CBN POLICY: DE-DOLLARISATION THROUGH CURRENCY SWAPS AS A PRUDENTIAL POLICY

By Chinedu Okoye

Summary:

• The Naira has gained some relief as the Central Bank successfully cleared the $10 billion FX forwards owed to banks.

• Demand dynamics remain unchanged due to low FX supply, and the stability is expected to be short-lived.

• Reducing dependence on the US dollar for international transactions and BRICS nations' de-dollarization push offer an opportunity to diversify reserves.

• Currency swap instruments between the Central Bank of Nigeria and the People's Bank of China, and between the CBN and the Reserve Bank of India could stabilize the Naira without committing dollar resources to acquire these currencies.

Taming Market Demand for US Dollars:

The recent efforts by the Central Bank of Nigeria to unify exchange rates by floating the Naira to "reflect market realities" have led to a steep fall in the currency against the greenback. 

While the Naira received a boost of $10 billion from the securitization of the government's NLNG dividends, it also lifted the ban on Forex Sales for 41 key goods.

However, the relative strength of the Naira is expected to be short-lived due to structural issues and low FX earnings. Hence, reducing the demand for US dollars through diversification of foreign reserves and transactions away from the dollar is a viable policy alternative.

De-dollarization through Reserve Assets Diversification for Exchange Rate Stability:

De-dollarization and diversification of foreign reserve assets at the Central Bank can alleviate the adverse effects on the Naira by reducing the demand for dollars in international transactions, especially by using alternative currencies like those of BRICS nations.

Aggressive De-dollarization moves by BRICS Nations:

BRICS nations are aggressively pursuing de-dollarization by encouraging trading in their local currencies. This approach can help mitigate the excessive demand for the US dollar.

A Case for Central Bank's Foreign Reserve Assets Diversification:

Nigeria, as a significant producer of crude oil and with substantial trade with BRICS countries, can diversify its FX reserves for hedging purposes. This can be achieved through currency swap arrangements with countries like India and China.

India and China are chosen based on their volume of trade between Nigeria. As at 2021 Nigerias total trade with China and India was approximately $40.95 billion. 

Viability of a Diversified Reserve:

Diversifying reserves and reducing dependence on the US dollar for trade and cross-border transactions with BRICS countries appears plausible. However, it may take time, given the dominance of the dollar in global trade.

Benefits of Currency Swaps:

Currency swaps can provide liquidity, reduce costs associated with borrowing in foreign currency, and lock in exchange rates against future changes. These swaps can help stabilize the Naira without depleting scarce dollar reserves.

Restructuring Central Bank's Reserve Assets Portfolio Using Currency Swaps:

Currency swaps between Nigeria and its largest BRICS trade partners can increase foreign reserves, stabilize the Naira, and reduce reliance on the US dollar for international transactions. This should be implemented in stages.

Stages for Diversification:

1. Sensitize stakeholders and assess the viability of the diversification scheme.

2. Arrange swaps on a portion of the total value of trade and international transactions with BRICS countries.

3. Convert Chinese debt to Yuan and use Yuan for subsequent borrowing.

4. Gradually move towards conducting direct trade with BRICS countries in their local currencies, freeing up dollar reserves.

Diversifying foreign reserves and reducing dependence on the US dollar through currency swaps with BRICS nations offers a promising path to stabilize the Naira and ensure long-term exchange rate stability. 

It essentially replaces FX forwards and with the use of FX swaps, a less costly and more controlled move, if implemented gradually, and all stakeholders taken into consideration. 

A successful implementation of this seemingly complex exchange rate policy would not only stabilize the Naira, but also make for a more resilient and balanced economic outlook.