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Understanding the Currency Swap Agreement between Nigeria and China

April 14th 2016

In the last 48 hours, much has been made about the success of President Muhammadu Buhari’s trip to China. For some, it was about the ability to borrow or source cheaper funds and for others, it was the increased investments Chinese companies have promised to make in Nigeria’s potential growth sectors such as mining and agriculture.

However the most far reaching and consequential achievement came in the currency swap agreement. While Nigeria is a little late in the game, this agreement was a long time coming. Ghana, South Africa and a few other African nations had begun storing foreign reserves in China’s currency, the Yuan. And just last year, the Yuan received a status upgrade by the World Bank and IMF as a Global Currency much to the chagrin of many western economist who have long accused China of manipulating it currency to make its goods cheaper to the foreign market.
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Lets answer a few questions

What is this agreement about? 

In the simplest of terms, CBN would now store a higher percent of its foreign reserves in Yuan as opposed to just Dollars, Pounds and Euros as is the predominant norm. Those reserves ideally would be made available to Nigerians who need it in transactions where they need it.

I have no business traveling to China so why does this matter to me?

Currently a large amount of the demand of the US Dollar is for trade. Importers need it to pay their suppliers because those suppliers won’t accept Naira because it isn’t a global currency and there is no demand for Naira outside Nigeria. That pushes the price of US Dollars up at the parallel market so when you need it for other things, you are competing with people who need it as well but to buy goods from one of the largest supplier of goods to Nigeria; China.

I don’t understand… 

Lets use an example. Lets say a business man wants to import an item from China. Prior to the agreement, he would first have to source for USD (pay a premium) and then purchase Yuan (attract additional financial charges via bank or BDC). With this agreement, CBN borrows Yuan from China and stores it in reserves. So if that same business man wants to import from China, he could source the Yuan directly from CBN and pay the suppliers without using the dollar as an intermediary currency.

Other benefits by default mean decreased demand for US Dollars by importers thereby reducing the pressure that the USD has put on the Naira since oil prices crashed.

Make no mistake, China wins in the long run. It increases its exports to Nigeria exponentially with funds it’s loaned Nigeria creating more jobs for it’s people back in China. And yes, that money comes back to China with interest.

Nigeria wins in the short with a boost to its currency. However, the cheaper import costs and financial obligations reduces the much needed pressure to increase local manufacturing. Nigeria can take advantage of this situation by focusing their import strategy on Capital Expenditures that can help boost local manufacturing and ween themselves off Chinese goods. Will that happen? One can hope but history tells me that we will choose the path of least resistance.