1. What is a Currency Swap
Its a Derivative currency trading instrument where the principal and interest in a currency is swapped or exchanged for the principal and currency of another currency
Eg i swap US Dollars for Japanese Yen
2. Why use a Currency swap
To reduce currency exchange risk ..lets assume i have US Dollars and want to import Honda cars from Japan, i can simply swap my USD for Japanese Yen and buy the cars in Japan…
(I am being simplistic)
3.1 Why are Nigeria and China swapping Currencies?
Normally if you want to trade globally you use US Dollars. So to import from China I take Naira convert to Dollar then convert my Dollar to Yuan (Basic unit of Chinese Currency).
3.2 Now with a currency swap..I go from Naira to Yuan by swapping my Naira for Chinese Yuan..China also goes from Yuan to Naira…so we “swap” currencies when trading. Nigeria and China don’t need to buy US dollars to settle trade transactions.
4. What are the benefits?
The effect is a potential reduction in demand 4 USD for trading & settling of trades between China and Nigeria. I stress potentially.This reduces demand for USD to fund Chinese Imports thus a potential strengthening of the Naira, all things being equal
5. 1 Does this favour Nigeria?
Nigeria largest imports are from China, so payments for Chinese imports take a big chunk of $ Fx
Pay for imports with Naira helps the balance of payment. Nigeria's US Dollars fx reserves last longer, thus improvement in soverign confidence
5. 2 It potentially means China pays for oil imports in Naira not US dollars….( just saying)
6. Other issues…
Nigeria has also agreed to hold a larger percentage of our Foreign Reserves in Chinese Currency. This is good, as its a diversification of Nigeri's reserves.
7.What is future direction for Naira/USD?
The key drivers of the exchange rate are the revenues from crude oil and pace of imports.
Swap address the issues of pressure on fx reserves to fund imports from China…it cant address revenues from crude oil..
8. Long term, the decision has to reached on if the Naira should trade at a Premium or Discount to the Chinese Currency.