This article is part of our #FirstWord series to provide context on trending news.
The Central Bank of Nigeria (CBN) entered a three-year currency swap agreement worth $2.4 billion with the Peoples Bank of China (PBOC). The swap, worth $2.4 billion, is to boost commercial ties and reduce the need to use the dollar in bilateral trade between both countries. The deal was signed on Friday, April 27, 2018, in China.
What does this mean?
In a currency swap, one party borrows a specific amount of foreign currency from another at agreed interest and exchange rates. At the same time, it lends the same amount of money to the other party in its own currency. In this case, the CBN swapped ₦720 billion for 15 billion yuan, with each amount deposited in the corresponding central bank.
During the contract period, Nigeria would have to pay yuan interest on the borrowed amount (and vice versa), though the government has provided no information on how much this interest would be and whether it is a fixed or floating interest rate.
There are two ways a currency swap can be settled. Either Nigeria would have to repay the borrowed amount at a pre-agreed exchange rate (at the inception of the contract) or at the prevailing exchange rate at the time. The former helps Nigeria lock-in an exchange rate and removes any exchange rate risk, but the latter would allow Nigeria to benefit if the naira strengthens in the next three years. It is unclear which approach Nigeria has taken.
Why was the agreement made?
The CBN started making moves for the swap two years ago. After the 2014 crash in oil prices decimated Nigeria's dollar earnings, it began searching for other ways to boost its foreign currency reserves. Hence, the swap.
Now the CBN can sell yuan to Nigerian banks the same way it sells dollars. Similarly, a Nigerian trader can go to a commercial bank with a quote from his Chinese trading partner and request yuan as he would for dollars. The same goes for Chinese traders with Nigerian trading partners or Chinese firms looking to invest in Nigeria.
This deal, by removing the requirement to obtain dollars for Chinese imports, removes strain on the central bank's dollar reserves, currently estimated to be around $48 billion.
Speaking in 2014, Kingsley Moghalu, then a deputy governor at the CBN, explained that the bank was looking to increase the percentage of yuan in its foreign reserves. According to Moghalu, 85% of its foreign reserves were in dollars, and it needed more of the Chinese currency as the world market had recognised yuan as a global reserve currency.
Why is the swap important?
The swap transaction should improve foreign currency access for Nigerian businesses that trade with or invest in China (and vice versa) by removing the hassle of having to convert from naira to dollar before converting from dollar to yuan.
China is one of Nigeria's largest trading partners, with trading volumes between both countries totalling $12.3bn in 2017. This agreement will help to further improve economic cooperation between the two countries.
“With the operationalisation of this agreement, it will be easier for most Nigerian manufacturers, especially small and medium enterprises (SMEs) and cottage industries in manufacturing and export businesses to import raw materials, spare-parts and simple machinery to undertake their businesses by taking advantage of available renminbi liquidity from Nigerian banks without being exposed to the difficulties of seeking other scarce foreign currencies.” – CBN
Ultimately, the currency swap should boost Nigeria's foreign reserves and smoothen trade relationships between China and Nigeria – which can only help local businesses.