Nigeria edging closer to China — Bank of America Merrill Lynch

Lagos, Nigeria, Capital Markets in Africa — Buhari’s recent trip to China generated impressive headlines on funding. If the whole $6bn infrastructure loan is disbursed, it could give a significant boost to Nigeria’s productivity. However, in the short term, the focus is on some important details of the currency swap arrangement and to what extent it can alleviate the pressure on Nigeria’s FX reserves.

CBN lauds currency swap with China, but important details are missing 
The Industrial and Commercial Bank of China (ICBC) has agreed a swap with the Central Bank of Nigeria, which CBN Governor Godwin Emefiele claims will strengthen the naira through lower dollar demand. In theory, Nigeria will provide a certain amount of naira to the ICBC in exchange for yuan, which the CBN can then provide to domestic banks. According to local press reports, a framework has also been agreed that will make it easier to settle trade deals in yuan. The yuan’s share in Nigeria’s $27.2bn of foreign reserves could increase from current levels of 6.7%.

Significant details of the deal including the size, tenor and exchange rate to be used for this agreement have not been officially announced. The exchange rate that is used (if different from the cross rate implied by the official naira exchange rate) could have important implications for President Buhari’s willingness to be more flexible on the currency.

Though some government officials have described this deal as more of a “partnership” than a swap, the aims are clear. Emefiele hopes that importers will start to open letters of credit in yuan instead of dollars, encouraging more trade with China but also reducing domestic demand for dollars, which has weighed on reserves.

An asymmetric trade relationship means FX shortage may persist 
China accounts for 24% of total import demand, but we do not believe the dollar shortage can be solved this easily. Nigeria has run a persistent trade deficit with China, which reached $14bn last year. Unless China is willing to take more naira than it needs to buy Nigerian crude (to facilitate the higher value of Nigeria’s imports from China), then Nigeria’s deficit in foreign exchange (yuan or dollars) is likely to continue. Moreover, the main issue of FX liquidity is still very much linked to restrictions on imports and on the domestic trading of dollars. Until regulatory changes are made here, we do not expect to see a substantial improvement in dollar liquidity.

A key aim of Nigeria’s policymakers is to diversify the economy and build a viable manufacturing sector. Looking at SSA imports from China, 27% are machinery and electronics, while 19% are textiles and clothing. Nigeria relies heavily on imported intermediate goods, and being able to import these more cheaply from China than from the rest of the world has typically been a boost for the economy. However, Chinese competition poses a threat; the textile industry in Nigeria has been a notable casualty. With the manufacturing sector having only recently exited recession (growing by just 0.4% in Q4 2015), boosting trade with China may be a mixed blessing.

China buys time for Nigeria to muddle through given pressures on the budget 
Lending through currency swaps at this level implies a certain degree of trust between governments, which take on the risk that one party may not be willing or able to honour the terms of the agreement when the swap is unwound. This deal, therefore, has important implications for the increasing role that China has in financing Nigeria. The finance minister has already stated that issuing external debt in yuan is being considered and the minister of trade and industry has claimed that the $6bn of infrastructure loans from China are available for Nigeria to spend as soon as appropriate projects are selected.

According to the finance minister, the 2016 budget will include NGN1.8tn ($9bn) of capital expenditure, directed towards roads, housing, power and health to boost GDP growth. PPPs will also be used to attract private capital. However, pressures on the budget are coming from all directions. Plans to use money set aside for joint venture cash calls of the national oil company (the NNPC) to fund the budget could be helpful, but despite last year’s bailout, some of Nigeria’s states are again struggling to meet their obligations, leaving civil servants without salaries. The central government will make NGN11bn ($55m) of loan payments for March on their behalf, but we suspect this could a recurring problem. With more than $10bn of debt, the liabilities of state governments could represent a significant burden for federal government finances, putting ambitious capital spending plans at risk.

Though we remain concerned about Nigeria’s outlook, and expect GDP growth of just 2.5% in 2016, the financing of this year’s budget and much-needed investment in infrastructure is helped by striking large bilateral deals with China. Feedback from both debt and equity investors suggests that they will remain on the sidelines until the naira is devalued. Alternative sources of financing like this buy Nigeria more time to “muddle through” without having to change its official stance on the currency. However, we would remain cautious on taking headline numbers as fact. Committed flows of FDI are often much larger than the actual investments seen to completion. Therefore, Nigeria may still need to look elsewhere for external financing.