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China carries out its first foreign currency swaps

Pushing China's foreign exchange reform ahead by another step, the central bank yesterday carried out its first currency swap deals with local banks in a move that could help bring more flexibility to the market.

The People's Bank of China confirmed that it was carrying out its first foreign exchange swap deal yesterday, but would not give more details. A Beijing-based trader for a major state-owned bank said that the central bank offered one-year currency swaps worth US$6 billion at 7.85 Chinese yuan per dollar.

In spot dealings, the yuan closed at 8.0805 to the dollar on Thursday.

Analysts said that it wasn't clear exactly what mechanism the central bank was using in its swaps transactions, but said it could be selling dollars and buying yuan on the spot market, and a year later could reverse the deal at the set rate.

That would have the effect of removing yuan from the money market. At the same time, the central bank could use the swap rate to signal its expectations about how fast it expects the yuan's value to rise, they said.

The swap deal didn't seem to have any immediate effect on the onshore yuan spot market.

Offshore, nondeliverable forwards -- a measure of expectations for the yuan's value that has no direct impact on current exchange rates -- moved toward the one-year swap rate set by the central bank, to 7.78 in the morning from 7.75 late Thursday.

Late Thursday, China's State Administration for Foreign Exchange announced it would also introduce a new currency trading system allowing interbank market members to trade directly with each other. It also invited qualified members to apply to become market makers for yuan spot trading.

A market maker agrees to act as either a buyer or seller in a financial transaction when no other party can be found.

Currently, the central bank is China's key market maker in US dollar trading due to tight restrictions on foreign exchange dealings, though regulators earlier announced they were considering letting other banks become market makers.

The yuan doesn't trade on world markets and Beijing sharply restricts buying and selling on the sole official Chinese exchange. Daily fluctuations in the yuan's value, which is linked to a basket of currencies of major trading partners including the US, are limited to 0.3 percent up or down from its opening level.

Since a 2.1 percent revaluation of the yuan on July 21 to 8.11 yuan per dollar, the Chinese currency has gained only 0.36 percent.
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