Since the outbreak of the international financial crisis, China s central bank has been actively engaged in cooperation initiatives at the international and regional level, including the signing of a few bilateral currency swap agreements with neighboring countries and regions, which has boosted the confidence and capability of all parties concerned to handle the ongoing crisis.
At the G20 Summit in Washington D.C. in November 2008, President Hu Jintao pointed out that efforts should be made to encourage regional financial cooperation, to enhance the capacity of providing liquidity assistance, to improve regional financial infrastructure and to make best use of regional liquidity assistance mechanisms.
Since the conclusion of the Summit, the People s Bank of China (PBC), responding to the requests of neighboring countries, has earnestly studied the issue and signed multiple currency swap agreements, making currency swap an important instrument to strengthen the capacity of providing mutual liquidity assistance in the region.
Until recently, the PBC has signed 6 bilateral currency swap agreements with other central banks (monetary authorities) totaling 650 billion yuan, including the framework agreement signed with the Bank of Korea involving 180 billion yuan on December 12, 2008, the formal agreement signed with the Hong Kong Monetary Authority involving 200 billion yuan on January 20, 2009, the formal agreement signed with the Bank Negara Malaysia involving 80 billion yuan on February 8, 2009, the formal agreement signed with the National Bank of the Republic of Belarus involving 20 billion yuan on March 11, 2009, and the formal agreement signed with the Bank Indonesia involving 100 billion yuan on March 23, 2009, on March 29, 2009 in the sideline of the Annual Meeting of the Inter-American Development Bank Group, Governor Zhou Xiaochuan signed with the Central Bank of Argentina a framework agreement on currency swap involving 70 billion yuan, which will be soon followed by a formal agreement.
At present, the PBC is discussing with other central banks with similar requests on establishing bilateral currency swap arrangements.
Currency swap (or cross currency swap) refers to the exchange of one currency into the equivalent amount of another between two market players holding two different currencies in the agreement that the principal in the two currencies will be exchanged back and the accrued interest be duly paid at the pre-set date.
The agreement signed between the two parties is called currency swap agreement. Currency swap originated in the 1970s, and was mainly adopted by commercial entities with a view to cutting financing costs and covering exchange rate exposure by capitalizing on their respective comparative advantages. In recent years, central banks have resorted to currency swap to accommodate the needs of promoting regional financial cooperation, implementing monetary policy and maintaining financial stability.
For example, the PBC joined the 10+3 (ASEAN countries plus China, Japan and South Korea) currency swap framework in 2001. Since November 2005, the PBC has been conducting RMB/foreign currency swap transactions with commercial banks in order to adjust the liquidity of the RMB and foreign currencies. Since the end of 2007, in order to tide over the financial crisis and provide short-term dollar liquidity to some countries, the Federal Reserve has established currency swap arrangements with the central banks of the countries concerned.
Generally speaking, central banks use currency swap as a way to address the short-term liquidity problem so as to cope with the current crisis more efficiently and safeguard the stability of the financial system. Innovation can be found in the currency swap agreements singed between the PBC and other central banks (monetary authorities), such as the extension of the effective period to 3 years, and the expansion of the swap arrangement to trade finance.
In the context of the financial crisis, these new practices will promote bilateral trade and direct investment, and drive economic growth. Currency swap enables a central bank to inject the swapped amount in a foreign currency into its domestic financial system, which will be borrowed by domestic commercial entities to pay for imports from the other country.
As such, the exporters in the other country can receive the proceeds denominated in the domestic currency, which will effectively avoid exchange rate risks and reduce the cost of fund transfer. Against the backdrop of sluggish economic and trade growth, heightening fluctuations on the foreign exchange market and shrinking trade finance, these innovations can play an important role.
As the currency swap agreements between the PBC and other central banks (monetary authorities) come into effect, central banks of the emerging market economies will be able to conduct operations in a more self-initiated and flexible manner. This signifies that central banks of the emerging market economies are increasingly capable and resourceful to handle the financial crisis and maintain financial stability, hence better positioned to play a bigger role in safeguarding regional and global financial stability and promoting trade and investment growth.
