from Follow the Money

The Bank of Korea follows the PBoC’s lead ..

January 4, 2007

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It looks like the Koreans are going to let their local banks swap their won for the central banks’ dollars.   That means the banks get to play with the dollars – and presumably make a bit more adventurous investments than the central bank.    

Lending out some of the central banks reserves is one way to cope with the recent surge in capital inflows: the flood of capital inflows can finance a surge in Korean FDI rather than a surge in Korean reserves.  Or a surge in Korean purchase of those kinds of US debt that yields a bit more than US Treasuries and Agencies.  The Korean Times:

In a departure from its conservative stance on the use of currency reserves for investment purposes, the Bank of Korea (BOK) yesterday said it will increase its lending of foreign currencies to local banks to promote their overseas securities investments.

Beginning this month, banks will be allowed to use the loans from the BOK to buy foreign stocks and bonds. Banks can exchange up to $5 billion worth of Korean currency into dollars at the central bank through currency swap deals, and invest the money in overseas securities markets.

In addition, the central bank has permitted banks to lend dollars to companies as part of efforts to boost overseas investments.

Currency swaps do one other thing: they also remove some won from circulation (sterilization).   Rather than having won to lend out, the banks have dollars.  

The Koreans did $500m in swaps last year; $5b is a big increase.   And since the Bank of Korea promises to buy the dollars back at a fixed exchange rate in the swap contract, the banks don’t have to worry about the exchange rate risk either.

We know that China did this in 2005 (see the IMF Article IV) in a small way.  It may have done even more of these kinds of swaps in 2006 – swapping the PBoC’s dollars for the banks RMB would give the banks more dollars to play with, and help explain the surge in private Chinese debt purchases in 2006 (see the World Bank Quarterly; “private” Chinese purchases of bonds and notes totaled $45b in the first half of the year) .  

One result of all this: the line between central bank purchases of US debt and private purchases of US debt is blurring.   Korean banks will soon be buying US debt with dollars borrowed (via the swap contract) from Korea’s central bank.  I suspect Chinese banks have been doing the same thing for some time now.

 

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