China-Pakistan RMB clearance arrangement: lower cost, greater vigour, and more input required
Advancing the China-Pakistan Economic Corridor (CPEC) with greater efficiency and making CPEC an exemplar of high-quality Belt and Road cooperation was one of the main themes during Pakistani Prime Minister Muhammad Shehbaz Sharif’s visit to China.
I tweeted an important development of China-Pakistan financial cooperation on my verified Twitter account: “Chinese and Pakistani central banks have signed a Memorandum of Understanding (MoU) to establish Chinese Renminbi (RMB) or Chinese Yuan (CNY) clearing arrangements in Pakistan, which will help enterprise and financial institutions conduct cross-border transactions using RMB and further facilitate bilateral trade and investment. The tweet has attracted a lot of attention in Pakistan.
In recent years, the Chinese Yuan clearing mechanism has been widely welcomed in many economies in Europe, the Middle East, Southeast Asia, etc., since the RMB has overtaken the Japanese yen to become the fourth global payment currency, according to the 2022 RMB Internationalization Report released by China’s central bank. The report also says that China’s central bank, the People’s Bank of China (PBOC), has authorized 27 overseas Chinese Yuan clearing banks in 25 countries and regions by the end of 2021.
In Pakistan, the yuan clearing arrangement is nothing new. Since 2011, Pakistan and China have had Currency Swap Agreements (CSA). State Bank of Pakistan (SBP), the Pakistani central bank, has approved the Industrial and Commercial Bank of China (ICBC) and the Bank of China (BOC) for clearing and settlement mechanism of Chinese yuan in 2015 and 2018, respectively.
In 2018, the Pakistani central bank approved that the country will allow Chinese currency to be used for imports, exports, and financing transactions for bilateral trade and investment activities. According to the bank’s statement, a regulatory framework including opening letters of credit, clearing of transactions and financing facility in the yuan has already been put in place.
As Pakistan’s first qualified RMB Clearing Mechanism, ICBC Karachi Branch has successfully launched a portfolio of products, including RMB forwards, swaps, Letters of Credit, Guarantee, and structured trade financing in Pakistan. In 2018, the Bank of China officially launched its services in Pakistan for clearing and settlement mechanisms of the Chinese yuan for bilateral trade, investment activities, imports, exports, and financing transactions. In 2020, ICBC Karachi Branch became the first bank in South Asia to be qualified as a direct participant in the Cross-border Interbank Payment System (CIPS) by PBOC and SBP, which indicated that RMB clearing facilities would be further improved and strengthened.
An important issue to be noticed is that Yuan clearing and settlement business is not limited to Chinese and Pakistani banks. In 2019, the State Bank of Pakistan allowed Standard Chartered Bank (SCB), Pakistan, to establish a local Chinese Yuan Renminbi (CNY) clearing and settlement set up in the country. Pakistani central bank has allowed Standard Chartered Bank, Pakistan can open CNY accounts of the banks operating in Pakistan to facilitate settlement of CNY-based transactions such as remittance to/from China.
The use of the yuan was focused on trade in the beginning but was later expanded to direct investment and financial transactions. Using RMB in cross-border trade can achieve a direct settlement between CNY and Pakistan Rupees.
Financially speaking, the Yuan clearing and settlement in Pakistan will help to reduce the exchange rate risk, which will help further reduce transaction costs, enrich investment and financing options, and better meet the needs of enterprises, individuals, and financial institutions. Moreover, there has been a growing trend toward promoting the use of local currencies to settle transactions between two or more countries in recent years.
The major benefit of this arrangement would be that Chinese products and investments that will come to Pakistan or Pakistani products that will go to China will be more competitive due to transactions done directly in their local currencies, not through the long and complex procedure of U.S. dollar-based transaction via New York, especially when Pakistan is facing forex reserves depletion as the rupee faces pressure from rising interest rate set by the Fed and a stronger U.S. dollar.
By far, most of the transactions of CPEC projects and China-Pakistan trade are still made in dollars. But if more transactions can be done directly in ruppe/yuan, the cost will be lowered, and the net profits will be higher.
Therefore, as trade and investment continue to surge, and Pakistan is expected to have more share in the Chinese market, more innovative RMB financial instruments are needed.