Nigeria deals the dollar another blow

September 6, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Imagine you get an email from someone claiming to be a Nigerian central banker. Yes, just imagine that. Your correspondent has heard that you are of sound character and good judgment, and is in search of a safe haven to store $3 billion in oil riches. In return you are offered untold goodies –- numerous investment opportunities and access to a huge potential market of middle-class consumers.

China is the lucky recipient of just such a communication. Nigeria’s central bank will transfer a tenth of its $33 billion foreign exchange holding into yuan assets, it said on Sept. 6. That fits with China’s ambition to turn its money into globally accepted tender that matches its status as the world’s second-biggest economy. It also deals another blow to the U.S. dollar’s status as the world’s reserve currency.

Nigeria isn’t the first to dip a toe into China’s yuan pool. The Philippines and Hong Kong too have discussed expanding yuan reserves, presumably to chase political favour and capture long-term currency appreciation. Investible assets aren’t easy to find, since China has barely any external debt. But central banks can invest in China’s interbank market, as Malaysia did in 2010, on a case by case basis.

Despite Nigeria’s bold move, China’s currency still has few of the qualities of a credible reserve currency. Low inflation is usually a pre-requisite, yet China’s runs at above 6 percent. Stable monetary policy is another typical condition, yet China lacks an independent central bank. Most importantly, China’s capital controls make it hard to see how holder of yuan reserve assets can liquidate them in a crisis.

Nigeria probably has other priorities, such as continued Chinese investment. The Middle Kingdom has been a keen partner for the oil-rich nation. Among other things it has signed a $23 billion agreement to build three oil refineries -– though little of that has yet been spent. Nigeria’s foreign investment fell to a five-year low in 2010, helped by a hostile business climate, endemic corruption and uncertainty around mired oil sector reforms. Nigeria’s yuan purchase looks more like a gesture of goodwill than a shrewd economic decision.

It would be a mistake to read too much significance into the move. But growing support for yuan reserves does represent another cut of confidence in the dollar. For the dollar to lose its status, it may need a thousand more such cuts. A trend, however, is emerging.

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