Nigeria-China currency agreement: what’s the fuss all about?
In a bid to ease the pressure on the foreign exchange liquidity, the Nigerian government – Central Bank of Nigeria – entered a deal with the Industrial and Commercial Bank of China Ltd. on Yuan transactions.
According to the Director-General of the African Affairs Department of China’s Foreign Ministry, Lin Songtian, the deal meant that the Yuan will flow freely around Nigerian banks and will even be included in the country’s foreign exchange reserves. This deal is one of the outcomes of the meetings between Presidents Muhammadu Buhari and Xi Jinping of China, during the Nigeria-China Business/Investment Forum in Beijing, China.
In layman terms, trade can be transacted directly in Yuan, between both countries; no need to bring in the dollar. About 70% of import transactions is with China, so why not trade in Yuan, right? It actually isn’t that straight forward. The deal doesn’t end there. There will also be an increase in the percentage of Nigeria’s foreign reserves held in Yuan, in order to diversify the reserves.
This swap arrangement isn’t unique to Nigeria. In 2015, The South African Reserve Bank (SARB) signed a three-year bilateral swap agreement with the People’s Bank of China (PBoC) for the exchange of local currencies between the two central banks of up to 30bn yuan (R57bn). And some other countries have entered into similar agreements. Generally, the purpose of such an agreement is to support trade and investment between the involved countries, and also to act as a mitigating resource for short term balance of payment pressures.
There is limited information surrounding this transaction. We don’t know if there’s a duration in the swap agreement, how much is involved, and if the currency will be traded in similar manner.
How will this solve the current foreign exchange arbitrage/crisis?
Nigeria is currently operating a dual foreign exchange system. The interbank market, which is the official market, is managing the naira exchange rate within N197 to a dollar within a band of plus or minus three per cent. The parallel market – the black market – which accounts for about 10% of transactions, trades the Naira at ~N300 to the dollar.
The new dynamic with this swap is that an importer can now buy the yuan directly, instead of the former system where he had to buy dollars first to trade with their Chinese counterparts with. This swap will not miraculously increase the availability of foreign exchange nor will it bring the desired stability to the market. Other steps need to be taken in addition to address the wide margin between both exchange rate markets.
There have been lots of arguments in the market about the current demand for dollars not being real, i.e., a lot of demand is as a result of speculation and to benefit from the wide margin between the official and the parallel markets. Of the monthly demand of $4 -$5 billion, the official market meets only between 10% and 25%. Will the swaps fix that or relieve the pressure? Will the need for some foreign reserves to be held in yuan and not dollars douse the speculation? I don’t think so. The opportunity to game the system still exists and that needs to be addressed.
Ease of transaction
This seems to be a step in the right direction if the details of the deal are favourable although there has to be clarity on the duration and amount. It will continue to build favourable trading relationships between both countries. But the terms have to be done right to ensure it is a win-win for both parties.
Exchange rate policy in Nigeria
The main objectives of exchange rate policy in Nigeria are to preserve the value of the domestic currency, maintain a favourable external reserves position and ensure external balance without compromising the need for internal balance and the overall goal of macroeconomic stability.
According to a poll by Reuters, a dollar shortage, which has dampened businesses that need the dollars for imports, would prompt a devaluation by September. Now that there is a new dynamics to things, will the need to devalue dissipate?