Chinese Yuan (CNY) and US Dollar $. – File Photo by AFP

KARACHI: The landmark currency swap agreement (CSA) between the central banks of Pakistan and China will promote bilateral trade, finance direct investment between the two countries in the respective local currencies and serve any other “purpose” as mutually agreed between the two central banks.

In a statement to explain the CSA between State Bank of Pakistan (SBP) and Peoples Bank of China, Governor SBP, Yaseen Anwar said both the Central Banks will have the ability to draw on the swap line any time during three years tenor of the swap.

He said SBP can purchase Chinese Yuan (CNY) from PBC against its local currency (Pak rupee), and repurchase its local currency with the same CNY on a predetermined maturity date and exchange rate.

Similarly PBC can also purchase PKR against CNY. Standard market pricing will apply on the date of utilisation.  Like any swap, the pricing is linked to interest rates’ differentials between the two currencies, he added.

However, drawing under the swap line by either of the central banks will be contingent on 1) bi-lateral trade being denominated in local currencies, or 2) financing of direct investment between the two countries.

On December 23, 2011, SBP Governor had signed a landmark CSA with the Peoples Bank of China (PBC) in Islamabad in presence of the Prime Minister of Pakistan and the State Councillor of the Peoples Republic of China.

Yaseen Anwar said this agreement represents a significant achievement for both governments in promoting and enhancing not only bilateral trade, but also the opportunity to significantly increase investment in Pakistan going forward.

CSA has been executed for a tenor of 3 years in respective local currencies, Pakistan Rs 140 billion and Chinese Yuan 10 billion. This is the second CSA after the first one signed with the Central Bank of Turkey on November 1, 2011.

SBP Governor said that while such CSAs are strictly bilateral arrangements, the precise terms and conditions of each of these CSAs are confidential between the two Central Banks.

However, a close scrutiny of the information available in the public domain indicates that the principal objective of these swaps is to promote the use of regional currencies for trade settlement purposes and specifically in the case of China, it is to enhance the role of the Chinese Yuan in international trade and investment.

China’s concurrent Yuan local currency settlement programme is also consistent with the underlying currency swap objectives. The latest CSA between Pakistan and China also reflects similar objectives of promoting trade and investment in bilateral currencies.

Explaining the modus operandi and benefits of CSA, the SBP Governor said that since the CSA is a bi-lateral financial transaction, all terms and conditions apply equally to both countries and the pricing is based on standard market benchmarks which are widely acceptable in the respective domestic markets of the two countries.

He noted that the announcement of the CSA will give a positive signal to the market on the availability of liquidity of the other country’s currency in the on-shore market.

This means that for example, SBP will have the ability to draw on the swap line and provide Chinese Yuan to banks in Pakistan. Banks will on-lend this liquidity to importers/ exporters involved in trade denominated in Yuan.

At maturity, the importer/ exporter will repay the foreign currency to the lending bank; and the bank will repay to the respective central bank.

The trade financing regulations in foreign currencies are already available in Pakistan for providing liquidity and facilitating trade.

The same concept will also apply in the case of PBC borrowing PKR for trade or investment in Pakistan.

He said SBP will lend CNY to banks which will on-lend to importers with letters of credit denominated in CNY. On the maturity date of the letter of credit (LC), the importer will pay off the overseas supplier by borrowing in CNY.

Assuming borrowing is for 6 months, the importer will save on the rupee cost and after six months the importer will buy CNY against PKR and pay off the CNY loan. The availability of on-shore CNY financing will encourage importers to open CNY denominated L/Cs, he noted.

Explaining advantages to exporters with letters of credit/ contracts denominated in CNY, he said that once the contract is established, the exporter will borrow in CNY, sell CNY against PKR and utilize PKR for its local operations.

On the maturity date of the contract, the exporter will receive CNY from the overseas buyer and payoff the CNY loan locally, he added.

Referring to utilisation of PKR in China, SBP Governor said that the same concept will apply to PBC drawing PKR against the swap line and lending the same to banks in China.