Since the inclusion of the Chinese currency among basket of reserve currencies that have special drawing rights

Mayowa Akinola

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 operat*