Financial Development and Central Bank Bilateral Currency Swaps: Is there Trade Effect?

ABSTRACT The proper assessment and understanding of the financial system are at the core of a robust analysis of macroeconomic fundamentals (Svirydzenka, 2016). Bilateral currency swap enables countries to boost their liquidity access in the financial system for trade and financial transaction. Significantly, we examine the financial development of both China and its currency swap partners. We test our empirical model using data on financial development for a sample of 27 countries. We provide empirical evidence that currency swap is important for trade especially for countries with relatively low level of financial development. It is well documented that the differences in development amongst countries are substantial, and such differences are important in the determination of trade pattern. The level of financial development was proxied by the interaction term of disaggregated measure of financial development such access, depth, and efficiency each interacted with swaps. We provide empirical evidence that differential level of financial development can be a key determinant of whether a country can use currency swap lines for international trade. In rich countries, strong financial system promote trade, the opposite is the case in poorer ones. Perhaps, empirical tests on the influence of financial system and on trade remain on the research agenda especially looking at industry-level import and export data.