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Focus: Renminbi Swap Network - Possible path to global financial safety net

by OMFIF Analysis

Focus: Renminbi Swap Network - Possible path to global financial safety net

This Focus report assesses the increasingly important role of Chinese swap agreements in the global financial system. Currency swaps, which allow central banks to exchange a set amount of local currency with another central bank at a fixed rate, are an important stabilising factor in financial markets. Access to foreign currency allows central banks to lend those funds to domestic banks and companies, ensuring they have access to short-term capital for their foreign currency activities.

Swap lines are predominantly accessed when countries face funding constraints or are suffering exchange rate fluctuations or market shocks. After the global financial crisis, the US Federal Reserve swap network helped prevent dollar liquidity shortages from turning into insolvency problems that would have exacerbated the post-crisis fallout. The importance of Fed swap lines highlights the dominant role of the US economy in the international financial system as the issuer of the global reserve currency, the largest participant in financial markets, and a key trade and investment partner for most countries.

Since 2008 the European Central Bank and People’s Bank of China have created their own swap networks, driven by the importance of these currencies to international payments and financial market activities. This reflects the gradual shift towards a multicurrency reserve system. The economic growth of regions outside the US has resulted in greater amounts of non-dollar financial transactions, from bilateral trade and investment to local currency bond issuance. This has created a growing need for many countries to hold non-dollar currency reserves.

China sees benefits in lower dependence on dollar
China is the second largest economy, a principal trade partner for most countries, and an important source of global capital and investment flows. However, the international use of its currency has remained limited. Since late 2008 the Chinese authorities have sought to change this, seeing benefits in lower dependence on the dollar and in greater international pricing in renminbi. The currency’s inclusion in the International Monetary Fund’s special drawing right, alongside the dollar, euro, sterling and yen, was an important milestone, enshrining the renminbi as a reserve asset. This could spur further development of the SDR as an international payment and accounting instrument, with the expansion of SDR-denominated bonds and other financial market instruments.

The use of a basket of currencies that includes the renminbi could help mitigate exchange rate risks and price fluctuations of securities denominated in SDR. It would also reduce overreliance and excess demand for the dollar, while boosting demand for renminbi. These have been long-term goals of the Chinese authorities. In addition to increasing the use of SDR, the PBoC has established a network of swap agreements worth almost $500bn to boost the use of its currency in financial transactions.

There are questions about the continued trajectory of the renminbi, given risks to the Chinese economy in the medium term. However, as a political as much as an economic tool, China is likely to continue expanding the international use of renminbi. This includes initiatives to price energy and other commodities in the currency, and the expansion of multilateral investment banks that use renminbi.

For the pdf of the Focus report please click here