Macroblog has also kindly provided some link to the definition of swap. So let's try to understand whether it is fair deal to the banks, or if not who is going to be benefited if RMB appreciates (or depreciates).
A swap is basically an exchange of interests earned by the two parties involved.
- Say, A has USD1, in 12 months, he will earn interest based on US interest rate, i.e. 4.74%. (see here, but number might change slightly every day)
- But if he changes this into RMB and puts it into the bank, he could only earn the RMB interest rate, at 1.8%. (note: PBC's website shows 金融机构存款利率 is 2.25% set on Oct/2004, which is what i used initially, so there is a smaller basis point adjustment. According Jorge (see update below), after 20% tax the effective return is 1.8%.)
- The difference in interest rate is 2.84%, which is quite significant (this is one of the reason that speculators believe the exchange rate could change)
- The state banks have RMB8.0805, they have two options to invest
- (A) earn 1.8% interest, have 8.0805 x 1.018 in 12 months;
- (B) exchange to USD with PBoC, earn 4.74% interest in 12 months, then exchange USD1.0474 back to RMB, if at the same rate of 8.0805, it will make 1.0474x8.0805 in 12 months
- (B) is obviously a better option for the state banks, but a bad deal for PBoC
In short, this is just a simple mathematical exercise. If the swap contract is for 24 months, the strike price wil be 8.0805x(1.0216/1.0486)^2=7.67. (2-year rate for USD is 4.86%; 2-yr rate for RMB is 2.70% in PBC's site with 20% tax applicable)
This tells us NOTHING about the expectation of RMB excahnge rate. Because the return for PBoC and the statebanks are not affected by any change in the currency market.
P.S. In reality PBoC should take into account the volatility (though there is no historical data) and charge a premium if it expects USD to appreciate, and a discount if otherwise. PBoC probably wants to use some RMB to cope with the capital inflow (FDI + speculator) and expect the flow may reverse in future, so it is willing to do the swap. This provides an additional avenue to sterilize the USD (vs issuing RMB bonds).
Update (Nov 29 evening): Standard Chartered Bank's Wang Zhihao apparently did the same calculation in a report titled "RMB Silent and important move 人民币：沉默而重大的举措" It was also reported that NDF contract converged from 7.74 up to 7.77 immediately after the news was heard. Wang commented that traders correctly interpreted the signal that the x-rate will be more stable.
Update (Nov 30) to explain the 1.8% RMB interbank yield: Jorge explained the tax (at 20% of the interbank rate 2.25%) in a comment; Dan Slater of loomberg said "China's banks are being squeezed by deposit rates of around 2.25%, compared to money market rates, which are just over 1.5%."