How to correctly understand the China Arab Currency Swap Agreement?, Argentina repays IMF $1.7 billion debt currency with RMB | Agreement | Correct Understanding

Recently, Argentine Economy Minister Massa announced that the Argentine government will repay the International Monetary Fund with an upcoming $2.7 billion debt, of which $1 billion will be provided by the Latin American Development Bank, and the remaining $1.7 billion will be paid using the equivalent Chinese yuan under the currency swap agreement between China and Argentina.

On June 9th this year, the People's Bank of China and the Central Bank of Argentina renewed their bilateral currency swap agreement, with a swap size of RMB 130 billion/4.5 trillion pesos and a validity period of 3 years.

Based on this, the use of equivalent Chinese yuan under the currency swap agreement between China and Argentina to repay soon to be due US dollar debt has raised market concerns. Some argue that in the context of the enormous devaluation pressure on the Argentine peso, China will suffer exchange rate and other losses as a result of currency exchange between China and Argentina.

In fact, this understanding is incorrect. What exactly is a central bank currency swap? What are the impacts of currency swap agreements on bilateral trade? How does it promote the internationalization of the RMB?

Correctly Understanding Currency Swaps

According to official economic data released by Argentina, the country's inflation rate reached 8.4% in April this year. The cumulative inflation rate in the past 12 months has risen to 108.8%, the highest level since 1991. Since the beginning of this year, the cumulative depreciation of the Argentine peso has exceeded 23%.

Some argue that against the backdrop of the enormous devaluation pressure on the Argentine peso, we have switched to a bunch of worthless pesos.

The fact is not so. "This understanding is not accurate, and the concern that the Argentine peso may continue to depreciate and cause foreign exchange losses in our country is one-sided," said Chang Ran, a senior researcher at Zhixin Investment Research Institute, to First Financial.

Chang Ran pointed out that currency swap agreements are not direct currency exchange, but a financial tool for trade and investment that can be initiated by both parties when there is a demand for trade and investment. China and Argentina have signed a currency swap agreement, in which Argentina will use the equivalent of 1.7 billion US dollars to repay its debt. China will import goods and services from Argentina or make direct investments. The currency swap in this situation not only reduces Argentina's financing costs, but also expands our country's trade network and investment scope.

Currency swap usually refers to the market transaction behavior in which two trading entities holding different currencies exchange equivalent currency at the beginning of the period according to a predetermined agreement, and then exchange their respective currencies and pay corresponding interest to each other at the end of the period. The prior agreement between the two parties is a currency swap agreement.

Currency swap originated in the 1970s, primarily between commercial institutions, with the aim of leveraging comparative advantages, reducing financing costs, and locking in exchange rate risks. In recent years, central banks of various countries have also begun to use currency swaps for regional financial cooperation, implementing monetary policies, and maintaining financial stability.

Chu Xiao, a researcher at the Bank of China Research Institute, told First Financial that the local currency swap agreement is an important cooperation arrangement between the central banks of the two countries, aimed at promoting smooth trade and investment, and strengthening financial cooperation between the two sides.

Taking the agreement between China and Argentina as an example, as early as 2009, the People's Bank of China and the Central Bank of Argentina signed a bilateral currency swap agreement. The swap size of this agreement is 70 billion RMB/38 billion Argentine pesos. The effective period of the agreement implementation is 3 years; After multiple extensions, on June 9th of this year, the People's Bank of China announced that it had renewed a bilateral currency swap agreement with the Central Bank of Argentina, with a swap size of RMB 130 billion/4.5 trillion pesos and a validity period of 3 years.

Chu Xiao stated that through this agreement, China and Afghanistan can directly exchange their currencies, reducing transaction costs and risks, and improving the convenience of bilateral trade.

According to market analysis, the borrowing and lending of currency swap agreements have a term, and after maturity, both parties are required to repay the local currency and interest according to the originally agreed exchange rate and amount. That is to say, currency swap is not a real currency swap, borrowing RMB also requires repaying RMB, and there is no exchange rate loss involved in this.

Another viewpoint is that currency swap agreements may cause pressure on the renminbi exchange rate to depreciate, and this understanding is also inaccurate.

As of the end of 2021, the People's Bank of China has signed bilateral currency swap agreements with central banks or monetary authorities in a total of 40 countries and regions, with a total amount exceeding 4.02 trillion yuan and an effective amount of 3.54 trillion yuan.

Chang Ran stated that based on the disclosed offshore RMB trading volume, the global trading volume in 2022 is approximately 3.5 trillion yuan per day. The total amount of RMB swaps between 40 countries is approximately equivalent to the daily trading volume in the offshore RMB market. Even if currency swap agreements increase RMB trading in offshore markets, the impact on offshore RMB exchange rates is not enough to raise concerns about exchange rate depreciation fluctuations.

The internationalization of the RMB has a significant promoting effect

In fact, currency swap agreements have a positive impact on bilateral trade and have a more significant driving effect on the internationalization of the renminbi.

Argentina's choice to use the renminbi to repay IMF debt is actually a recognition of the internationalization of the renminbi. In Chu Xiao's view, this indicates that China, as the world's largest developing country, is gradually recognized for its international status, and the internationalization of the renminbi will also receive increasing attention from the international community.

Chu Xiao believes that on the one hand, from the perspective of the scale of RMB usage, as China and Argentina's economic and trade relations continue to deepen, bilateral currency swaps can provide more potential RMB liquidity, support cross-border trade and investment between China and Argentina, and thus increase the international scale of RMB usage. On the other hand, from the perspective of monetary confidence, bilateral currency swaps can enhance Argentina's confidence in the stability of the renminbi market, and also reflect its recognition of China's international status, further increasing its willingness to use the renminbi.

In recent years, the People's Bank of China has signed and renewed currency swap agreements with multiple countries. For example, on August 1st, the People's Bank of China and the Bank of Mongolia renewed their bilateral currency swap agreement, with a swap size of 15 billion RMB/7.25 trillion Mongolian Tugrik and a validity period of 3 years. The renewal of the bilateral currency swap agreement between China and Mongolia will help further deepen financial cooperation between the two countries, promote bilateral economic and trade exchanges, and maintain financial market stability.

Chang Ran believes that as some regions gradually "de dollarize", more and more enterprises tend to use RMB for trade financing and pricing settlement to avoid exchange rate risks, reduce exchange costs, and improve financing efficiency. By the end of March 2023, the share of the renminbi in China's cross-border income and expenditure had risen to 48%, surpassing the share of the US dollar. Bilateral currency swaps can provide more potential RMB liquidity and support cross-border trade. Meanwhile, bilateral currency swaps can enhance the confidence of importing regions in the Chinese yuan and help attract foreign central banks to choose the Chinese yuan as an anchor currency or reserve currency. The main impact of bilateral currency swap in the short term is on RMB transactions between China and the signatory countries of the agreement. With the increase of overseas RMB stock, under the influence of network externalities, different overseas countries will also use RMB more for transactions, which will further promote the internationalization level of RMB.

It is worth mentioning that on August 1st, the new SDR currency basket came into effect for one year. The renminbi is increasingly recognized by international investors and is being used more and more in areas such as international payments, investment and financing, foreign exchange trading, and international reserves, gradually becoming an important supplement to the international monetary system.

On May 11, 2022, the Board of Directors of the International Monetary Fund completed its five-year SDR valuation review, maintaining the current SDR basket currency composition unchanged. The weight of the renminbi was raised from 10.92% to 12.28%, and the weight of the US dollar was raised from 41.73% to 43.38%. At the same time, the weights of the euro, yen, and pound were lowered from 30.93%, 8.33%, and 8.09% to 29.31%, 7.59%, and 7.44%, respectively, while the weight of the renminbi remained in third place. The new SDR currency basket officially came into effect on August 1st last year and will undergo the next SDR valuation review in 2027.

According to the official IMF foreign exchange reserve currency composition data, as of the end of the first quarter of 2023, the US dollar accounted for 59.02% of global foreign exchange reserves, making it the largest reserve currency held by major central banks worldwide; Next is the euro, accounting for 19.77%; The Chinese yuan accounts for 2.58%, ranking fifth.