NIGERIA-CHINA CURRENCY DEAL, A BLESSING OR CURSE?

By

Salis, Kolawole Yusuf (E-SKY)

During his recent visit to China, President Muhammadu Buhari of Nigeria signed a landmark currency deal with the Industrial and Commercial Bank of China Ltd. The agreement will allow Nigerian traders and businesses, which imports mainly from China conclude their transactions in Chinese currency, the Renminbi (Yuan), instead of the dollar. The new agreement would see Nigeria-China trades, which accounts for over 70 percent of imports into Nigeria, concluded in the Yuan. Until now, over 90 percent of international trades between Nigeria and the world are done in dollars, and in the process putting so much pressure on the naira. Nigeria imports almost all it needs from the West, Asia and Middle East.

The concept of currency swap denotes an agreement between two institutions or countries to carry out exchange in one currency for equivalent amounts in net present value terms in another currency. Simply, it is often an arrangement between two friendly countries to trade in their own local currencies, paying for import and export trade at pre-determined rates of exchange without the use of a third currency like the United States dollar.

At the start of a currency swap, central bank 1 sells a specified amount of currency A to central bank 2 in exchange for currency B at the prevailing market exchange rate. Central bank 1 agrees to buy back its currency at the same exchange rate on a specified future date. Central bank 1 then uses the currency B it has obtained through the swap to lend on to local banks or corporations. On the specified future date that the swap unwinds and the funds are returned, central bank 1, which requested activation of the swap, pays interest to central bank 2.

Since the financial crisis of 2008, the currency swaps have been adopted by central banks to obtain foreign currency to boost reserves and lend on to domestic banks and corporations. While the terms of swap agreements are designed to protect both central banks involved in the swap from losses owing to fluctuations in currency values, there is possible risk that a central bank will refuse, or be unable to honour the terms of the agreement. For this reason, lending through currency swaps is a meaningful sign of trust between governments. It can also be a sensitive domestic political issue, however; legislators in the United States, and even public commentators in China, have expressed concerns about the level of risk their respective central banks are taking in extending swap lines to certain nations.

China, for instance, has signed swap deals with about 30 countries since 2008 with the biggest being the 400 billion Yuan currency swap with Hong Kong in November 2014. According to a publication by the People’s Bank of China, these swap agreements were intended not only to “stabilise the international financial market,” but also to “facilitate bilateral trade and investment.” Noticeably, the swap agreements are denominated in renminbi (also known as the Yuan) and the local currencies of the counterparty countries without involving the US dollar. The swaps typically last for three years after which they are renewable.

On December 12, 2007, the Federal Reserve extended swap lines to the European Central Bank (ECB) and Swiss National Bank (SNB). European bank demand for dollars had been pushing up, and creating accentuated volatility in, U.S. dollar interest rates. The swap lines were intended “to address elevated pressures in short-term funding markets,” and to do so without the Federal Reserve having to fund foreign banks directly.

The ECB established swap lines with Sweden in December 2007, the SNB and Denmark in October 2008, and the Bank of England in December 2010. The Euro area, Sweden, Denmark, and the UK had relatively low foreign exchange reserves going into the crisis, owing to the costs involved in holding reserves and the belief that there was little likelihood that more would be needed in the foreseeable future. However, banks in these countries borrowed large sums in foreign currencies in the years leading up to the crisis. When it became difficult for them to borrow funds in 2008, they turned to their central banks, reserves of which proved insufficient to meet the unanticipated demand. The ECB swap lines were therefore called into use in 2009 to provide Sweden and Denmark euros with which to top up their foreign exchange reserves, and the swap line with the SNB was called upon to provide the ECB with Swiss francs.

Since 2007, developed-economy central banks have also provided swap lines to a limited number of emerging economies. Because of the risks associated with swap lines, the Federal Reserve has been much more cautious in extending them to emerging economies than it has been with other developed economies. The Federal Reserve insisted on provisions allowing it to seize their assets at the New York Federal Reserve in the case of failure to repay. In October 2008, the Federal Reserve extended swap lines to Brazil, Mexico, South Korea, and Singapore. In 2011, the Bank of Canada, Bank of England, European Central Bank, Bank of Japan, Federal Reserve, and Swiss National Bank announced that they had established a network of swap lines that would allow any of the central banks to provide liquidity to their respective domestic banks in any of the other central banks’ currencies. In October 2013, they agreed to leave the swap lines in place as a backstop indefinitely.

The reported Nigeria-China currency swap deal establishes an arrangement between the Industrial and Commercial Bank of China Limited and the Central Bank of Nigeria, on the back of President Muhammadu Buhari’s recent visit to China. In anticipation of the critical aspects of the swap line such as size, duration, effective date and cost, a cursory analysis is relevant.

With Chinese exports accounting for about 80 per cent of the total bilateral trade volumes, it has been argued in some quarters that Nigeria does not stand to reap any commensurate benefit from the deal given the large trade imbalance in favour of China. The “flooding” of Nigerian markets with cheap Chinese goods have adversely affected domestic industries, especially in textiles.

The argument further goes; the currency deal would only reinforce Nigeria’s position as a dumping ground for goods from China and rubbish the import-substitution efforts of the Federal Government. The antagonists of the deal also opined that it is rather hasty to accumulate a substantial proportion of the country’s foreign reserves in Chinese currency in view of the volatility associated with the Yuan (RMB) and the fact that it is not yet an international reserve currency.

It is pertinent to make it clear to the business community in China not to see Nigeria as a consumer market alone, but as an investment destination where goods can be manufactured and consumed locally. Worthy of note also is the fact that the Yuan is on its way to becoming an international reserve currency with effect from September 2016. This would pave the way for broader use of the renminbi in trade and finance, securing China’s standing as a global economic power.  The Chinese currency is already one of the top 10 most traded international currencies according to a recent report by the Bank for International Settlements.

It is safe to conclude that the swap arrangement is being established in the context of the rapidly growing bilateral trade between Nigeria and China. According to a recent CBN report, “business and trade relations between Nigeria and China have grown astronomically in the last decade with bilateral trade volumes rising from $2.8bn in 2005 to $14.9bn in 2015. Nigeria accounted for 8.3 per cent of the total trade volume between China and Africa and 42 per cent of the total trade volume between China and the Economic Community of West African States countries in 2015.

For the average Nigerian, rather than converting Naira to dollar before proceeding to change to yuan as is the current case, one can just have Naira converted to yuan directly. Considering the volume and value of trade between Nigeria and China it is expected to reduce the demand for the dollar and in the long run strengthen the Naira. Nigeria converted about one tenth of its reserves into yuan a few years ago and plans to increase the stock of yuan this year from panda bonds proceeds.

The Minister of Finance, Kemi Adeosun, had disclosed the plan by Nigeria to issue panda bonds (denominated in yuan) as part of strategies to finance the 2016 budget deficit. Other factors held constant, the currency swap deal is also expected to strengthen the naira since Nigerian traders, who import mainly from China, can now conclude their transactions in the yuan instead of the dollar. And from China’s point of view, the currency swap will increase the demand for the yuan as it marches towards establishing its currency as a reserve currency in the future.

Conclusively, without doubt, a currency swap deal with China, as the experiences of other countries have proved, is susceptibly a win-win deal. It is not for nothing that many developed and developing countries are queuing up to sign currency swap agreements with China, the second biggest economy in the world. The fact that countries that utilised the three-year swap line offered by China opted for renewal is a genuine factor to be evaluated. Nigeria either absorbs as palliative remedy to her ailing economy trending amongst growing club of countries seeking to “de-dollarise” and diversify risk in foreign exchange management, or tends other way round.

Author: Salis, kolawole E-SKY

(+234) 8032467356

>E-SKY is An Economist and Research Analyst in corporate practice

Dated: Friday 18th March, 2016.