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In early September 2011, then CBN Governor Sanusi Lamido Sanusi announced Nigeria’s desire to hold up to a tenth of its $32 billion foreign exchange reserves in Chinese Renminbi (Yuan) as a diversification strategy to protect Nigeria’s sovereign wealth after the United States credit rating got downgraded by S&P from AAA to AA+ due to fears of a rising US government budget deficit and ballooning debt burden.
Sanusi believed that China would allow Nigeria to use the yuan to purchase higher yielding Chinese government debt which are only open to a small group of qualified foreign investors. Sanusi asserted that Nigeria may allow China to settle oil purchases in Yuan which will allow some of our foreign exchange earnings to be in Yuan and not all in dollar. He even talked up the possibility of a currency swap deal with China. At the time, Nigeria held 79% of foreign reserves in dollars and the rest were held in Euros and Swiss francs.
Three years down the road nothing significant had happened except Sanusi was no longer CBN Governor. Then Deputy CBN Governor Kingsley Moghalu said in 2014 that Nigeria held only 2% of its external reserves in Yuan which is miles away from the 10% target Sanusi set in 2011, 85% of our foreign reserves was now held in dollars, up from 75% in 2011 (so no diversification essentially) and there was noYuan-Naira currency swap deal in place and Nigeria was still not settling oil contracts with China in Yuan (so the roundtripping between Yuan-Dollar-Naira continued).
Finally, progress on currency swap deal
IMF announced in November 2015 that it has approved for the Chinese yuan to be added to its elite Special Drawing Rights basket of reserve currencies, which includes the U.S. dollar, the euro, the pound, and the yen, paving the way for developing countries like Nigeria to comfortably hold Yuan in their foreign exchange reserves. In April 2016, Central Bank of Nigeria signed an agreement with the Industrial and Commercial Bank of China (ICBC) to allow renminbi transactions among Nigerian banks and the inclusion of the Chinese currency in Nigeria’s foreign exchange reserves. Now it gets a little confusing, didn’t CBN say they already had yuan in Nigeria’s foreign reserve back in 2014? Anyway, the framework for the naira-yuan currency swaps deal was agreed but the size of the deal was conveniently left unreported. Again, the deal got stalled until 2018.
Mission accomplished
In May 2018 CBN announced that it has signed a currency-swap agreement worth $2.5 billion to boost commercial ties with China by providing adequate local currency liquidity to Nigerian and Chinese industrialists and reduce the need to use dollar in their bilateral trade (so less roundtripping). According to CBN, the deal will also help to improve the speed, convenience and volume of transactions between the two countries.
CBN explained that 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 RMB liquidity from Nigerian banks. In our opinion, while the swap deal looks great when you superficially analyse its benefits, a critical examination will show that this deal isn’t as fantastic as we initially thought.
Most likely outcome
Swap money will be depleted in 4 months not 3 years. The $2.5b currency swap deal is a three-year agreement between Nigeria and China but both parties are aware that based on the quantum of trade between both nations, the funds are not expected to last beyond 4 or 5 months. Trade deals between Nigeria and China is projected to exceed $10b in 2018, with swap arrangement of just $2.5b, this deal is looking more like a pilot test than a real deal since simple arithmetic will show that the deal won’t last up to 5 months in the best-case scenario.
We project 2018 trade deals between Nigeria and China will exceed $10b from $9.2b in 2017 buoyed by rising crude oil prices (which will push Chinese crude import spending higher) and continued economic recovery in Nigeria which should help boost Nigerian import spending on Chinese products. Therefore, a two-year currency swap deal of $20b representing 40% of our external reserves may have been more appropriate: China is Nigeria’s second largest trading partner so why not?
Dollar demand will ease but so also will dollar supply, thus eroding most of the benefits that would have come out of the swap deal in terms of strengthening the Naira. Yes, for the first four or five months while the currency swap funds are available, demand for dollar by Nigerian businesses to pay for Chinese imports will disappear. But so also will the supply of dollars which China uses to fund its infrastructure projects here in Nigeria. Previously, China would have had to use its dollars to purchase naira to settle local contractors and construction workers, this won’t happen when the swap fund is available. As at January 2017, China had already invested or financed up to $22b of infrastructure projects here in Nigeria, another $23b projects are still on-going with another $40b worth of projects in the pipeline according to Mr. Wang Yi, China’s Foreign Affairs Minister. These figures make China an invaluable source of foreign exchange for the Nigerian economy.
Repatriation of profits to China will increase. Chinese businessmen will have no difficulty taking profits back home thanks to our currency swap deal. This may increase capital outflows in Nigeria and further weaken the currency. Even though the size of the repatriation may not be too significant, it is still going to take up a chunk of the currency swap money.
FX pressure will remain unchanged or could even worsen. Any slack in the demand for dollar will be picked up by yuan such that import spending and FX demand remain constant. In fact, Nigeria’s imports are more likely to go up than down because of this currency swap deal. Availability of yuan will facilitate importation from China making it easier to import merchandise and will do nothing to affect our exports to China. Almost all $1.6b of Nigeria export to China last year was crude oil sales so we should be talking about settling oil contracts with China in Naira not Yuan. If exports are not Naira denominated products, Naira is more likely to depreciate than appreciate while FX pressure remains the same. Hopefully, higher crude oil prices will net out higher imports this year.
No long-term solution still
Overall, we are not critical of the currency swap deal, it has its use. We are concerned that this deal has no long-term benefit to the Nigeria economy in its current form. We implore policy makers to start taking drastic steps to solve our import addiction rather than continue to provide short term solutions to our FX challenges. The dollar is up more than 1,500% against Naira in the last 20 years! If we don’t see transformational reforms in trade, manufacturing and exchange rate management in Nigeria, the next 20 years may just look like the last.
Emeka Ucheaga
Ucheaga is Managing Partner, Emeka Ucheaga Advisory
