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December 20, 2017


THE recent announcement by Planning Minister Ahsan Iqbal that all trade between China and Pakistan will now be settled in local currency, whether the Pakistani rupee or Chinese yuan, has raised some interesting questions. A swap arrangement between China and Pakistan was signed on Dec 31, 2011. Explaining the purpose of that arrangement, then governor of the State Bank of Pakistan, Yaseen Anwer, said “the principal objective of these swaps is to promote the use of regional currencies for trade settlement purposes” as well as advancing China’s aim of making the yuan into an international currency.

The size of the swap was 10 billion yuan from the Chinese side, and Rs140 billion from Pakistan ($1.6bn). Importers and exporters could now use the facility to settle their trade in the currency of both countries, instead of relying on US dollars, where a conversion fee would attach an extra cost. But in the years since its launch, the facility was rarely used by traders. Its biggest utilisation came in 2013, when the State Bank used it to draw $600 million to help the government tide over an emerging balance of payments crisis just long enough to get past the elections.

So when Ahsan Iqbal chose the occasion of the launch of the CPEC Long Term Plan to announce that “we are examining the use of RMB instead of the US dollar for trade between the two countries”, the first reaction amongst those who follow financial developments between Pakistan and China was: what is there to examine? A mechanism to do exactly this has existed for six years now.

Amongst those asking this question is Salim Raza, former governor of the State Bank. “I’m puzzled by the announcement,” he says. “It is not clear what exactly is being asked by the Chinese here, perhaps they’re just urging us to start using the swap arrangement, or perhaps they have asked for more” than just settlement of bilateral trade in local currency.

So long as the use of the yuan is restricted to settlement of trade-related payments, it has little impact on Pakistan’s economy. The fact that Pakistan runs a large and persistent deficit in its bilateral trade with China means that the supply of yuan will continuously need to be replenished, either through borrowing or through an expansion of the swap arrangement, or a combination of both.

Since the signing of the swap arrangement, Pakistan’s bilateral trade deficit with China has more than tripled, going from $4bn to more than $12bn today. Imports from China were $14bn last fiscal year, whereas exports stood at $1.5bn.

“If this is to extend beyond trade-related payments,” says Mr Raza, “then we have to be mindful. If it extends to commercial banking, or payment for services in the local market, then it runs the risk of introducing a parallel currency.”

In the fall of 2008, then finance minister Shaukat Tarin travelled to China as Pakistan was in the midst of a large balance of payments crisis of the sort that have episodically afflicted the economy. He returned bearing $500m as balance of payments support from the Chinese government, along with a missive from them, saying “we don’t usually do this sort of thing”.

To him, the proposal of conducting bilateral trade in local currency is a good one, “provided they are willing to commit to advance placement of yuan within Pakistan to support the move”, he says.

A high-level source in the Planning Commission, who could not speak for attribution, could only say that the proposal is still at an early stage and has some way to go before it is finalised. The Long Term Plan of CPEC, under which the proposal is being advanced, specifically mentions tripling the size of the swap arrangement to 30bn yuan in order to facilitate local currency settlement of all trade transactions.

China has been on an accelerating drive to globalise its currency for many years now. It has sought to encourage the use of the yuan as a reserve asset, meaning central banks of other countries can hold their foreign exchange reserves in yuan rather than dollars. It made a strong bid to include the yuan in the IMF’s basket of Strategic Drawing Rights (SDR), the currency the fund uses for its lending operations. But its strongest push towards the goal of globalising its currency has come in the form of massive swap arrangements with central banks of more than 30 countries around the world, totaling almost $490bn according to Bloomberg.

There is little data on how much these swaps have actually been drawn down though. Perhaps it is its reliance on Letters of Credit as the only mechanism to effect payment that serves as a disincentive for many traders to use the swap, since importers of Chinese goods rely on other channels to make payment. But how exactly the proposal will be effected, and how it will plug the persistent shortage of yuan in local foreign exchange markets, remain central questions as it moves forward.

Published in Dawn, December 20th, 2017