China and Britain have reached a three-year deal to swap their currencies when needed, the first such agreement between Beijing and a major developed economy and a move that could help boost the Chinese yuan outside Asia.
In a statement released late Saturday, the Bank of England said Governor Mervyn King and his counterpart at the People’s Bank of China, Zhou Xiaochuan, signed an agreement to set up a three-year swap line with a maximum value of 200 billion yuan ($32.6 billion). It means that Bank of England could draw on the line with the PBOC when there is a sudden shortage of yuan funds in the U.K. market—and make the yuan, also known as renminbi, available to banks under its jurisdiction.
China’s central bank has increasingly used such bilateral currency-swap deals in its effort to promote the yuan in global trade and finance. So far, the PBOC has signed nearly two trillion yuan worth of currency-swap deals with some 20 countries and regions, including Hong Kong, Thailand, Singapore, New Zealand, Argentina and Malaysia. Most of the pacts so far have been with emerging economies in the Asian-Pacific region and don’t include major economies such as the U.S., Japan and those in the euro zone.
These currency lines, though rarely tapped, could enhance foreign investors’ confidence in trading of the yuan. “The bilateral swaps are a backstop of sorts but are still needed to help facilitate the growth of renminbi in foreign markets, especially if challenging liquidity conditions were to emerge,” said Paul Mackel, head of Asian currency research at HSBC Holdings HSBA.LN -0.44% PLC in Hong Kong. The deal with Britain “is not just a symbolic move because it will help support the overall depth and liquidity of renminbi” in the U.K. market, he added.
An expansion of yuan trading into London could help China advance its goal of turning the yuan into an international currency, a key part of its broader push to open up its financial system. Currently, Beijing maintains a tight leash on cross-border fund flows, making it difficult for the yuan to accumulate overseas.
Chinese officials in recent months have increased their rhetoric toward making the yuan a freer currency, hinting that a plan on yuan convertibility would be proposed later this year and include steps aimed at allowing freer flows of its currency and ways to let Chinese individuals make overseas investments.
Some scholars within China expect the yuan to become basically convertible as early as 2015, though Chinese officials have never given a timeline for how soon that would occur. The timing would depend on progress in China’s efforts to overhaul its creaky financial system and open its capital account—efforts that could be slowed if China’s economy sputters or its financial system hits turbulence.
U.K. bankers and politicians are counting on the yuan to help cement London’s role as the center for global foreign-exchange trading. This comes as cities such as Singapore, Tokyo, Taipei, Luxembourg and Kuala Lumpur are all exploring the possibility of becoming offshore yuan trading hubs—a status only the Chinese territory of Hong Kong currently enjoys.
Since early last year, bankers hoping for a surge in yuan business in London have lobbied Downing Street to set up a currency swap line with Beijing, according to banking executives involved in the discussions. But initially, U.K. policy makers had largely left it to the private sector to figure out ways to boost yuan trading. Nonetheless, talks on a potential swap line between Beijing and London continued as a lack of yuan liquidity in the London market has become one of the biggest challenges to the city’s ambitions.
Britain already has swap lines with the U.S. Federal Reserve, the European Central Bank and the Bank of Japan, 8301.JA +1.82% though they haven’t been used much other than at the height of the global financial crisis. Early this year, Bank of England said that a consensus had been reached between the bank and the PBOC to facilitate discussions on the establishment of a three-year renminbi-sterling currency swap line.
In the Saturday statement, Mr. King said the deal will help support U.K.’s domestic financial stability. “In the unlikely event that a generalized shortage of offshore renminbi liquidity emerges, the bank will have the capability to facilitate renminbi liquidity to eligible institutions in the U.K.,” Mr. King said.
Yuan trading in London has grown rapidly in the past year as more U.K. businesses and investors start to embrace the currency: Daily yuan trading in London more than doubled in the year to June 2012, to $1.7 billion, according to a recent survey by Bourse Consult for the City of London. But that still pales in comparison to yuan trading in Hong Kong. Average daily yuan trading volume in the territory rose to a record $63.6 billion last month, according to the Hong Kong Monetary Authority.
PBOC officials have said similar agreements with other countries would depend on whether there is demand. “This is a market-driven process,” Yi Gang, a deputy PBOC governor, said in March. “I think if both parties think a swap agreement is helpful, why not do it?”