CURRENCY SWAP DEAL

Currency swap deal ‘ll boost foreign reserves

By Omodele Adigun

“When funding markets in one currency deteriorate, it becomes difficult for banks outside that currency area to fund their assets tied to this currency since they have no direct access to the foreign central bank that issues the currency. But if their home central bank has a swap line with the foreign central bank, the home central bank can provide its banks with the required liquidity in the foreign currency without using its foreign reserves.”

With this extracts from the European Commission Bank (ECB), the bilateral currency swap agreement between the Central Bank of Nigeria (CBN) and the Peoples Bank of China (PBoC) may not be only about increasing bilateral trade between Nigeria and China but also part of the CBN’s strategies to guard the nation’s resurging reserves.


 
In announcing the deal, CBN has said that the $2.5billion (RMB 16billion) transaction is aimed at providing adequate local currency liquidity to Nigerian and Chinese industrialists and other businesses, thereby reducing the difficulties encountered in the search for third currencies.

“Among other benefits,” explained Isaac Okorafor, the apex bank’s acting director of Corporate Communications, “is that this agreement will provide Naira liquidity to Chinese businesses and provide Renminbi liquidity to Nigerian businesses respectively, thereby improving the speed, convenience and volume of transactions between the two countries. “It will also assist both countries in their foreign exchange reserves management, enhance financial stability and promote broader economic cooperation between the two countries.

“With the operationalisation of this agreement, 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 Renminbi liquidity from Nigerian banks without being exposed to the difficulties of seeking other scarce foreign currencies.

“The deal, which is purely an exchange of currencies, will also make it easier for Chinese manufacturers seeking to buy raw materials from Nigeria to obtain enough Naira from banks in China to pay for their imports from Nigeria. Indeed, the deal will protect Nigerian business people from the harsh effects of third currency fluctuations,” said Okorafor
Shedding light on how currency swap has saved local banks, ECB states:

“During the financial crisis following the collapse of Lehman Brothers in September 2008, for example, funding markets dried up because of extreme risk aversion. Under these circumstances it became difficult for euro area banks to obtain US dollars to fund their USD-denominated assets. To prevent disruptions, such as banks having to sell assets abruptly and thus provoking extreme price movements, the ECB and the Federal Reserve set up a currency swap line, allowing the ECB/Eurosystem to provide US dollars to banks located in the euro area.”

Aside this, there was also thinking in some quarters that the inflation rate , currently at 13.34 per cent, will shrink further with the currency swap .
But experts refuted that, saying the agreement would not necessarily crash prices. “This is not going to lead to the Federal Government’s revaluing the currency,” says Johnson Chukwu, the Managing Director of Cowries Assets Management Limited.


 
Toeing the same line, Ayodele Ebo, the Managing Director of Afrinvest Securities Ltd. said he could not foresee any immediate drop in the prices of the Chinese imports. “It will just ease importation and doing business with China,” he added.

Recall that Bismarck Rewane, the CEO of Financial Derivatives Company (FDC) Limited, picking holes in the arrangement when the deal was first mooted two years ago, had cautioned that what the deal was “to concentrate your trade in the hands of one country”.


 
Hear him: “With the deal, Nigeria will be using the yuan to import from China, while they (China) will use the naira to buy crude oil from Nigeria. And then they (China) will take the oil to sell in the market to get dollars. So Nigeria’s dollar income will reduce and its imports from the rest of the world would also reduce. So Nigeria will be more dependent on China. That is all,” Rewane said.

The CBN Governor, Mr Godwin Emefiele, had told a national daily then that the currency swap would definitely benefit Nigeria “because the essence of the mandate is to ensure that Nigeria is designated as the trading hub with China in the West African sub-region for people who want the renminbi as a currency denomination.

“Also for us, we believe that using the renminbi will improve trade with China, as this will encourage importers to open L/Cs in the Chinese currency for the importation of raw materials, equipment and machinery from China, rather than other trading regions, so the agreement will encourage trade between both countries.”

But Rewane cautioned that the deal would dam the inflows of dorlar into Nigeria .
“It doesn’t change anything. The man who is going to import from the US, or the man who is going to import a car from Germany, will he need yuan to buy it. We are only playing with mirrors. It does not increase the actual flow of dollars to Nigeria. It only means that our trade is more concentrated in Chinese goods and the Chinese with the naira they get from Nigeria when they buy oil,” the FDC boss added.

A currency swap line is an agreement between two central banks to exchange currencies. They allow a central bank to obtain foreign currency liquidity from the central bank that issues it – usually because they need to provide this to domestic commercial banks.
ECB explained that, while swap lines were initially used by central banks to fund certain market interventions, in recent years, they have become an important tool for preserving financial stability and preventing market tension from affecting the real economy.

On how a swap deal helps in foreign exchange reserves management, the bank explains in its website:
“The swap agreements established by the ECB since 2007, for instance, have been geared towards providing foreign currency liquidity to domestic banks. When funding markets in one currency deteriorate, it becomes difficult for banks outside that currency area to fund their assets tied to this currency since they have no direct access to the foreign central bank that issues the currency. But if their home central bank has a swap line with the foreign central bank, the home central bank can provide its banks with the required liquidity in the foreign currency without using its foreign reserves.”
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