Published: October 12, 2011
With China now the second largest economy in the world, no company can afford to ignore the strategic opportunities for sourcing and selling in China. With significant restrictions on the RMB posing particular challenges for companies operating in China in the past, there has been reticence in many cases to invest too heavily in China due to the potential issue of “trapped” cash. With fiscal and currency reforms gradually being introduced, including the development of an offshore RMB market (CNH), a key issue for treasurers and finance managers, and their colleagues in procurement and sales, is how to take advantage of new opportunities to enhance their trading activities in China.
A major example of currency liberalisation in China is the RMB cross-border settlement scheme, launched in 2008. Initially, the scheme was launched on a pilot basis, enabling foreign companies to settle cross-border, authorised trade transactions with a limited number of mainland designated enterprises (MDEs) in specific cities. As the scheme became established, the eligible cities and provinces, and therefore the number of eligible MDEs quickly grew. In June 2010, all Chinese importers in the pilot regions became eligible, and by December 2010, the number of designated exporters had grown to over 67,000, representing 30% of total exporters. Since August 2011, the geographic boundaries have been lifted so exporters across China are eligible to apply for MDE status.
A major example of currency liberalisation in China is the RMB cross-border settlement scheme, launched in 2008.
The gradual expansion of the RMB cross-border settlement scheme, together with growing familiarity and confidence by foreign companies, has resulted in the volume of cross-border trade settled in RMB accelerating considerably over the past two years. While initially Chinese buyers fuelled the growth in RMB-denominated cross-border trade, which indeed was a major driver behind the scheme, the volume of exports under the scheme is also now increasing as the restrictions on exporters have continued to lift. According to the Hong Kong Monetary Authority, while the RMB-settled volume accounted for less than 1% of cross-border trade during the first half of 2010, by the end of the year, this had risen to 4%. In quarter 1, 2011, RMB cross-border trade grew 7% and had reached 10% by the end of quarter 2. Estimates earlier this year suggested that 12% was possible by the end of 2011 but based on recent growth, this is likely to be conservative.
While the ability to settle cross-border trade transactions in RMB is a new phenomenon, larger MDEs in China with sufficient negotiating power have been pricing sales to foreign customers in RMB and demanding RMB-denominated pricing from foreign suppliers for a long time. At the point of settlement, the transaction was then settled in the agreed foreign settlement currency (e.g., USD) at the exchange rate valid on the settlement date. This applied not only to transactions conducted on open account, but letters of credit were also being denominated in RMB, with settlement in foreign currency equivalent, and MDEs too can now settle these in RMB. Settling transactions in RMB is clearly an advantage for Chinese companies as their foreign exchange risk is eliminated, but there are increasingly advantages too for foreign companies, particularly those with both payables and receivables in RMB. By enabling exposures to be netted, currency risk is removed and margins can be preserved, greatly enhancing companies’ ability to do business in the region without ‘trapping’ cash or creating significant currency exposures.
Transactions priced in USD or another foreign currency have not been immune from risk for foreign suppliers or buyers. With rapidly increasing labour costs as well as currency appreciation, longer-term USD-denominated contracts have often been subject to renegotiation, which has resulted in uncertain costs and revenues for foreign companies. These issues that result in fluctuation of contract pricing are only set to continue, with many industries and companies located in the coastal cities in particular struggling to attract a suitably skilled workforce to deal with increasing customer and supply demands, despite workforce surpluses in other parts of the country. In March 2011, Yin Weimin, Chinese minister of human resources and social security, explained that the minimum wage was expected to increase by 13% over the next five years, but some industries are seeing double digit rises, particularly assembly line businesses where staff turnover often exceeds 25% and wages increased by over 40% in 2010.
[[[PAGE]]]
Both treasury and procurement have a strong vested interest in the terms of export and import transactions, so determining an appropriate strategy for trade with companies in China should be an important issue for both business functions, particularly as RMB liberalisation continues.
For companies that previously denominated transactions in RMB, but settled in USD, particularly those with both assets and liabilities in RMB, RMB settlement may offer considerable opportunity to reduce FX exposure and ensure price certainty. For transactions previously denominated in USD, switching to RMB as the contract currency may also create greater predictability of costs and income, and treasury can then hedge RMB appreciation to some degree.
While Hong Kong has become the offshore RMB (CNY) trading centre, Singapore and London, in particular are next.
Linked to liberalisation of the RMB, the development of an offshore RMB market (referred to as CNH) also provides significant opportunity for foreign multinationals doing business with entities in China. This is particularly the case since July 2010, when CNH became a deliverable forward currency in Hong Kong, so RMB earned on cross-border sales can be exchanged into other currencies such as USD, EUR, JPY and HKD. For example, we are working on a 5 year procurement contract with a major UK corporation for purchasing capital equipment in RMB, which is highly attractive from a pricing perspective, even though the company does not receive cash flows from China. Procurement and treasury should therefore be looking across the entire group to review trade flows into and out of China, and determine how costs can be controlled by leveraging RMB as a currency, and also how currency risk exposures could be moved out of the country. A company may look at the opportunity to move USD risk away from its Chinese subsidiary, which cannot be managed as easily within China, but offshore, this risk can be effectively netted through trade flows across the group.
There are some other interesting trends emerging too as a result of RMB liberalisation. In some cases, whole industries are shifting to RMB as a primary trading currency: China is now the world’s largest producer of packaging materials, and this is an industry in which transactions are rapidly switching from USD to RMB. In other cases, we see evidence that RMB is being used for transactions that are typically denominated in USD globally, irrespective of the local currency. For example, in July 2011, Australian group Fortescue Metals announced that it was now transacting sales of iron ore to buyers in China in RMB. While such an announcement would not seem to be surprising bearing in mind the levels of growth in RMB trade that we have seen, it is significant in that commodities transactions are typically denominated in USD or GBP, depending on the commodity, on a global basis, irrespective of the location of either buyer or seller. With these types of precedent, that are likely to have a major impact on buying practices of the future, procurement and treasury need to work together to determine a group-wide response and strategy for reducing risk, fixing costs and exposure.
The introduction and subsequent expansion of the RMB cross-border trade settlement scheme, and the creation of an offshore RMB market continues to develop rapidly as part of the Chinese Government’s 12th Five Year Plan (2011-2015) that aims to boost cross-border use of the RMB and facilitate international trade and investment. In August, the Chinese government gave Renminbi Qualified Foreign Institutional Investors (RQFIIs) an initial quota of RMB20bn to invest in mainland China’s RMB-denominated securities market, and allowed mainland Chinese investors to invest in the Hong Kong Stock Exchange’s ’Exchange-Traded Fund’. The Chinese Ministry of Finance also announced that it would issue RMB20bn in RMB-denominated bonds in Hong Kong.
These measures are a significant step forward in promoting RMB China’s national currency as a major international reserve currency. During a conference in September 2011 organised by the Hong Kong Monetary Authority, bank chiefs and corporate finance executives indicated their view that RMB will rapidly become an alternative or even preferred international settlement currency, not only for pan-Asian trade, but on a global basis. Furthermore, while Hong Kong has become the offshore RMB (CNY) trading centre, Singapore and London, in particular are next. Companies need to determine an appropriate strategy for trade in China, based on their procurement and finance needs, as well as sales. Liberalisation is by no means yet complete, and challenges still remain, but by working with the right banking partner that can understand and address the company’s regional and global needs, companies can implement a flexible strategy by which they can take advantage of continuing deregulation.
How Thought Leadership Can Reduce the Cost of Sales by Patrik Havander, Havander & Partners A focused attention on the costs incurred by the global sales and marketing processes is becoming increasingly important for corporate banks and their transaction banking departments. While the client/bank relationship remains vital, research has shown that in fact relationship selling […]
