Jan 16 - 22, 20

The currency swap agreement with China is expected to extend short-term liquidity support to Pakistan, as the country's current account deficit is feared to widen further in the coming months because of debt repayments and a lack of external aid.

The country will shore its declining foreign currency reserves through the currency swap deal signed with China last month.

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 early this year.

Under the deal signed between the two countries on December 23, 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.

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

Local 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 local 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.

The foreign exchange reserves were at $16.77 billion in the week ending Dec. 23, compared with a record $18.31 billion as of July 30.

The current account widened to $2.104 billion in July-November of current fiscal year ending June 2012 compared with $589 million in the same period a year ago.

The landmark currency swap agreement was signed on the occasion of visit by a high-powered delegation from China headed by Dai Bingguo, China's state councilor to Islamabad last month. The currency swap agreement will last for three years and can be extended by mutual consent.

The deal was signed between State Bank of Pakistan (SBP) and Peoples Bank of China (PBC).

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

The deal will take time to influence currency market, which is currently experiencing massive fluctuations on exchange rate.

The swap arrangement 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. China may later convert the deal into a loan with a mark-up at market rate. China is suspected to be reluctant in trading in Pakistani currency

The currency swap deal will provide an additional facility to both exporters and importers and also to the investors of both the countries.

Being the world's biggest market, China has vast scope for Pakistani products. Opening letter of credit in Yuan could provide additional line for payments or an investor could benefit from the agreement, which has over $3.1 billion liquidity facility.

The currency swap agreement is expected to improve trade between the two countries, which 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.

This is for the second time that Pakistan signed a currency swap agreement with China after it signed a similar arrangement with Turkey. 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.

Some experts argue that dealing in the Pakistani rupee or Yuan as an invoicing currency instead of the US dollar would initially pose new risks to businesses in both countries, as both the currencies are not nearly as liquid as the US dollar.

China has already signed currency swap deals with eight 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.

Currency swap deals, which give central banks access to each other's currency, 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.