China made another stride towards currency internationalization when the People’s Bank of China, its central bank, signed an agreement with the European Central Bank on October 10 for a bilateral currency swap. The pattern is set to continue, market observers say.
"The ECB is about the 20th institution to sign a swap deal with the PBoC in a trend that we will definitely see continuing," says Andy Seaman, partner and fixed-income portfolio manager at Stratton Street Capital. "It’s just a matter of time before another is signed."
The deal between the ECB and the PBoC will be valid for three years and allows for a maximum size of Rmb350 billion ($57 billion) when Chinese currency is provided to the ECB and €45 billion when the PBoC receives euros.
According to data released by the PBoC, the swap line with the ECB is the third largest after Hong Kong, with an agreement set at Rmb400 billion; and South Korea, with Rmb360 billion. The swap follows a similar deal signed between the PBoC and the Bank of England in June for Rmb200 billion.
The PBoC has been on a quest to sign bilateral swap agreements with central banks since the onset of the financial crisis – intended to serve as a liquidity backstop for China in times of international liquidity shocks. The swaps can also serve to reduce transaction costs of cross-border exchange for local ﬁrms.
The swap also has symbolic importance, reflecting the growing trade between eurozone countries and China.
According to the European Commission, European exports to China increased by 5.6% in 2012, reaching €143.9 billion – more than doubling in the previous five years. In the same year, Europe became China’s biggest export destination, accounting for €289.7 billion in goods. China is Europe’s second-largest trading partner, behind the US, and the EU is China’s largest trading partner. Bilateral trade between the two regions reached €433.6 billion in 2012.
"A swap line is a backstop liquidity provider, which is initially driven by trade, but then acts to facilitate trade," says Seaman. "As it stands, France would be a country to benefit from the ECB swap line in Europe, because it settles 10% of all trade in renminbis, the second-largest amount in Europe after the UK. But there is no reason why this can’t change."
According to Swift RMB Tracker, London accounts for 62% of global renminbi trading outside of China and Hong Kong, and 28% of all international renminbi payments are made in the UK. Second in line is the US, which accounts for 13% and then France at 10%. Singapore and Switzerland account for 9% and 6% respectively.
But just because the PBoC has signed swap agreements with many central banks since the financial crisis, it doesn’t mean that the Chinese will necessarily tap the liquidity, says Qinwei Wang, China economist at Capital Economics based in London. "So far, China has actually used only a small amount of the liquidity facilities open to it." Only Hong Kong – still the main hub of offshore renminbi trading – has had to activate its swap with China (in 2010 when it faced a renminbi squeeze).
But compared with the rest of Europe, London is ahead of the game now not only in scale but also in the depth of relationship it has already forged with China, says Wei Yao, China economist at Société Générale corporate and investment banking group. "From a central bank point of view, although the ECB is bigger and the swap line is larger in volume, London is much more interesting because it will be the place that encourages more private portfolio flows. London definitely has the competitive advantage."
|China has agreed to open up its markets for UK investors in a deal arranged on October 15 during a visit to China by UK chancellor of the exchequer George Osborne and London mayor Boris Johnson|
"This will give British fund managers an opportunity to diversify away from illiquid dim sum bonds out of Hong Kong and make attractive returns," says Seaman.
In return, London will ease restrictions on Chinese banks, allowing them to set up wholesale banking branches in the UK, a measure that has been restricted since the financial crisis hit in 2008, limiting foreign presence in the UK to subsidiaries. RQFII quotas for continental European countries might be the next step the PBoC takes, says Yao.
"Although the new RQFII quotas will ease control of capital flows to and from China and will increase the attraction of the renminbi, the problem is the terms are still limited," says Wang. "It’s not a very strong move because leaders in Beijing are still wary about creating more volatility in the market than needed. I doubt that the renminbi will be a major currency in the next two to three years, precisely because some of the measures they are taking are still too small."