Not Signed, Not Sealed, Not Delivered
So last week, the Central Banks of China and Nigeria didn’t sign a bilateral currency swap agreement. Rather, it was a mandate that was signed with the Industrial Commercial Bank of China (ICBC), for Nigeria to be the West African trading hub for the renminbi.
But according to the CBN governor (in a phone interview with ThisDay newspaper), a currency swap deal is to be concluded in a few weeks.
From when the story initially broke, there has been a lot of confusion and reservations. So, i decided to give my voice to, hopefully, clarify some of the assumptions arising from the brouhaha while we wait for more details on this deal.
What really is this bilateral currency swap agreement?
The anticipated bilateral currency swap agreement between CBN and PBoC is, in theory, known as a central bank liquidity swap. To put it simply, it is mutual agreement between central banks to use each other’s currencies to manage demands from their local banks.
Central Bank A can draw from the swap line, same as Central Bank B if the need arises as well. The party who initiates a transaction from the swap line becomes the receiver of the swap and the other party becomes the giver of the swap. The currency of the receiver (of the swap) is will be held as collateral while the giver receives interests on the amount drawn down by the receiver until repayment is made. Collateral is held in case of default by the receiver.
So at this point, if you’re wondering if there’s any difference between a central bank currency swap (CBCS) and a collaterized loan facility? The answer is no. They’re technically the same thing.
Using a CNY50bn swap line scenario signed between CBN and PBoC.
CBN decides to initiates a CNY100m transaction with a 9 month tenor. The naira equivalent (exchanged at a rate based on current level) will be held as collateral* by PBoC while the CNY100m earns an interest at a rate also agreed at the beginning of the transaction. However, there’s no talk about PBoC holding naira in reserves. This is where the ICBC comes in — acting as stand-between to hold naira for PBoC. The naira, from this transaction, will only come into use if there’s a default at the end of 9 months — ICBC will take the collateral (naira) to exchange for yuan or any other preferred currency from willingly counter-parties.
But not to worry, Nigeria is expected to be able to make repayments from its nascent yuan reserves.
Now, the PBoC, through a local bank in China, decides to finance cassava imports and they initiate a NGN500m transaction with a 90 day tenor. The yuan equivalent will be held in our reserves as collateral while our Naira is used to make payments. At the end of 90 days, ICBC pays back the naira principal (with interest) and CBN returns yuan, for onward delivery to PBoC.
How China Changed the Game
As against the scenario explained above, CBCS used to be a lot simpler. China changed its dynamics with their agenda of trying to make the yuan a widely used reserve currency.
Initially, the usage of these swaps were to basically provide a form of foreign currency loan between central banks to meet short-term funding needs, acting as a liquidity backstop. They had no restriction on usage to a particular currency or any underlying trade.
So basically, Central Bank A, when its local banks are in need of funding, would ask Central Bank B to credit their account with x amount to support them (x determined by the capacity of the borrowing central bank).
In 2008, Bank of England initiated a swap with Federal Reserve to raise dollar liquidity during the financial crisis. Before then, swap lines already existed between Swiss National Bank, European Central Bank, Federal Reserve and a host of others.
As CBCS grew in prominence, China saw an opportunity to use this avenue to facilitate trade in renminbi. They sought out trading partners to give these ‘central bank loans’ to finance imports, from their country, packaging it with bilateral trade agreements that will encourage its usage.
But these swap lines’ usage has been lopsided. Most of China’s trading partners have either been countries dependent on their imports, with ailing economy or in the midst of a crisis. The reality is, the countries entering into a CBCS agreement with China tend to need it more than they do.
The last time China initiated a transaction on its swap lines was in 2014, and this was with South Korea for the payment of imports. The amount was negligible in terms of their volume of trade — about half a million dollars (That was all I could find on their swap transactions after rummaging the internet. China’s media control is next level, plus the PBoC’s operations are often in discreet).
It is worthy of note that China doesn’t have swap lines with US or Japan, and according to the Observation of Economic Complexity, both countries make up to 40% of its import origins.
However, the lopsidedness of swap usage is not limited to China alone, the existing CBCS are mostly signed by central banks of developed economies with emerging and frontier economies.
The million-dollar question — will China initiate transactions on from the swap line to finance imports from Nigeria?
As it stands, it is very unlikely. The average tenor of a CBCS is around 3 years and China’s major import from Nigeria are crude products, which doesn’t require currency swaps for its purchase.
Here is why:
- Stating the obvious, crude oil is priced in US dollars
- As a result, China will have to look for a counter-party that is willingly to buy the naira, they are getting from the swap, for dollars. It will be counter intuitive for Nigeria to sell dollars to China as it defeats the purpose of the swap — which is to reduce the demand on dollars and build its foreign reserve. Same reason applies as to why Nigeria would not sell its crude in naira to China either (selling in naira would mean less dollars in reserves). Rumour has it that China wants our oil receipts in exchange for yuan. I hope the Nigerian Government is not gullible to agree to such terms;
- And lastly, the issue of currency convertibility within the agreement. Will both countries allow the swapped currencies (yuan and naira) to be exchanged, at will, with any other currency? This will have implication on monetary policies for both central banks.
Another million-dollar question —will the naira appreciate against the dollar because of this CBCS?
No. Reduced dollar demand does not directly lead to a naira appreciation (i.e. dollar depreciation). For the dollar to depreciate, because there’s yuan inflow, there has to be a sell down of dollars that wants to be converted to yuan. Which will not be the case. Because, most importers are going to be using naira, to buy yuan, to finance their transactions.
Besides, who is going to be selling their scarce dollars (for naira) to buy yuan, when they can just use naira to buy the yuan directly instead?
Also, don’t forget that fx demand for invisible transactions like services, medical tourism etc. are still mainly funded in dollars, which accounts for about 41%** of total official demand.
Notwithstanding, because of the arbitrage opportunity that exists — the dollar-yuan is a widely traded and flexible currency pair while the yuan-naira is currently fixed (based on the current exchange rate policy). Economic agents will rush to buy the fixed currency pair in order to sell the flexible currency pair to make a quick buck, when it appreciates in their favour.
This can have some effect (causing some movement) on the dollar-naira currency pair.
Conclusion
Let’s be real, we will be doing most of the transaction initiations on this CBCS. The numbers don’t lie.
China will largely be holding our naira in reserves waiting to return it as we pay back their money. This is not a bad thing if the trade imports being financed will be used solely for raw materials to aid development.
On the plus side, China’s swap lines can be flexible. In 2015, Argentina used their swap line with China to manage its economic crisis (they opted for ease in convertibility; ability to exchange part of the yuan for dollars if they wanted to pay down on foreign obligation to stabilize foreign reserves).
Using some of the yuan to ease some of the country’s debt obligations is not a bad idea. It will reduce the pressure on the revenue side. Let’s hope the CBN can negotiate for similar terms with the PBoC.
By and large, a swap agreement between Nigeria and China will be beneficial to the country; you can read on why i think so here.
* I would like to point out that the monies held (earmarked) as collateral in reserves will not be left in the account earning nothing. It can be invested in the country’s government securities.
** External Sector Statistics > Foreign Exchange >Sectoral utilization for transactions valid for foreign exchange (US $ million) Jan. 2015 — Mar. 2016 from Central Bank of Nigeria Statistics Database. Available at: http://statistics.cbn.gov.ng/cbn-onlinestats/DataBrowser.aspx
