Feb 26, 2013 05:07 PM

Closer Look: Britain, China Make Slow Progress on Currency Swap Deal

(London) -- The Bank of England's governor said on February 22 during a visit to China that the bank and its Chinese counterpart were close to signing a three-year currency swap arrangement.

The statement by Mervyn King raised hopes that the two countries were nearing a long-anticipated deal.

Such an agreement would allow the central banks to swap currencies for financing bilateral trade and direct investment.

The arrangement would support domestic financial stability, King said. "In the unlikely event that a generalized shortage of offshore renminbi liquidity emerges, the bank will have the capability to provide renminbi liquidity to eligible institutions in the UK," he said.

In fact, the shortage of yuan might have little impact on the country's financial stability since yuan settlement accounts for only a small part of foreign currency transactions in London. More importantly, such an agreement would be a key part of setting up an overseas yuan settlement center in London.

The overseas market for yuan trading is still far off as the capital pool is small while services and products are quite limited. Therefore, liquidity provided by monetary authorities would help the market attract more investors.

Overseas yuan deposits have been used as a key barometer of the development of the yuan settlement market. This index fluctuated a lot in London last year. Global financial services consultancy Bourse Consult said that at the end of June yuan-dominated interbank deposits fell to 7.2 billion yuan from 74 billion yuan at the end of 2011.

The significant decline is believed partly due to weakening anticipation of yuan appreciation and an increase in yuan-dominated investment tools.

Paola Subacchi, international economics research director at London-based Chatham House, said in an earlier paper that the sources of overseas yuan liquidity included cross-border transactions by financial institutions and monetary authorities. Since the yuan is not fully convertible to other currencies, monetary authorities have been the major source of yuan liquidity.

Last year, Britain's treasury announced plans to make London the leading international center for trading the yuan outside the Chinese mainland and Hong Kong.

But London has been tardy in taking concrete steps compared some of its major competitors. In 2010, Singapore signed a 150 billion yuan currency swap agreement with People's Bank of China, the central bank.

Clearing banks for yuan settlement were established in Taipei and Singapore in 2012, boosting the cities' status in international yuan trade.

Despite yuan transactions in London growing to the second largest in the world in 2012, trailing only Hong Kong, settlement still has to be made through the clearing bank in Hong Kong.

Calls for currency swaps between the central banks of China and Britain have increased from both sides.

Xia Bin, director of the Financial Research Institute at the State Council's Development Research Center, said during a December visit to London that he hoped "to see more cooperation and discussion about currency swaps between the Bank of England and the Chinese government, and an agreement will push forward London's development as a yuan trading center."

But the Bank of England has long been hesitant to launch currency swaps with other countries. It has such arrangements only with the U.S. Federal Reserve and the European Central Bank, deals that were signed after the financial crisis.

The latest progress announced by King may mark a breakthrough. But so far, no details about the arrangement have been revealed. It seems the two parties have many issues to settle.

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