The Canton Fair, China’s largest annual import and export trade show, has long been the barometer of the dragon’s economic health. The latest gathering in Guangzhou last October had many Chinese merchants scratching their heads (besides working hard to bargain up their goods and lure buyers to sign on the dotted lines)—about an increasingly volatile renminbi?
In April this year, their fears were heightened. China's central bank widened the daily trading band to 1% from 0.5%.
The daily trading band limits only intra-day volatility and has no bearing whatsoever on the day-to-day movement of the renminbi exchange rate determined by the PBoC. But the clear indication from the central bank is that volatility is here to stay.
And volatility matters. If you need to ship a cargo-full of Christmas toys destined for Walmart’s US superstores a year from now and you could end up booking a loss if the yuan-US dollar cross rate fluctuates beyond your assumption. This mathematics troubles them.
Since China settles most of its international trade in US dollars, hundreds and thousands of Chinese exporters, many of whom are small and medium enterprises with no budget for or understanding of financial hedging products, they are often at the mercy of the global currency wars.
While the bigger Chinese players can enter swaps with the help of major PRC banks, derivative products are highly regulated in China and are off-limit to most mum and pop shops.
Some PRC “treasurers” (the term is rarely used in China, but their tasks are usually handled by the corporate “chief accountants” and CFOs) resort to grass-root hedging—by adding a buffer to the traded amount, a not-so-precise assumption they figure out in their heads. And the unlucky ones end up absorbing the loss bitterly, since forfeiting a contract can ruin your business reputation.
Meanwhile, others have tried to convince their foreign clients to settle in renminbi, but with few successes: their customers complained that it is hard to buy renminbi in the international market since it is largely illiquid.
The bargaining power of renminbi will only peak when China becomes the world’s major buyer, not the seller. Contrary to global oil trade protocol, Iran willingly accepts the renminbi for its oil since China is one of the dwindling numbers of customers she has left under current US-led trade embargo.
With no crystal ball in hand to predict movement of the renminbi against the dollar, Zhou Zhongfei, vice president of Shanghai University of Finance and Economics, advises PRC enterprises to settle their trade earlier, preferably by limiting their contracts to a year or less.
Another option is to include extra room for negotiation.
A treasurer for Hong Kong medical equipment company which manufactures in the mainland and ships to Europe and the U.S., says he has added a clause in the contract stipulating that if the renminbi-US dollar cross rate fluctuates beyond an agreed range, then the parties reserve the right to renegotiate the contract again.
With all that said, FX risk is only one of the issues that keep Chinese exporters awake at night as they tackle sluggish demand in the mature markets.
“With the rising costs of raw materials, and a hike in Chinese workers’ wages and operation expenses, the currency risk is only one of the variables we have to rein in within our business operations,” the treasurer says.