, capitals flows and international remittance and foreign exchange reserve. Both trade deficit and exchange rate volatility correlates and has direct impact on overall economic situation of the country. In present day situation, increase in trade results in increase in foreign currency debt. That is the reason why countries have started using cross-currency swaps so as to take the advantage of the comparative advantages.
A cross currency swap is basically a foreign exchange agreement between two countries where one currency is traded for another for a fixed period of time. In other words, swap is a form of loan to a country where one country gives its currency to another in return for an equal amount of the other country's currency at a later date.
US Dollar was solely used as a global currency from 1944 to 1971, whereas most of the currencies did not peg against the dollar after the collapse of the fixed exchange rate regime in 1971.
Since then the dollar remains the world's de facto currency as the US was the world's prominent economic power and most of the international business remains in US dollar. As per a recent report, around 60 per cent of world's business is done in US dollar whereas the dollar continues to dominate global currency reserves with 63.9 per cent being held in dollars as compared to 26.5 per cent in Euro.
Amid global economic uncertainties and ensuring stability of the financial markets, it has become important for the stable economic development for the developing countries to work on alternate currency options.
China has taken the lead by singing currency swap agreements with many of its different trading partners including South Korea (RMB 180 billion or US$26 billion), Hong Kong, Malaysia (US$ 16 billion), Belarus (US$2.9 billion), Indonesia (US$14.6 billion), Argentina (US$10.2 billion), Brazil, Iceland (US$513 million) and Singapore (RMB 150 billion or US$ 22 billion).
The accords have enabled these countries to place orders for Chinese imports in RMB rather than dollars. China has so far signed swap agreements of worth US$100 billion (RMB 700 billion), according to reports. India and Japan have also increased the size of their agreement to $15 billion.
Various developing countries have signed currency swap agreements in the past. However, Pakistan signed its first currency swap agreement with Turkey in late 2011. Pakistan like other countries has to use its US dollar reserves for the payment of its import bills.
According to the State Bank of Pakistan, the agreement was concluded in Pakistan Rupee/Turkish Lira with value amounting to one billion dollars in equivalent local currencies, and the tenor of the agreement would be three years. The core objective of the currency swap arrangement with Turkey was to finance bilateral trade.
After successful execution of currency swap agreement with Turkey, Pakistan signed another currency swap agreement with China in December 2011 worth 10 billion Chinese Yuan and Rs140 billion for promoting bilateral trade between the two nations for a fixed term of three years.
It is expected that these agreements will provide an extra advantage to the importers and exporters of the respective countries and also enhance the foreign direct investments. Independent analysts expect that the currency swap agreements will enable the business communities of these countries to trade in their respective currencies without putting pressure on the dollar-based foreign exchange reserves.
It would not be wrong to say that these agreements are basically more beneficial for Pakistan than China and Turkey because Pakistan, being a weaker economy than China and Turkey, can gain maximum benefits from these facilities as these agreements will support the country's economy by providing short-term liquidity support.
In addition, main advantage of entering into a currency swap agreement is its flexibility; it will not only reduce the transaction costs for the local traders but will also minimize the risk of fluctuations in rupee exchange rate.
Billing Chinese customers in their own currency instead of US dollars would also bring opportunities to expand trade margins of Pakistani traders and reduce the currency risk and related hedging costs.
The dark side of the currency swap agreements is that it is new for the Pakistani market and local business communities are not very familiar with such transactions. Therefore, it is anticipated traders would prefer using dollar as their base business currency instead of yuan or lira. The government officials are also not fully aware of the nitty-gritty of such agreements and their functionalities.
These agreements will help Pakistan in increasing its trade and at the same time it will also not affect the dollar dominated trade because major imports of Pakistan remain dominated in US Dollar. The local traders are also requesting the government of Pakistan to negotiate and sign a similar currency swap agreement with Iran.
Due to economic sanctions on Iran, it is difficult for the traders to settle their dues timely resultantly they have to do a lot of maneuvering to recover their dues. Therefore, the agreement with Iran will enable the traders of both the countries to settle their import and export payments easily and more efficiently.
Pakistan imports and exports several items from and to Iran and a currency swap agreement would be a blessing as the trade between the two countries would be adjusted by buying and selling from one another in their respective currencies.
It is in the interest of the country and its trading partners to undertake trade in their own currencies but the problem is that Pakistan's financial system is really not prepared to comprehend the swap deals. It is therefore important for the financial institutions to take the lead, create awareness among stakeholders, and utilize the facilities effectively.