Daily Management Review

Chinese Exporters Use Currency Swaps To Keep Their Dollars When The Value Of The Yuan Declines


Chinese Exporters Use Currency Swaps To Keep Their Dollars When The Value Of The Yuan Declines
According to government data and interviews with enterprises, Chinese exporters are employing a complex currency swap method to postpone turning their dollar revenues into yuan out of concern that they will lose out on possible increases in the U.S. currency.
The fact that China's state banks are counterparties to some of these swap agreements that enable exporters to convert their dollars into yuan suggests that the nation's currency regulator is at ease with these transactions even as authorities work to reduce the strong pressure on the yuan in spot markets.
Exporters like Ding, a businessman from Shanghai, are afraid to sell their dollar earnings and convert them into yuan because the yuan recently fell to nine-month lows.
"My fellow exporter friends and I have been discussing if we want to use foreign exchange swap trades to get the yuan," said Ding, who trades in electronics and toys and prefers to go by his last name.
"The key concern is that the price of the dollar keeps going up."
Foreign capital leaving the faltering economy is pushing the yuan even lower, which has lost more than 5% against the dollar so far this year, including a 2% decline this month alone.
By using swaps, exporters can exchange their dollars for yuan at banks through a contract that would eventually reverse the flow and return their dollars to them.
However, economists believe the Chinese monetary authorities can't truly force exporters to convert dollars, even though they remove a crucial source of dollar supplies from the spot yuan markets.
According to the nation's currency regulator, Chinese enterprises exchanged a record $31.5 billion for yuan with commercial banks in July alone, and a total of $157 billion this year.
When the yuan declined past 7 to the dollar, a mark the local currency has only crossed three times since the 2008 Global Financial Crisis, Ding had first intended to transfer his dollar holdings.
But as speculation increased that the Federal Reserve will keep raising U.S. interest rates for longer, as well as as forecasts for continued weakness in the yuan, whose yields are falling as China loosens monetary policy to bolster faltering economic activity, he changed his mind.
"The growing monetary policy divergence is the key reason behind the trend," said Gary Ng, senior economist for Asia Pacific at Natixis.
"As it is unlikely to see any fundamental change in the short run, the gravity of yield differentials will drag the yuan and prompt exporters to bet on the dollar."
In the currency forwards market, rates have also changed due to rising U.S. yields and the expanding disparity between them and Chinese rates. As a result, exporters are now under no obligation to even lock in a forward rate to sell their dollars. Compared to a current rate of 7.29, the one-year yuan is quoted at 7.02.
Traders claim that if businesses utilise their own funds, the State Administration of Foreign Exchange enables sell-buy dollar-yuan swaps.
Exporters receive local currency for business needs when they swap higher-yielding dollars for the less expensive yuan for even three months. They also gain an annualised 3.5% profit on the swap arrangement.
"By trading FX swaps, exporters can postpone their settlements while meeting their yuan demand," said Becky Liu, head of China macro strategy at Standard Chartered Bank.
They could also place the dollars in deposits at 2.8% and use those as collateral for yuan loans, with net gains of about 2%, which would be less lucrative but still useful.
In an effort to deter hoarding and encourage exporters to exchange their dollars for yuan, China's lenders have dropped those dollar deposit rates twice this year. However, more exporters appear to have switched to swaps.
China Merchants Bank, which is partially owned by the government, even prods exporters to employ swaps.
"If companies want to retain their dollar deposits, they can sign up foreign exchange swap products to increase the returns on dollar deposits," the bank said in trade recommendations.
 In the meantime, China's central bank has stepped up efforts to defend the yuan by continuing a trend that has been going on for months of setting yuan mid-point benchmarks that are firmer than anticipated and even ordering certain domestic banks to reduce their foreign investment.
State banks can engage in swaps to buy dollars from the onshore forwards market and sell them in the spot market to halt swift yuan losses thanks to exporters' swaps, which provide them with a large amount of dollars to employ in their yuan operations.