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Tarisa Watanagase, the governor of the Bank of Thailand, said last week the central bank was conducting a study into the possibility of creating an international currency swap agreement with China. This would be aimed at diversifying the currency risk of exporters and importers as well as the Bank of Thailand's international reserves. Tarisa did not specify as to when the study was going to be completed. But she pointed out that if the international currency swap agreement with China were to be signed, Thailand would be able to use the yuan or the baht, instead of relying on the US dollar alone, to settle some of its trade with China.

Since December, China has signed currency swap agreements with seven of its trading partners including Argentina, Belarus, Brazil, Hong Kong, Indonesia, Malaysia and South Korea. The swap agreements would enable these countries to pay for Chinese exports in yuan rather than dollars. At the same time, Chinese firms would pay the goods exported from these trading partners with their respective currencies. The sizes of the bilateral swap agreements between China and its key trading partners are huge. Argentina entered into a bilateral 70 billion yuan (US$10.2 billion) currency-swap agreement that enabled Argentina to place orders for Chinese imports in yuan and not dollars. This followed a 100 billion yuan ($14.6 billion) currency-swap agreement with Indonesia and a 20 billion yuan ($2.9 billion) agreement with Belarus. Most recently, they closed an agreement with Brazil.

The trend is clear. China is taking its own step to challenge the predominance of the US dollar. As the US is dealing with its insolvent financial system and has been printing money to prop up its economy, confidence in the US dollar is waning. China, which now holds about $2 trillion in US dollar assets, has diversified away from the US dollar assets. A weakening dollar would hurt Chinese wealth, built up over 30 years of economic liberalisation and growth. Hence, the bilateral currency-swap agreements are seen as an option right now to reduce the currency risks.

Although Thailand has established a sound relationship with China, it is inconvenient that it has moved slowly in financial cooperation, compared with other neighbouring countries, which have already entered into currency-swap agreements with China. Tarisa said the central bank was studying the size of the Kingdom's trading volume with China, as well as the size of credit lines, in order to come up with an appropriate currency-swap agreement. The study would be finalised after discussions with the private sector about the need for such an arrangement, and the swap agreement would have to be approved by Parliament in accordance with the Constitution.

Thai exporters and importers still quote their goods in the US dollar. It will take a while before they see the advantages of diversifying their currency risks. Tarisa also agreed that currency diversification would be beneficial to the Kingdom, while there appear to be no disadvantages in having such payment flexibility with China.

In spite of the growing trading volume in the yuan, the Chinese currency is not likely to replace the US dollar in the near term. But China is preparing steps to emerge as a global economic power. To assume this role, its currency would also have to be widely used and broadly accepted. Still, the yuan is not yet fully convertible. This means that China's currency can't be exchanged on foreign exchange markets for other currencies because the Chinese government has deemed it nonconvertible. Unlike the dollar, yen, or euro, this limits the yuan's use in international trade transactions. So China has opted, in the near-term, to enter into these bilateral currency-swap agreements. China prefers to do things step by step. All this activity, however, has been seen as China's eventual move to make its currency fully convertible and to challenge the US dollar as the world's reserve currency.

A currency swap between countries is basically a foreign exchange agreement where one currency is traded for another for a negotiated period of time. In essence, the swap is like a loan where one country gives its currency to another in return for an equal amount of the other country's currency at a later date.

As China has diversified its foreign reserves risks, it is not clear how the Bank of Thailand has adjusted its reserves management.

A bilateral currency-swap agreement with China is one good step to take. The Thai central bank now holds more than $120 billion in foreign exchange reserves, mostly in US dollar assets. China has moved frantically to convert its holdings of US dollar assets from long-term US treasuries to more short-term US treasuries. Moreover, one report indicated that it has used the US treasury holdings as collateral for loans to acquire hard assets such as oil, copper, soybean, gold or others which are strategic to China's long-term growth. Perhaps, the Thai central bank should start to look in this direction, as shown by the Chinese, to manage its foreign exchange reserves.