Wednesday, April 20, 2016 8:35AM/FDC
From China with Love
As the high powered presidential delegation returned from China and the post-summit euphoria dissipated. Nigerians are coming to terms with the reality or otherwise of the mega swap transaction.
As they say, Exchange is No Robbery. The big question, therefore is that do people really understand what this means? Or is this another exercise that will end-up in a crisis of false expectations?
Let’s try and keep this simple.
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, according to Barron’s, 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, an FX 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 FX forward rate as of the start of the contract. Thus, FX swaps can be viewed as FX risk-free collateralised borrowing/lending.
Enough of the complex stuff, now let’s simplify this further by answering the following questions.
Have we done this before?
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% of the country’s external reserves into the Chinese Yuan. At the time, Nigeria’s $32bn reserves level was 79% in dollars with the rest largely held in Euros and Swiss francs.
Why this deal with 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. Therefore both in terms of volume, value and direction, the terms of trade are stacked against Nigeria.
Bilateral trade between Nigeria and China has grown rapidly in the last decade. Trade volumes have risen by 432.1% from $2.8 billion in 2005, to $14.9 billion in 2015.
Last year, Nigeria accounted for 8.3% of the total trade volume between China and Africa, and 42% of the total trade between China and the Economic Community of West African States (ECOWAS).
This showed that compared to the other countries above, Nigeria’s trade volume with China alone accounted for 18% of the total trade with Nigeria’s major trading partners.
Is China a Master of Swap Deals? (Historical Context)
For a number of years now, the Chinese government has been entering into these swap agreements with various countries. The swaps typically last for 3 years after which they are renewed or increased. As at 2015, the people’s bank of China had signed 31 currency swap deals totalling RMB3.14trn. China has a trade volume of RMB10.747 trillion with these 31 countries.
South Africa is the only African country that has signed a currency swap deal with China. Other non-African countries include: the United Kingdom, EU, Russia, Australia and the UAE amongst others.
How will it Work?
The Central Bank of Nigeria (CBN) will convert a certain portion of its external reserves say $3bn to Naira (N200 x $3bn = N600bn) and deposit with the Peoples Bank of China. The Chinese government will give Nigeria the Yuan equivalent of $3bn.
· Nigerian trader wants to import spare parts from China
· Approaches Nigerian bank, pays N40m for $200,000 (at N200/$)
· Nigerian bank opens L/C, confirmed by Industrial and Commercial Bank of China (ICBC)
· Nigerian bank credits ICBC with N40m, goods are shipped and documents negotiated
· ICBC is long Naira and short Yuan
· ICBC needs to import goods from Nigeria i.e. oil at $43pb
· Pays NNPC with naira at $43pb x N200
· Nigerian oil exports to the rest of the world reduces by the volume sold to China
· Nigerian yuan earnings increase and dollar revenue reduces by the same amount
· Impact neutral on external balance
· Nigeria will end up importing more from China and selling more to China. EUREKA! EUREKA!
· It is the economic equivalent of Archimedes’ principle:
· The yuan volume is the object that is immersed in the Nigerian dollar pool. The amount of yuan will be equal to the dollars displaced.
· In the end oil revenue will not change and import volume will not.
· Destination of exports and origination of imports is all that will change.
Will this transaction make the Naira stronger in the Forex markets?
· No. The impact on the currency pressure is neutral. This is because the swap deal does not increase the inflow of forex into the country.
Will this deal help curb inflation?
· No. This is because the root cause of the spike in consumer prices is the scarcity of forex exchange and other cost push factors. The currency swap deal has not addressed this issue. Therefore, the problem of soaring inflation remains
· The deal will boost bilateral trade volumes between Nigeria and China
· It will also increase dependence on China for imports of raw materials and equipment
· It guarantees China a significant portion of our Nigeria’s trade but our trade with the rest of the world will reduce due to lower foreign reserves
· The agreement will allow Nigerian traders to transact business with the yuan instead of dollar
· You will see more Chinese cars, TV sets, smartphones and “tourists”
· Crude oil sales between Nigeria and China would be settled in Yuan/Naira and access to Yuan would also be easier
· The swap will eliminate challenges arising from transactions with the US dollar and promote business flexibility between Nigerian and China
While the objective of the swap deal is to correct the trade imbalance. The reality is that the deal will increase the dependency complex and parasitic relationship between Nigeria and China. Despite its drawbacks and more important, it will provide a negotiating platform for Nigeria to extract better trade and investment concessions from other Western countries.