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
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
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)
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
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
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
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.