The yuan is not fully convertible, meaning there are rules and regulations making the process of conversion more cumbersome. That can hinder trade as investors are nervous that there will not be enough yuan available if needed urgently for a deal.
David Bloom of HSBC said: “In a currency which is not fully convertible, this offers a pool of liquidity to draw on if needed. That always gives you a comfort as an investor.”
With this deal, Britain will become the first major developed economy to install a currency swap line with China, which should help London become a global trading centre for the yuan. The City is already the world’s biggest foreign exchange and bond trading centre and Chancellor George Osborne has been driving a campaign for Britain to win more yuan business.
The Bank of England says the main motive for the swap is financial stability, so it will be able to lend yuan to UK financial institutions if funding from other banks dries up.
The Bank of England governor, Sir Mervyn King, who is currently on a visit to Beijing, said: “In the unlikely event that a generalized shortage of offshore yuan liquidity emerges, the bank will have the capability to provide yuan liquidity to eligible institutions in the UK.”
China, meanwhile, sees the swap as a tool to finance trade and direct investment between the two countries. Bloom says: “They are opening up their country for investment. What you don’t want is to invest in a country and find out you’ve got a shortage of the currency you’re looking for.”
The yuan is one of the most important currencies in the world for trading goods and services, but its use is still limited in the much bigger global trade of shares and other financial instruments.
China is keen to support greater use of the yuan internationally but wants to maintain control over capital flows, to avoid a situation where investors fall out of love with the currency and sell it, with a destabilizing impact on the economy. As a result, it is opening up its currency markets slowly and in a regulated way, with swaps of this kind.
Bloom said: “They are not going for a ‘big bang’ approach, they are evolving the currency. This isn’t the Wild West, this is the controlled east.”
