Why the China-Korea Currency Swap Doesn’t Mean the THAAD Dispute Is Over

The currency swap agreement between China and South Korea, equivalent to $56 billion, was renewed in mid-October after initial reports that it had been allowed to expire on October 10. Although some are hopeful this signals a shift away from China’s ongoing retaliation against South Korea over the deployment of the Terminal High Altitude Area Defense (THAAD) missile defense system, it is arguably consistent with the way Beijing has been pressuring Seoul.

After both countries agreed to extend the currency swap deal in April 2016, Seoul first publicly expressed concerns about the fate of negotiations earlier this year in January. For the rest of the year, in the absence of comments from the People’s Bank of China – responsible for administering the swap with the Bank of Korea – media outlets speculated the agreement’s renewal was being leveraged to get Seoul to dismantle THAAD. This continued to be touted as the reason for the swap’s apparent expiration between when it was actually extended on October 11 and when the news of its renewal was announced on October 13.

That the swap was extended suggests one of two things: either Beijing may be ready to ease pressure against Seoul or the narrative of China’s retaliation against South Korea should be refined. Seeing this deal as proof of a true shift away from China exerting economic pressure on South Korea seems too optimistic. Will the “fire safety issues” which plagued Lotte’s stores in China now be addressed? Will we see a spike in Chinese tourists visiting Korea again, after their numbers fell by nearly half since last year? Will Beijing lift its ban on Korean cultural content? Or will Hyundai and Kia sales jump up after their combined sales fell by 45 percent since January? These scenarios seem highly unlikely, at least for the time being. Adjusting our characterization of China’s pressure on South Korea makes more sense, particularly in the context of increasing bilateral trade.

Despite the row over THAAD, South Korean exports to China have increased by at least 11 percent each month, year over year, in 2017. As of August, South Korean exports to China this year are above $88 billion, about $10 billion more than the same period in 2016. If this trend continues, total exports would be over $138 billion by the end of the year, the highest level since 2014.

How can this be reconciled with the woes of South Korean companies brought on by Beijing? Among the top five categories of South Korean exports to China in 2016, which includes electronics, instruments, chemicals, and plastics, trade has continued to grow this year. Much of these exports are for processing trade, accounting for three quarters of all of South Korea’s exports to China. Beijing has a limited ability to use these areas as leverage for political gains. Unsurprisingly, the South Korean industries hit hardest over THAAD are noticeably absent from this grouping. Further, the sectors Beijing has targeted seem to have a limited impact on their own economy, with costs spread out by consumers. Chinese consumers can visit other countries, buy other cars, shop at other stores, and watch other movies, though this narrows choices and raises prices over time. Essentially, China has been tightening the screws on sectors that will impact South Korea, but not hurt its own bottom line.

Allowing the currency swap with South Korea to lapse would have been just as detrimental for Beijing as it would have been for Seoul, if not more so. Media coverage of the swap’s potential expiration mainly focused on South Korea’s access to emergency liquidity, but this glosses over an important aspect of the agreement. Currency swaps are contracts between countries allowing each to draw foreign currency to help get out of or prevent a financial crisis. They can be denominated in either an international reserve currency, such as the U.S. dollar, or the local currencies of participating countries. Swaps in a reserve currency offer access to a more stable currency in a crisis, while swaps in local money encourage trade in those currencies as they help to ensure continued access to a partner’s money. If strengthening each country’s buffer against external shocks was the core issue of the China-South Korea swap, as coverage suggests, then it would have been in dollars. Yet, the arrangement is in renminbi (RMB) and won, contributing to Beijing’s broader priority of promoting the RMB.

Since 2008, China has undertaken over 30 bilateral currency swap agreements to internationalize the RMB, amounting to the equivalent of more than $460 billion. Among these agreements, the size of the currency swap with South Korea is second only to Hong Kong. This reflects China’s large trading relationship with South Korea – its fourth largest export destination – and consequently South Korea’s importance in advancing RMB usage abroad. Seoul also sees the benefits of denominating some of its swaps in local currencies to reduce dependence on the dollar, as illustrated by the renewal of its agreements with Australia, Malaysia, and Indonesia this year.

There are certainly other benefits from renewing the deal with South Korea, such as preventing contagion during a crisis, yet the rise of the RMB is a major priority for China, evidenced by its recent attempt to shake up oil markets. No matter how you slice it, you arrive at the same conclusion: to let the swap expire would have immediate, negative repercussions for Beijing. Thus, the renewal of the agreement by itself is not enough to signal China’s readiness to let up over THAAD. Rather, based on how South Korea has been targeted this year, it suggests more of the same.

A true change in Chinese policy would need to be signaled by improvements in affected South Korean sectors, such as tourism and autos. Anything less falls short of taking relations back to normal.