Since the inclusion of the Chinese currency among basket of reserve currencies that have special drawing rights (SDR), by the International Monetary Fund (IMF), the government of China has continued to see it as a reflection of the importance of its currency in the world’s trading and financial systems.
The country’s expanding role in global trade and the substantial increase in the international use and trading of the Renminbi (RMB) has seen it increasingly enter into currency swap agreements with a lot of countries.
China began signing bilateral swap agreements with other countries of the world in December 2008.
That was why in 2018, Nigeria entered into a currency swap deal with the country. The currency swap agreement with Nigeria was valued at $2.5 billion.
But prior to the deal with Nigeria, countries which include the United Kingdom, Belarus, Malaysia, South Africa, Australia, Armenia, Surinam, Hong Kong, Pakistan, Thailand, Kazakhstan, South Korea, Canada, Qatar, Russia, the European Union, Sri Lanka, Mongolia, New Zealand, Argentina, Switzerland, Iceland, Albania, Hungary, Brazil, Singapore, Turkey, Ukraine, Indonesia, Uzbekistan, and the United Arab Emirates had also entered into similar deal with China, with total value then put at over RMB3.137 trillion.
According to the International Monetary Fund (IMF), a currency swap line could be defined as an agreement between two central banks to exchange a cash flow in one currency against a cash flow in another currency according to predetermined terms and conditions. It allows 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.
As for its common tenor, currency swap maturities are negotiable for short (Up to one year) to long term, ranging between 3-10 years, making them a very flexible method of foreign exchange.
Currency swaps’ interest rates can be fixed or floating and is usually expressed as inter-bank lending rate prevailing in two-party markets, such as “LIBOR” plus or minus a certain number of points, based on interest rate curves at inception and the credit risk of the two parties.
As a matter of fact, swap lines were initially used by central banks to fund certain market interventions. Afterwards and over the past 10 years, the swap lines have become an important tool for preserving financial stability, preventing market tension from affecting the real economy and avoiding excess levels of accumulated reserves especially when the cost of such accumulation is higher, the IMF explained.
Also, currency swap agreements are designed to protect both central banks involved in the swap from losses owing to fluctuations in currency values.
But, there is still some risk that a central bank will refuse, or be unable, to honour the terms of the agreement. For this reason, lending through currency swaps is a meaningful sign of trust between governments.
Another function for currency swap lines is to ensure, for the central bank, a high level of operational readiness.
Central Bank of Nigeria’s Governor, Mr. Godwin Emefiele, had said the deal was sealed after over two years of painstaking negotiations by both central banks.
According to the CBN, the transaction, which was valued at 16 billion RMB, was 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.
The CBN said among other benefits, the agreement has provided naira liquidity to Chinese businesses and provide RMB liquidity to Nigerian businesses respectively, thereby improving the speed, convenience and volume of transactions between the two countries.
“It has also assist both countries in their foreign exchange reserves management, enhance financial stability and promote broader economic cooperation between the two countries,” it stated.
The operationalisation of the agreement made it 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 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.
“With this, Nigeria becomes the third African country to have such an agreement in place with the PBoC,” the had explained.
Commenting on the bi-lateral agreement, Research Analyst at FXTM, Lukman Otunuga, said the deal has improved the speed, but also the convenience of transactions between both nations.
To analysts at Cowry Assets Management Limited, the currency swap deal would facilitate trade between the two countries, by providing adequate local currency liquidity to Nigerian and Chinese industrialists and other businesses, thereby sidestepping a third currency – the US dollar.
“We expect the arrangement to ease pressure on the limited dollar supply at the Investors’ & Exporters’ forex window (I&E)and hence, enhance stability of thenaira/ dollar exchange rate,” the firm had added.
Also, the Director General of the Lagos Chamber of Commerce and Industry (LCCI), Mr. Muda Yusuf, had said the deal would positively impact trade and investments between Nigeria and China.
“However, it can only last if the exchange rate remains stable. This is because if there are issues with the exchange rate, it may affect it,” he added.
CBN Governor, Mr. Godwin Emefiele had explained that Nigeria was not the only country that had agreed to a currency swap with China, as several other countries – developed and emerging markets – with growing trade volumes with China had entered into similar currency swaps with the Asian country.
“The agreement on the currency swap with China will 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,” he had explained.
On its part, the IMF in a report, noted that currency swaps between the PBOC and foreign central banks are of lasting signiﬁcance to the international ﬁnancial reform.
First, they help reduce the dollar dominance in the existing international currency swap network and enhance the voice of emerging countries in the international ﬁnancial system.
“Despite the exclusive currency swap arrangements among Western central banks and their reluctance toward the international ﬁnancial reform, the currencies of emerging economies will inevitably play a bigger role in bringing more balance and diversity to the global ﬁnancial market.
“Second, although the currency swap arrangements made by the PBOC are generally small in scale compared with those among Western central banks, they have involved more partners. This kind of inclusiveness has received positive feedback from the international community, which better demonstrates that the international ﬁnancial reform should satisfy the needs and interests of the majority of countries in the world.
“Third, the currency swaps made by the PBOC or other ﬁnancial institutions such as the New Development Bank, Emergency Reserve Fund of BRICS, and Asian Infrastructure Investment Bank (AIIB) will continue generating new momentum to the reform of the international ﬁnancial system.
“While the U.S. continues to monopolise agenda-setting and rulemaking power in the world, it has no other choice but to adapt to the changing realities and be more accommodative to the collective needs of developing countries in establishing a more inclusive and balanced international ﬁnancial system. In a word, the PBOC-led RMB swaps and the USD swaps made by the U.S. “Federal Reserve are both transitional measures in the process of the international ﬁnancial reform. While neither alone can solve existing problems or defects in the international ﬁnancial system, they reﬂect the urgent need to build new mechanisms for broader international cooperation,” the fund added.