China Using Currency Credit Swaps To Help Re-Finance Errant BRI Projects

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A recent report by the Wall Street Journal has indicated innovative Chinese thinking when it comes to providing debt solutions to nations struggling to repay BRI related loans – currency swaps.

These are provided by the People’s Bank of China, which has helped numerous countries, including Pakistan, Sri Lanka, Argentina and Laos whose infrastructure projects caught development and operational colds due to Covid and the economic downturn. Mostly, this has been due to a downturn in expected cashflow revenues from projects such as railways, toll roads and other consumer driven projects, although some – and especially in Si Lanka – have been down to pure bad fiscal management and local corruption.

To get around the debt repayment issues, the PBOC has been opening swap lines that allow overseas central banks to exchange their domestic currencies for Chinese yuan. These transactions, allow China to prop up governments that borrowed heavily from Chinese banks as part of the Belt and Road Initiative to finance infrastructure projects.

By replenishing other countries’ reserves, the PBOC may be helping some of the world’s most indebted countries avoid rising borrowing costs. But detractors say the swaps also help paper over problems that led to their financial troubles in the first place.

Throwing heavily indebted countries such financial lifelines without insisting on economic overhauls is akin to “sticking your fingers in a dam,” said Gabriel Sterne, head of global emerging markets research at consulting firm Oxford Economics in London, although this view discounts the view that the Chinese are not already well aware of the issues concerning sovereign debt due to it and other investors.

The currency swap transactions also represent another potential liability for borrowers as rising interest rates, inflation, slowing growth and depreciating currencies impair creditor countries’ ability to repay their debts. The swaps are often rolled over, sometimes for years, with estimates that the average interest rate for using them has been around 6% of the value drawn. That is higher than rates imposed by the US Federal Reserve when it charges other central banks to swap their currencies for dollars, as well as the rate on typical International Monetary Fund loans. The difference is that the Fed and the IMF typically insist on political reforms and compliance with US trade objectives as part of its loan deals, whereas China does not impose additional conditions.

The PBOC says the swap lines are there to help grease the wheels of international trade, ensure financial stability and further the adoption of the yuan in a world where trade and finance are dominated by the U.S. dollar.

The swap lines serve another purpose for China—helping to ensure its borrowers can repay their loans when those borrowers are under growing financial stress. Chinese lenders are less likely to get repaid on time if costs soar for their borrowers and the risk of a sovereign default goes up.

Currency-swap arrangements are not new. The Fed maintains permanent swap lines with major counterparts including the European Central Bank, Bank of England and the Bank of Canada. They were a critical conduit for channeling dollars to teetering banks worldwide at the height of the 2008-09 financial crisis, and played a role in backstopping the global financial system during the Covid pandemic.

China’s central bank has extended currency-swap lines to many countries with a history of debt-repayment problems. Those facilities are narrowly focused on maintaining stability in a financial system that revolves around the U.S. dollar. The PBOC’s swap lines are broader in scope, and can be used by foreign central banks to address balance of payment needs. Other central banks such as those of Qatar and Japan are authorized to offer similar assistance to counterparts overseas, but none can match the PBOC in scale or extent of usage.

The PBOC’s swap network is the largest of its kind, according to the World Bank. The PBOC said in a 2021 report that it has swap facilities with 40 countries with a combined capacity of almost 4 trillion yuan, or about US$570 billion. This represents just slightly over 10% of China’s estimated US$4 trillion in BRI loans, suggesting that China has the debt issue covered.

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