Korea is seeking to form a permanent currency swap agreement with China, which holds the largest foreign reserves in the world, to stave off any future liquidity crisis. A currency swap allows one country to deposit its own currency in the reserves of another in return for currency from the other in case of a liquidity shortage.
In December 2008, just before the global financial crisis, the Korean government forged a US$26 billion currency swap agreement with China, but it expires in April 2012. "A permanent currency swap agreement with China can greatly reduce the risk of a foreign currency crisis," a government official said Monday. "As the first step to a permanent agreement, we proposed to the Chinese government providing the currency swap funds by both countries to businesses on each side to help them settle trade payments."
Under the proposal by the Bank of Korea, the People's Bank of China would give yuan to Korean commercial banks, which in turn would loan them to Korean exporters to settle payments with Chinese companies. Beijing is hoping to strengthen the yuan as an international currency, and Seoul believes Beijing may be receptive to the proposal.
Once the arrangement goes beyond supporting trade settlements, the countries would set up a permanent currency swap facility. Seoul also mulled a permanent currency swap agreement with the U.S. or Japan but chose China instead because the chances of success are greater.
The agreement "could be modeled on the US$2 billion permanent swap agreement with Canada and $6 billion agreement with Mexico, both NAFTA members," said a government official. "A permanent swap agreement between Korea and China will help boost the global status of the yuan."