By Zhu Yihong

Deputy Governor of the People’s Bank of China Madame Hu Xiaolian and Deputy Governor of the Bank of England Sir John Cunliffe after signing a Memorandum of Understanding on RMB clearing and settlement in London March 31, 2014. Source: BankofEngland’s flickr photostream, used under a creative commons license.

Renminbi (RMB) internationalization, like other Chinese initiatives such as the Asian Infrastructure Investment Bank (AIIB) and the One Belt, One Road initiative, has received significant attention during its opening stage. Since the 2008 global financial crisis, the Chinese government has been actively involved in efforts to internationalize the RMB. As the Chinese capital account is not open yet, and foreign countries cannot access RMB on international markets, one alternative approach toward increasing the international flow of the RMB is to sign swap agreements. Beijing has embraced these swap agreements as long term means to expand the use of its currency without significant changes to its capital account.

The original purpose of currency swap agreements is to provide countries with liquidity in times of crisis. For example, after the 1997 Asian financial crisis, Asian countries, including China, entered into swap agreements under the framework of the Chiang Mai Initiative. In the 2008 financial crisis, the United States conducted currency swaps with several countries, such as Korea, Brazil, Mexico, and Singapore, mainly to provide U.S. dollar liquidity for those countries. Some of the swap agreements are denominated in U.S. dollars while others are in local currencies. But none of the swap agreements under the Chiang Mai Initiative have been activated yet.

Beyond the moderate progress in Asian regional financial cooperation, China has signed swap agreements with approximately 30 countries since 2008 (see Table 1). The People’s Bank of China (PBOC) stated that those swap agreements were intended not only to “stabilize the international financial market,” but also to “facilitate bilateral trade and investment.”

 Table 1: China’s swap agreements and its counterparties

Sources: People’s Bank of China news releases, available here. Trade volumes were obtained from UN Comtrade, Classification: HS2007, Reporter: China, Year: 2013 here and converted from USD to RMB using the average exchange rate for 2013: 1 USD = 6.152292 RMB here. Note: The validity of the swap agreements is three years. Some countries have renewed or expanded the swap agreements with China. The listed agreements only include the most recent ones. Though several of the swap agreements have expired, they are still included since there’s high probability that they will be renewed.

Noticeably, the swap agreements are denominated in RMB and the local currencies of the counterparty countries, without involving the U.S. dollar. This indicates that the counterparties of the swap agreements are willing to hold RMB. For example, South Korea, one of China’s largest trading partners, is willing to have freer access to the RMB mainly to finance the bilateral trade. It first signed a swap agreement with China in December 2008, and has renewed and expanded the swap amount several times. There is indeed a strong correlation between the volume of the bilateral trade and the size of the swap agreement (see Table 2 and Figure 1).

Table 2: Correlation between trade volume and swap size

Figure 1: Correlation between trade volume and swap size (in billion RMB)

China’s swap agreement network includes a diverse range of countries. Geographically, it is not limited to the Asia and includes Latin America, the Middle East, and Europe (Figure 2). Economically, some counterparty countries are asymmetrically reliant on the Chinese economy, such as Mongolia and Pakistan; some have close economic relations with China, such as South Korea and Australia; and others have the potential to enhance their economic relationship with China, such as Latin American countries.

Figure 2: Geographical locations of China’s swap counterparties

Though economic motivation and trade relations sufficiently explain the size of the swaps, their symbolic meaning might carry more weight. Most of the swaps are guaranteed but have yet to be drawn on. There are also strategic and long-term considerations driving many of the swap agreements. Countries with natural resources, especially oil, such as from Middle Eastern countries, are present. Financial hubs such as the United Kingdom, Hong Kong, and Singapore are also included. Several out of the 31 swap countries are also test beds for offshore RMB clearing centers or the RMB Qualified Foreign Institutional Investor (RQFII) program (see Table 1).

RMB internationalization is distinct in the sense that the Chinese government is utilizing political power instead of market forces to start the effort. Countries like South Korea and Australia, which have close economic ties to China, even have expressed the willingness to hold the RMB as a reserve currency. Nevertheless, the prospect that those countries will become solid supporters of RMB remains uncertain. After all, South Korea and Australia are strategically aligned with the United States. Meanwhile, some claim that RMB is held mainly for arbitrage reasons, with appreciation expectation instead of fundamental attractiveness of the currency.

China is trying to expand the use of its currency through trade settlement, swap agreements, and investment facilities without swiftly opening-up its capital account. However, the overall progress and achievements of RMB internationalization will remain fragmented and modest without significant reform and opening of the domestic financial market. Eventually, it is up to the market and the business community to decide whether the currency is to play a broader and more substantial role.

Ms. Zhu Yihong is a researcher with the Freeman Chair in China Studies at CSIS.