A LARGE misunderstanding is growing that Pakistan has just opened the door to settling all bilateral trade with China in yuan instead of the dollar. It all began when, in response to repeated queries on the subject, the State Bank put out a press release on Jan 2 saying that such trade has been open for years, and there is no bar to using the yuan to settle payments for trade and investment from China.
“SBP has already put in place the required regulatory framework which facilitates use of CNY in trade and investment transactions such as opening of L/Cs and availing financing facilities in CNY,” the press release said. In fact, the yuan is not the only currency that is allowed to be used for settlement of cross-border trade and investment. Besides the dollar and yuan, the euro and Japanese yen can also be used similarly.
In any case, as the press release emphasised, the bank had “already put in place” all the tools that allow the yuan to be used for trade settlement. The process actually began in December 2011 when a currency swap arrangement (CSA) was signed between China and Pakistan.
The agreement was for three years, subsequently renewed, and up to 10 billion yuan were available to Pakistan to swap against rupees through it. The State Bank governor, in a written note released a week after the signature, said that the main objective of the agreement is to “promote the use of regional currencies for trade settlement purposes”, and for China CSAs of this sort, which were being signed with many other countries as well, were part of its overall ambition to internationalise the yuan and prepare for an era when China’s currency could rival the US dollar as a global currency.
The first auction of yuan was held in June 2013. Not a single bank submitted a bid.
Today, China has such CSAs with at least 30 other countries, totalling more than $550bn. But the ambition of a globalised yuan still remains a distant dream.
In Pakistan’s case, the signing of the CSA was followed by a lengthy period of putting in place the administrative tools necessary for its operation. Central banks of both countries needed the proper channels through which to effect the swap. Then they needed a mechanism through which to make the respective currencies available to their domestic banks.
That process ended in May 2013 when the State Bank announced the operational launch of the yuan settlement system. The way it was going to work was a little complex. The State Bank would conduct competitive auctions of the yuan for banks to participate in. Depending on the demand elicited from these auctions, the State Bank would request the requisite quantity of yuan from China, and offer an equivalent quantity of rupees as a swap. The exchange rate at the time was Rs14 to the yuan.
Banks could now ask to borrow yuan from the State Bank in two tenors: three and six months. After acquiring them, they could make these yuan available to their clients for payments connected to their dealings with Chinese companies, whether trade or investment related. On the settlement date, the banks would return the yuan to the State Bank, which would return them to China and retrieve their rupees.
The first auction of yuan was held in June 2013. Not a single bank submitted a bid. There was no interest whatsoever from the market. But in the meantime, the government of Pakistan was entering a serious balance of payments crisis as the foreign exchange reserves depleted to dangerous levels. During that time, then governor of the State Bank, Yasin Anwar, managed to use the swap facility to draw a large amount of yuan (the exact number was never officially announced, but I think I once heard him say at a public event that it was equivalent to $1bn), convert them into dollars, and place the resultant funds in the reserves, thereby pushing the approaching balance-of-payments crisis down by a few months.
A second auction was held in December 2013, and once again, no bids were received. The market remained uninterested in the facility. From then onwards, the State Bank discontinued the yuan auctions and told the banks to approach the central bank whenever a demand for yuan materialised, and an auction could be organised at short notice. Not a single bank has taken up the offer since then, showing that the level of interest in using yuan to make trade-related payments remains zero to this day.
When I spoke to a group of importers about why there was such a lack of interest in the yuan for settlement of trade payments with China, I received three responses. Some said they were fine with the dollar and simply not interested in the change. Others said the yuan was less stable against the rupee compared to the dollar (the yuan was Rs14 back in 2011, it is Rs17 now), and they did not want to deal with the exchange rate risk. Another group said that the yuan facility requires the transaction to be conducted through a letter of credit issued by a bank, whereas a large amount of under-invoicing takes place in imports from China, where the balance payment is made through an exchange company for concealment.
When asked why not use the yuan for the amount paid via L/C and the dollar for the remainder, they simply replied ‘why complicate things? If I’m dealing in dollars anyway, why shift to yuan for a part of the payment?’
So there is nothing new in the Jan 2 announcement of the State Bank. It is possible that at the moment, the Chinese authorities are simply focused on creating the pathways through which yuan settlement can be effected. Once in place, they will turn their attention towards getting increased utilisation. A set of incentives will be offered for the purpose, but until then, it remains business as usual.
The writer is a member of staff.
Published in Dawn, January 11th, 2018