Home Forex What’s China, Saudi Arabia’s currency swap pact?

What’s China, Saudi Arabia’s currency swap pact?

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China and Saudi Arabia have announced their first currency swap.

The swap, worth $6.93 billion, comes as relations between the two countries have deepened in recent years.

Saudi Arabia, the world’s top oil exporter, and China, the world’s biggest energy consumer, have worked to take relations beyond hydrocarbon ties in recent years, expanding collaboration into areas such as security and technology.

The swap agreement, which will be valid for three years and can be extended by mutual agreement, “will help strengthen financial cooperation… expand the use of local currencies… and promote trade and investment,” between Riyadh and Beijing, the statement from China’s central bank said.

But what is a currency swap agreement?

And should the United States, an ally of Saudi Arabia and a rival of China, be worried?

Let’s take a closer look:

What is a currency swap agreement?

As per Investopedia.com, a currency swap is a financial agreement.

In it, the two parties exchange a precise quantity of one currency for another currency of a corresponding rate.

Its goal is to lower risk, realise lower financing costs or, as in this case, get access to a foreign currency.

But how does it work?

Investopedia explains it thus, “In a currency swap, the two parties agree to exchange notional amounts of currencies at an agreed-upon exchange rate and then, at a specified future date, reverse the transaction at a prearranged rate. The swap rate is the difference between the two exchange rates, and it represents the cost of borrowing one currency compared to the other.”

So, why have China and Saudi Arabia made this pact?

As per SCMP, Beijing is trying to cut down its reliance on US currency and prop its own denomination up abroad.

The piece noted that Moscow’s invasion of Kyiv and the sanctions that followed showed the risks of currency being pegged to the dollar. The article also noted how spiking interest rates also increased the dollar’s worth of the dollar – thus causing some nations to switch to the yuan.

Riyadh, meanwhile, is attempting to increase foreign investment in line with its Vision 2030.

Crown Prince Mohammed bin Salman of Saudi Arabia. AP

Mohammad Bin Salman has made it a priority to decrease Saudi Arabia’s reliance on fossil fuels and expand its economy.

A piece in Yahoo noted that Saudi Arabia, which has been critical to propping up the petrodollar system built in the 1970s, is also looking to strengthen relations with trade partners.

A piece on the website Al-Monitor explained the benefits to both nations thus, “The swap agreement means that currency risk is lower for both countries to use the other countries’ currency. As a result, the financing costs for using the riyal and yuan will be lower for both China and Saudi Arabia and both countries will have easier access to the other’s currency. This means that a Saudi company, for example, may be more likely to choose to finance in yuan instead of US dollars than before the swap agreement was made. This in turn will increase the Chinese foothold in the Saudi economy and vice versa.”

Should US be worried?

Experts say that the US need not worry – yet.

“China seems to be using swap lines in a very different way to the US,” said Weitseng Chen, associate professor at the National University of Singapore. “(China) uses it as a credit line, so it’s on a constant basis, instead of a one-time, one-off thing during a financial crisis.”

Sharif Eid, a Dubai-based money manager at Franklin Templeton, told Bloomberg TV, “There is still a very deep reliance, for a very good reason, on the dollar as a basis for trade and monetary policy.”

“I don’t think that’s changing anytime soon.”

But an article in Business Insider, despite noting that despite the deal not being very large, could ‘loom larger symbolically’ given Saudi Arabia’s status as the world’s leading oil exporter.

China imported $65 billion worth of Saudi crude in 2022, according to Chinese customs data, accounting for about 83 per cent of the kingdom’s total exports to the Asian giant.

Russia remained China’s top oil supplier in October despite higher prices for Russian crude, with Saudi imports down 2.5 per cent from the previous month as it continued to restrict supply.

Chinese president Xi Jinping told Gulf Arab leaders last December that China would work to buy oil and gas in yuan, but it has not yet used the currency for Saudi oil purchases, traders have said.

Beijing is thought to have the world’s largest network of currency swap arrangements in place, with at least 40 countries, but seldom reveals the broader terms of its arrangements.

Argentina in October activated a currency swap line with China for the second time in three years to the tune of $6.5 billion to help increase its depleted foreign currency reserves in the midst of a major economic crisis, with annual inflation above 130 per cent and central bank dollar reserves hitting negative levels.

With inputs from agencies

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