Korea and China have reached an agreement on using the bilateral currency swap line ― currently at 64 trillion won (360 billion yuan) ― for trade settlement by their companies.
Given the absence of a won-yuan exchange market, the accord will pave the way for the companies to settle trade deals through their own currencies, not the U.S. dollar, which would have them avoid currency fluctuation risks.
The agreement bears special significance in that the currency swap, intended to help hedge against sudden capital outflows in times of financial crisis, will evolve into a means of trade settlement.
Under the proposed system, the central banks of Korea and China will swap their currencies within the limits of the currency swap and the currencies will be lent to importers for trade settlement via commercial lenders. This will make it possible for Chinese exporters doing business with Korean companies to be paid via the yuan and vice versa.
Most meaningful is that exporters and importers from the two countries can lower their exposure to currency fluctuations at a time when nearly 95 percent of trade settlements between Seoul and Beijing are made via the greenback.
Although China is Korea’s largest trade partner and Korea is China’s No. 4 trade partner, the percentage of trade settled via the yuan and the won remains at 0.8 percent and 0.04 percent respectively.
The new facility will also help the neighboring countries cope with the possible currency turmoil caused by industrialized nations’ massive monetary easing.
As Bank of Korea Governor Kim Choong-soo has pointed out, the agreement may encourage Korea and China to feel the need to make their currency swap permanent and further expand the upper limit. In October last year, Seoul and Beijing agreed to expand the currency swap deal from 180 billion yuan (32 trillion won) to 360 billion yuan in order to secure more foreign exchange liquidity amid growing economic uncertainty. Under the three-year deal, both can trade one country's local currency for the other's.
The agreement is the first step in the right direction but hopefully the central bank will use the accord as a reference for expanding more currency swap arrangements with other Asian countries with which Korea has close trade ties. At the same time, it will help boost Seoul and Beijing’s efforts to internationalize their currencies by reducing their heavy reliance on the dollar.
The key to making this agreement successful will lie in creating conditions for companies from the two countries to prefer payments by the won or the yuan to those in dollars.
Specifically, the central bank and the government must act to tackle corporate complaints about higher exchange fees imposed on the yuan. The financial authorities also should keep a close watch on whether balance is kept in the course of swapped currencies being used for trade settlements, considering that the yuan is controlled tightly by the Chinese government.