A lot has been said and speculated about the proposed currency swap deal between Nigeria and China and how it will alleviate the foreign currency pressure on the Naira. However, in the absence of details on the size or duration of the deal, one wonders if it will really make a meaningful long-term impact on the economy.
Let’s look at the bigger picture.
China has its own problems
China is currently the second largest economy in the world and the largest investor in Sub-Sharan Africa. The country isn’t without its own economic challenges and has devalued its currency four times between 2015 and 2016. In December 2015 the Chinese Yuan joined the Euro, US Dollar, British Pound and Japanese Yen in the IMF Special Drawing Rights basket as part of a bigger financial reform plan which will also lead to an increase in the convertibility of the Chinese currency.
This deal with Nigeria is not the first China has engaged in: there are currency swap agreements with 31 other countries with one of the key objectives being to facilitate bilateral trade and investment.
The Nigeria/China import Trade handshake
We all know Nigeria is a nation of importers, so any fluctuation in foreign exchange has a direct impact on many businesses and the economy as a whole. Out of the estimated $33Bn worth of imports that came into the country in 2015, about 25% was made up of goods from China, making the country our largest foreign trade partner for the importation of finished goods.
China does purchase some crude oil from Nigeria, but in the overall scheme of things, the value is negligible.
What exactly is a currency swap?
It’s best defined as an agreement between two parties to exchange two currencies at a certain exchange rate at a certain time in the future. In Nigeria the US dollar is the base currency for Foreign exchange transactions. This basically means if you want to buy foreign exchange in a currency other than US dollar, you would first buy the equivalent in USD and then convert at an agreed rate to the currency you want. The benefit of having a swap agreement with China is that it will now be possible to purchase the Yuan without first converting to USD, making the transaction cheaper.
So what does this deal mean for Nigeria?
The proposed currency swap agreement 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.
It also does not affect the existing backlog of unmet foreign currency demand. There isn’t any confirmed information right now on the exact value of the swap, but if you look at the agreement China has with countries with similar counterparty trade values as Nigeria, it’s highly unlikely the amount will meet the majority of Nigeria’s import trade requirements and there may even be a gap in meeting the demand for all import trade from China.
We also need to understand that this deal only impacts goods/services denominated in Yuan. FX transactions in other currencies won’t be affected by this deal. Finally, there is a risk of concentrating import focus only on China going forward. Great for China’s economy, not sure it’s so great for ours long term especially if we really want to move from being a nation of consumers to having a healthy mix of consumption and diversified production for both local and international markets.
This swap agreement is definitely a step in the right direction to ease some pressure on our foreign reserves, but it won’t be the magic solution most people expect it to be.