Making currency swap deal with China usable

Updated February 05, 2018

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We committed ourselves to China-Pak Economic Corridor (CPEC)-related investments that we could not afford and now we are beginning to feel the growing pains of the balance of payment crises.

In wake of depleting foreign exchange reserves and falling remittances, the ever-surging import bill due to CPEC is putting pressures on the balance of payment.

The demand for dollars remains high in the open market; the Chinese living in Pakistan and doing business are buying dollars, causing the demand to increase, while importers need dollars to settle their own trades.

State Bank of Pakistan (SBP) in its Monetary Policy Statement 2018 has increased policy rate due to devaluation, hike in oil prices and build up of additional demand pressures. The monetary authority has indicated overheating of economy due to demand-led pressures.

Governor SBP, Tariq Bajwa, while announcing the monetary policy 2018 last week had also urged to take more steps to make the Currency Swap Arrangements (CSA) usable with China.

China is now Pakistan’s largest trading partner and we are recipients of a huge FDI in CPEC-related projects. It is natural that the currency composition of Pakistan’s trade changes accordingly from dollars to that of local currencies i.e. yuan and rupee.

We need the yuan to finance Chinese import bill and avoid an unmanageable need for dollars

The debate about using local currencies under CSA in bilateral trade is unsettled in Pakistan. Chinese have proposed to use yuan, instead of the US dollar. The government has indicated that the Chinese demand is under consideration, while SBP through its press release on Jan 2, 2018 has stated that the required mechanism is in place.

The story gets confusing given that on Dec 23, 2011, SBP signed a 10 Billion Yuan Currency Swap Arrangement with Peoples Bank of China (PBC), and in 2013 SBP invited bids from all commercial banks selling yuan against the rupee.

Apparently, business communities here welcomed the use of yuan in bilateral trade, but not a single bank bid due to lack of market enthusiasm.

Some economists believe that using local currencies in bilateral trade will be extremely beneficial for Pakistan, especially when it comes to current account deficit and demand pressure on dollar.

The CSA works like this; a Chinese exporter is paid in rupees. The exporter takes this foreign currency to a Chinese bank and converts it to yuan. The bank, then, can exchange these rupees for yuan with the PBC. By reversing the swap with SBP, PBC can easily convert these rupees to yuan. The logic would be the same if roles are reversed.

Each time an importer in Pakistan purchases Chinese goods it should be recorded as an import with a contra-entry that will record fewer assets in yuan, resulting in a net short position (a net claim) in the International Investment Position (IIP) of the country.

Since external debt is derived from the IIP table, increase of liabilities (a net claim) needs to be settled at a prearranged date and rate. The same has been negotiated in the CSAs. The swap has a tenor of three years and loans are generously granted by both countries.

China’s reasons for entering into the swap may be to serve its economic interests providing opportunity to settle trade and investing as FDI in yuan, while maintaining monetary control over its currency. We badly need yuan to finance Chinese import bill and to avoid an unmanageable need for US dollars. With swap facility SBP can purchase yuan from PBC against local currency, and repurchase its local currency with the same yuan.

On demand side, export with China has declined for the last four years; it is estimated that export to China remained 15 per cent of imports during 2016-17. Exports to China shrank to $1.62 billion in 2016-17 from $2.69bn in 2013-14, while imports from China grew to $10.53bn in 2016-17 from $4.73bn in 2012-13.

Making CSAs ineffective due to political reasons causes undue harm to business potential and business communities. Asymmetric bilateral trade has rendered the CSA less attractive to the Pakistani business community and is a cause of uncertainty.

Though we are not yet there but according to an estimate Pakistan’s foreign currency reserves are good enough for a three-month import bill. A sense of déjà vu exists in the situation; in 2013 the reserves fell to a two-month import, admitting us into the International Monetary Fund (IMF) programme.

On the face of emerging challenges many analysts are asking how we can sustain real-sector growth through CPEC-related investments with declining foreign exchange reserves.

We will remain in perpetual debt by importing value-added goods and exporting unfinished low-value products. Now is the time to make policy adjustments by curbing the undue consumption through widening the tax net and solving the problem of under-invoicing via stringent custom control.

The writer is a visiting faculty member at PAF Kiet

Published in Dawn, The Business and Finance Weekly, February 5th, 2018