THE NIGERIA - CHINA FOREX DEAL EXPLAINED - AreaGist.com
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    THE NIGERIA - CHINA FOREX DEAL EXPLAINED


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    Much has been said and celebrated this week about the Nigeria - China Forex deal, but much is undoubtedly yet to be understood about the deal leading to all sorts of interpretations and postulations from different school of thoughts on whether we should at all be celebrating or how loud we should indeed celebrate. As it turns, and like in all other issues 'Nigerian', the school is quite a large one, with discussion participants ranging from Market Women to Economic experts all expressing their opinions even before President Buhari and his team returned to Nigeria with details of the deal. To this end, we are going to attempt to throw some more light on this issue as we see it in the proceeding write up. Please note that this is a very simplified version of the story, brought down to level of the man in the streets. Also note that the figures used here are not the exact rates, but convenient approximations for ease of calculations so as to drive the important points home.

    HOW CURRENCY EXCHANGE WORKS
    For international transaction between two countries to work, there must be a mechanism for the two different to exchange their currencies via their Central Banks to settle the transactions .e.g. if Nigeria buys 600 Chinese Yuan worth of products from China and China buys N20 worth of products from Nigeria, it means currency has to be exchanged between these two parties at an exchange rate of 20 to 600, i.e. 2 to 60 or simply put, a ratio of N1 to Y30 .
    However, there are over 200 currencies in the world today and not every country has the wherewithal to do exchange settlements with every other 199 countries at the same time, most countries just cannot afford it. America is however big enough to do this so for countries who cannot afford it the dollar now becomes the standard international exchange currency. i.e. You can exchange your currency to the US Dollar, and then the US dollar can then be converted to any currency of your choice. This is essentially what is meant when we refer to the dollar as an international Medium of exchange.There are other internationally exchangeable currencies e.g. Euro, Pound etc but they are not as convertible as the dollar.

    Before now the Chinese currency (Yuan) was not easily convertible to the Naira because both countries' Central Banks do not store their reserves in each others currency, thus the only way to transact between China and Nigeria was to first convert either currencies to the dollar. In line with this,facts recently made available showed that 70% of the Nigerian demand for the dollar was to convert eventually to the Yuan to conclude transactions between Nigeria and China. This multiple currency conversions inflates currency price due to what economics call TRANSACTIONAL COSTs .e.g. The bank has to make profit,the Nigerian selling to the black marketers has to make profit and also the black market sellers have to make their profit. This is further complicated by demand,supply and availability issues, adding to the cost of exchange rate.

    THE ADVANTAGE OF THE NEW DEAL
    With this recent agreement between Nigeria and China, the Chinese currency and Nigerian currencies are now directly inter-convertible via their central banks, meaning Nigeria will make Naira available to the Chinese central bank and vice versa. This will enable Nigeria and Chinese business men and women trade together easily knowing their governments will settle the transaction using the prevailing exchange rate. Thanks to this , the cost of converting from the naira to the yuan will no longer be impacted by transactional cost of passing through an intermediary currency - the dollar. This means that it will now be cheaper to convert from naira to yuan.
    For example, prices listed on a popular Chinese trading portal, which quotes the price of goods in both yuan and US dollar, shows a particular leather Handbag quoted as 297yuan or 46dollars, this shows that the dollar exchanges for about 6.5 yuan. Therefore, a Nigerian who wants to buy this bag now has the option to pay in dollars or pay in yuan with varying consequences as follows;


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    THE NIGERIA – CHINA FOREX DEAL EXPLAINED

    by admin | Apr 16,2016

    ChinaNigeriaForexDeal

    Much has been said and celebrated this week about the Nigeria – China Forex deal, but much is undoubtedly yet to be understood about the deal leading to all sorts of interpretations and postulations from different school of thoughts on whether we should at all be celebrating or how loud we should indeed celebrate. As it turns, and like in all other issues ‘Nigerian’, the school is quite a large one, with discussion participants ranging from  Market Women to Economic experts all expressing their opinions even before President Buhari and his team returned to Nigeria with details of the deal. To this end, we are going to attempt to throw some more light on this issue as we see it in the proceeding write up. Please note that this is a very simplified version of the story, brought down to level of the man in the streets. Also note that the figures used here are not the exact rates, but convenient approximations for ease of calculations so as to drive the important points home.

    HOW CURRENCY EXCHANGE WORKS
    For international transaction between two countries to work, there must be a mechanism for the two different to exchange their currencies via their Central Banks to settle the transactions .e.g. if Nigeria buys 600 Chinese Yuan worth of products from China and China buys N20  worth of products from Nigeria, it means currency has to be exchanged between these two parties at an exchange rate of 20 to 600, i.e. 2 to 60 or simply put, a ratio of N1 to Y30 .

    However, there are over 200 currencies in the world today and not every country has the wherewithal to do exchange settlements with every other 199 countries at the same time, most countries just cannot afford it. America is however big enough to do this so for countries who cannot afford it the dollar now becomes the standard international exchange currency. i.e. You can exchange your currency to the US Dollar, and then the US dollar can then be converted to any currency of your choice. This is essentially what is meant when we refer to the dollar as an international Medium of exchange.There are other internationally exchangeable currencies e.g. Euro, Pound etc but they are not as convertible as the dollar.

    Before now the Chinese currency (Yuan) was not easily convertible to the Naira because both countries’ Central Banks do not store their reserves in each others currency, thus the only way to transact between China and Nigeria was to first convert either currencies to the dollar. In line with this,facts recently made available showed that 70% of the Nigerian demand for the dollar was to convert eventually to the Yuan to conclude transactions between Nigeria and China. This multiple currency conversions inflates currency price due to what economics call  TRANSACTIONAL  COSTs .e.g. The bank has to make profit,the Nigerian selling to the black marketers has to make profit and also the black market sellers have to make their profit. This is further complicated by demand,supply and availability issues, adding to the cost of exchange rate.

    THE ADVANTAGE OF THE NEW DEAL
    With this recent agreement between Nigeria and China, the Chinese currency and Nigerian currencies are now directly inter-convertible via their central banks, meaning Nigeria will make Naira available to the Chinese central bank and vice versa. This will enable Nigeria and Chinese business men and women trade together easily knowing their governments will settle the transaction using the prevailing exchange rate.

    Thanks to this , the cost of converting from the naira to the yuan will no longer be impacted by transactional cost of passing through an intermediary currency – the dollar. This means that it will now be cheaper to convert from naira to yuan.

    For example, prices listed on a popular Chinese trading portal, which quotes the price of goods in both yuan and US dollar, shows a particular leather Handbag quoted as 297yuan or 46dollars, this shows that the dollar exchanges for about 6.5 yuan. Therefore, a Nigerian who wants to buy this bag now has the option to pay in dollars or pay in yuan with varying consequences as follows;

    If she decides to pay with dollars and she secured dollar from the parallel market at N330, the bag would cost her a total of  N15,180
    If she decides to pay with dollars and she secured dollar from the banks at official rate of N200, then the Bag would cost her a total of N9,200
    if she decides to pay in yuan and thanks to Buhari , she is able to get yuan at  N30 to the yuan official rate from Banks, then the same bag would cost her only N8,910 ( a little better than the dollar official rate).

    THE CATCH 22 :
    Notice in the above calculations there was no option for securing the yuan from the black market as it is basically not currently available in the Nigerian black market. Therefore what is not yet known is if the federal government intends to meet all yuan demands only via the official bank rate of N30, this is very unlikely, it is more likely that the yuan will be made available to black market dealers to meet demand like the dollar and if that is the case, the black market speculators may simply shift from the dollar to the yuan.

    The Euphoria that has griped Nigerians this week was in barely a consequence of comparing apples and oranges i.e comparing black market dollar with official yuan rate (because there is no black market yuan rate as of today). What should be compared is apples and apples i.e. black market yuan and black market dollar or Official dollar rate vs official Yuan rate. As earlier stated it is very unlikely that the federal government will meet all demands for yuan via the official rate as it will mean a complete reversal of Buhari’s policy of discouraging importation and revamping local production as this will simply mean subsidizing importation once more.

    While we wait to see the detailed position of the federal government on this. because the technical committee set up to fine tune the details of this agreement have not submitted their report yet. We think it would be more likely that the final outcome will be the availability of the yuan to black marketers for onward trading to the general public. The cost of this last leg of the transaction is what no one knows for no.

     

    Is the above interpretation correct ? please tell us what you think in the comments below.

     

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