China Ends Swap Lines with South Korea: A Dog that Doesn’t Bark

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China has declined to renew the $56 currency swap line with South Korea.  The swap line has been in place for eight years. Initially, it was launched at $26 bln in 2009 and expanded in 2011.  It has been extended twice since then.  

 

The swap line from China was South Korea’s largest swap line, accounting for almost half of all of its official currency swaps.  Just two days ago, news wires were reporting that officials were optimistic that the swap line would be renewed.  

However, financial statecraft is an integral part of China’s foreign policy.  It often tries to use its financial and economic strength to reward its friends and punish its enemies.  It offered assistance to countries that dropped recognition of Taiwan.  It canceled the currency swap line with Japan in 2015 when Japan nationalized a couple of small islands for which it also has a claim.  

Refusing to renew the currency swap with South Korea appears to be largely a protest over the deployment of the missile defense system.  Ostensibly the defense system is meant to offer protection from North Korea, but Chinese officials are well aware that the missile defense can be used against it as well.  Also, there appears to be some suspicion that the advanced radar that is needed for the missile defense could also be used for spying purposes.  

China has put into place more than two dozen currency swap arrangements.  In part, China was motivated by the US swap lines during the Great Financial Crisis.  Some Chinese officials thought that the swap lines the US had arranged were part of the new global financial architecture.  Officials also saw the swap lines as a way to promote the yuan for international use.  

Chinese officials were mistaken.  The currency swap lines that the Fed offered were not part of a new architecture.  It was a response to the old architecture in which the dollar was a significant funding currency.   One important aspect of the policy response to the crisis that is under-appreciated is that there was no coordinated intervention in the foreign exchange market.  Policymakers seemed to realize the problem was not the price of the dollar (or exchange rates more broadly) but the access to dollar funding as the US commercial paper market collapsed, and interbank activity (counterparty trust) ebbed.  

The fact that China’s swap lines have barely been used reflects the fact that the yuan is not a funding currency now.  It may be in the future.  The yuan swap lines are largely about confidence and appearances, and not so much about substance.  

Do not shed tears for South Korea.  It does not need the swap lines.  It has accumulated nearly $385 bln in reserves.  Proportionately, it is roughly the same size as China’s, a bit more than 25% of GDP.  South Korea no longer has a swap line with the US either.  It does have a few bilateral swap lines that amount to about $22.5 bln.  There is also the Chiang Mia Initiative that followed the 1997-1998 Asian financial crisis that is a multilateral effort.  Under that agreement, South Korea can access another $38.5 bln.  

At the same time, China’s anger and frustration toward South Korea should not be underestimated.  China’s boycott of Korean goods due to the missile defense is palpable and more significant than the end of the swap lines.  The boycott, reportedly, has hit consumer goods producers, including autos, supermarkets, and tourism.  Auto sales by Hyundai and Kia in China, their biggest market, halved this year.  Some observers see this as partly a function of Chinese mercantilist practices.  The idea is that China wants foreign car producers to buy Chinese parts instead of importing them.  It may be difficult to separate the two strains, but this particular issue seems political. 

South Korea has responded by offering assistance to companies being hurt by China’s boycott.  The actions range from tax deferrals and cheap loans to new tourist initiatives.  Note that South Korea added new launchers to its missile defense system last month.  

South Korea’s Kospi is among the best performers this year, up more than 21%, barely trailing the MSCI Asia Pacific Index, which has gained a little more than 22% year-to-date.  Foreign investors have returned to South Korea stocks.  Korean markets were closed for an extended holiday, but foreign investors have bought $1.4 bln worth of Korean shares this month, which is more than three times more than foreigners purchased of Taiwan shares.  Year-to-date, foreign investors have bought $7.65 bln of Korean shares and $7.27 bln Taiwanese shares. The South Korean won has appreciated 6.4% against the dollar this year, which is about one percentage points more than the yuan and two percentage points more than the yen.  

The talks between China and South Korea continue.  However, it does not seem reasonable to expect the swap line to be renewed any time soon.  And the absence of the swap line has no real impact on South Korea.