Naira Volatility: Currency Swap Deal to the Rescue?

With the perennial volatility of the naira, Obinna Chima wonders if the option of a currency-swap with China, will help provide stability to the naira

Since the financial crisis of 2007, central banks around the world have entered into a multitude of bilateral currency swap agreements with one another.
These agreements allow a central bank in one country to exchange currency, usually its domestic currency, for a certain amount of foreign currency. The recipient central bank can then lend this foreign currency on to its domestic banks, on its own terms and at its own risk.

According to the Council on Foreign Relations (CRF), an independent, non-partisan think tank, over the past seven years, the swaps have been used by central banks to obtain foreign currency to boost reserves and to lend on to domestic banks and corporations.

While the terms of swap agreements are designed to protect both the central banks involved in the swap from losses owing to fluctuations in currency values, there are some risks that a central bank will refuse, or be unable, to honour the terms of the agreement, the CRF noted in a report.

For this reason, lending through currency swaps is a meaningful sign of trust between governments. It can also be a sensitive domestic political issue.
This, clearly, could be one of the reasons why the Nigerian government does not want to hurriedly divulge full details of its trip to China, especially in the area of a currency swap deal that had been widely reported.

President Muhammadu Buhari recently travelled with a high-level government delegation to China where he signed a $6 billion deal to fund joint infrastructure projects.

During Buhari’s visit to Beijing, the Industrial and Commercial Bank of China Ltd (ICBC), the world’s biggest lender, and Nigeria’s central bank signed a deal on yuan transactions.
“It means that the renminbi (yuan) is free to flow among different banks in Nigeria, and the renminbi has been included in the foreign exchange reserves of Nigeria,” Lin Songtian, Director General of the African Affairs Department of China’s foreign ministry, told reporters.

The agreement was reached following a meeting between Buhari and Chinese President Xi Jinping.

The move came after the Minister of Finance, Mrs. Kemi Adeosun, said recently that Nigeria was looking at Chinese panda bonds – yuan-denominated bonds sold by overseas entities on the mainland – adding that they would be cheaper than Eurobonds.

Nigeria’s central bank has said it plans to diversify its foreign exchange reserves away from the dollar by switching a stockpile into yuan. It converted up to a tenth of its reserves into yuan five years ago.

Lin said a framework on currency swaps had been agreed with Nigeria, making it easier to settle trade deals in yuan.

But while the market was still digesting the implication of the agreement with China, the Minister of Foreign Affairs, Geoffrey Onyeama, disclosed that, contrary to reports, there was no currency swap agreement between Nigeria and China.

“It’s not really a swap. What it takes is that as the Chinese economy goes strong, there is pressure on them from the trading partners, international financial institutions. They agreed that the money should be internationalised. So, they started that for a while. They were protecting it also.

“They did not allow it to be fully exchangeable. But now their economy is fully strong, they are looking for a way to internationalise the currency. Now, they were saying, essentially, that they wanted to segment it,” he explained.
For a number of years now, the Chinese government has been entering into these swap agreements with various countries. The swaps typically last for three years after which they are renewed or increased. South Africa is the only African country that has signed a currency swap deal with China.

What is a Currency Swap?
The current deal is essentially a countertrade agreement (trade by barter) as it involves the exchange of crude oil for goods from China.
However, a report by Lagos-based Financial Derivatives Company Limited said a swap is traditionally defined as an exchange of one security for another to change the maturities of a bond portfolio or the quality of the issues in a stock or bond portfolio.

On the other hand, a forex swap agreement is a contract in which one party borrows one currency from, and simultaneously lends another to, the second party. Each party uses the repayment obligation to its counterparty as collateral and the amount of repayment is fixed at the forex forward rate as of the start of the contract. Thus, forex swaps can be viewed as forex risk-free collateralised borrowing/lending.

“This is not the first time Nigeria has attempted a countertrade agreement. In 1985, Nigeria signed three separate deals with Brazil, Austria and Italy. In addition, Nigeria had earlier tried to diversify its external reserves away from the US dollar monopoly.
“In 2011, erstwhile CBN Governor Mallam Sanusi Lamido Sanusi, converted 10 per cent of the country’s external reserves into the Chinese Yuan. At the time, Nigeria’s $32 billion reserves level was 79 per cent in dollars with the rest largely held in Euros and Swiss francs,” the FDC report pointed out.

Why Nigeria Can’t Ignore China
China as at 2014 toppled America to become the biggest economy in the world, according to figures from the International Monetary Fund (IMF). The IMF figures put the size of the Chinese economy at $17.61 trillion as at 2014 and is expected to extend its lead, with the IMF estimating its economy will be worth just under $26.98 trillion in 2019. That would be 20 per cent bigger than the United States economy, which is forecast to be worth $22.3 trillion by then.

That is why serious countries across the globe are not ignoring China.
China is the leading trading partner of Nigeria. Nigeria imports several products from China, including, but not limited to raw materials, industrial machinery and motor vehicle spare parts. On the other hand, Nigerian exports are mainly crude oil. Bilateral trade between Nigeria and China has grown rapidly in the last decade.

For Nigeria, in terms of the volume of trade between the West African nation and China, investigations by THISDAY showed that Nigeria’s trade with the Asian giant has grown in leaps and bounds compared with nine other major trading partners.

For instance, in 2014, while Nigeria’s estimated trade volume with China alone was $11.76 billion, the country’s (Nigeria) trade volume with United States, Britain, France, Germany, Turkey, India, Japan, Italy and South Africa combined was $66.8 billion (see table for breakdown on page 1).

This showed that relative to the nine countries, Nigeria’s trade volume alone with China accounted for 15 per cent of the total trade with Nigeria’s major trading partners.
In 2015, Nigeria’s trade volume with China rose to $14.94 billion, representing 22.2 per cent of $78.56 billion of Nigeria’s total trade with eight of its major trading partners. Data on trade with South Africa in 2015 was not available.

But from the latest available figures, the trade imbalance between Nigeria and China is significant, as Nigeria is a major export market for China, absorbing $16.9 billion worth of Chinese goods in 2014. China does also buy some Nigerian crude, but it’s a lot less – $2.4 billion in 2014 (and probably half that today).
China has a trade volume of RMB10.747 trillion with the 31 countries with which it has currency swaps.

Support for the Naira
While Nigerians still await the full details of the arrangement with the Chinese government, the Central Bank of Nigeria (CBN) Governor, Mr. Godwin Ifeanyi Emefiele, has expressed optimism that a currency swap deal with China will strengthen the naira and help reduce the strong demand for the US dollar in the country.

Emefiele said Nigeria was not the only country that had agreed to a currency swap with China, as several other countries – developed and emerging markets – with growing trade volumes with China had entered into similar currency swaps with the Asian country.

He said as the second largest economy in the world, more and more countries are turning to China for business, as the country seeks to make its currency a convertible global currency like the US dollar, the euro, the Japanese yen and British pound sterling.

To buttress Emefiele’s point, information provided by the Peoples Bank of China (PBOC; China’s central bank) showed that China had bilateral currency swap agreements with 31 central banks for varying sums as at the end of 2015.

The countries are the United Kingdom, Belarus, Malaysia, South Africa, Australia, Armenia, Surinam, Hong Kong, Pakistan, Thailand, Kazakhstan, South Korea, Canada, Qatar, Russia, the European Union, Sri Lanka, Mongolia, New Zealand, Argentina, Switzerland, Iceland, Albania, Hungary, Brazil, Singapore, Turkey, Ukraine, Indonesia, Uzbekistan, and the United Arab Emirates, totalling RMB3.137 trillion.

Emefiele said: “The agreement on the currency swap with China will definitely benefit Nigeria because the essence of the mandate is to ensure that Nigeria is designated as the trading hub with China in the West African sub-region for people who want the renminbi as a currency denomination.

“Also for us, we believe that using the renminbi will improve trade with China, as this will encourage importers to open L/Cs in the Chinese currency for the importation of raw materials, equipment and machinery from China, rather than other trading regions, so the agreement will encourage trade between both countries.”

But when reminded that trade between Nigeria and China was skewed heavily in the favour of China, he said: “On the reverse, we are working to encourage the export of raw materials to China in order to reduce the trade imbalance.

“And we aim to become competitive by improving on infrastructure especially in the area of electricity and ensuring that credit is made available to manufacturers at concessionary rates.”

Emefiele, however, declined to reveal how much Nigeria had proposed under the currency swap with China, saying that talks were still ongoing with the PBOC and would be concluded in the next few weeks.

But a source in the presidency conversant with the talks revealed that the CBN had proposed a swap of RMB50 billion, about N1.98 trillion ($10 billion).
“The Peoples Bank of China, however, is unlikely to agree to what was proposed, so we are looking at a swap somewhere in the region of RMB20 billon, which is about N792 billion to N990 billion ($4 billion to $5 billion),” the source revealed.

Implication for Nigeria
A Lagos-based CSL Stockbrokers Limited, in a report noted that the China swap deal would help to streamline Nigerian trade with the Asian country.

They also stated that it would ease demand for the dollar and was expected to provide some relief to the parallel market naira/dollar exchange rates.

But the report pointed out that the deal does not alter the fundamental fact that Nigeria is running a current account deficit and will therefore still need investment inflows to stabilise the external accounts and stimulate the economy.

“Looking first at the currency swap, this essentially entails an exchange of currency between ICBC (who receive naira) and the CBN (who receive yuan) at a pre-agreed exchange rate. The two entities will have agreed an interest rate on the swap as well until maturity when the currencies will be re-exchanged.

“Prior to maturity, the CBN can supply Yuan to Nigerians importing goods from China while the ICBC can supply naira to Chinese importers of Nigerian goods. From Nigeria’s perspective, this helps importers overcome the challenge of accessing forex, something that has impinged the ability of many Nigerian firms to operate.

“Importantly, Nigerian importers of Chinese goods (which form the largest share of Nigeria’s import basket) will now not have to buy US dollars to purchase goods from China as they will have some direct access to the Yuan.

“More broadly, the swap deal does not alter the fact that Nigeria is consuming more than it is producing and that more forex (yuan, dollars or any other foreign currency) is flowing out the current account than in.

“This is reflected by a current account deficit. The swap therefore also does not change the fact that Nigeria will continue to rely on financial and capital account inflows to cover the shortfall in the current account. Until these flows are forthcoming, Nigeria’s external accounts and economy will remain under pressure,” the report added.
But the chief executive of Financial Derivatives Company (FDC) Limited, Mr. Bismarck Rewane, cautioned that what the deal has done is “to concentrate your trade in the hands of one country”.

“With the deal, Nigeria will be using the yuan to import from China, while they (China) will use the naira to buy crude oil from Nigeria. And then they (China) will take the oil to sell in the market to get dollars.

“So Nigeria’s dollar income will reduce and its imports from the rest of the world would also reduce. So Nigeria will be more dependent on China. That is all,” Rewane said.
Rewane also disagreed with the CBN governor on the impact of the swap on the naira, stressing that the effect would be neutral.

“It doesn’t change anything. The man who is going to import from the US, or the man who is going to import a car from Germany, will he need yuan to buy it. We are only playing with mirrors. It does not increase the actual flow of dollars to Nigeria. It only means that our trade is more concentrated in Chinese goods and the Chinese with the naira they get from Nigeria when they buy oil,” the FDC boss added.

But another economic analyst who did not want to be named, welcomed the currency swap, noting that in seeking foreign aid for the country, Nigeria’s policy makers over the years had allowed themselves “to be led into a blind alley by Nigeria’s Western masters and mentors”.
He was of the opinion that by widening the scope of the country’s international friendship and in particular by the establishment of diplomatic, cultural, trade and other mutually beneficial relations with China, Nigeria had taken the right step.

“The foreign policy of Nigeria should be independent and should be guided by the following principles: the promotion of economic relations with all nations of the world; co-operation with all nations of the world in so far as they respect the ideals for which we stand; respect for the sovereignty of nations and non-interference in their domestic affairs; and attraction of foreign assistance (capital, technical skills and training opportunities for Nigerians) on the most advantageous terms,” he said.