A better dealThe upshots are positive for Chinese firms and their UK partners alike. For businesses in China, being paid in US dollars (USD) carries a cost. It generally takes seven to ten days to convert the funds to RMB (which the supplier is obliged to do unless he is offsetting his own USD imports). The time value of that process and the administrative costs of making the transactions, as well as the loss of working capital, can be significant. By receiving payment, or making it, in USD, Chinese firms also take on the FX risk of currency movements. Consequently, Chinese firms have historically sought to cover their transaction costs, and hedge against adverse currency movements, by adding a premium to the prices they charge. The People’s Bank of China (PBOC) estimates the cost of transacting in USD, for Chinese firms, to be two to three per cent. When they factor in an extra margin to hedge their FX risk, price increases can be as much as eight per cent. If UK companies, are prepared to transact in Renminbi they can avoid those premiums and secure a better price. On the other side of the transaction, those selling into the Chinese market will find their goods or services more competitive in real terms as their buyers won’t suffer the additional cost of buying USD to facilitate a deal. UK businesses may even find new buyers altogether, as some Chinese firms simply won’t transact unless in their own currency. Buying goods from china to UK
Mitigating riskOf course, cross-border transactions carry currency risk whatever the denominations involved and the more liberal approach of the Chinese authorities means that fluctuations in Renminbi are ever more likely. Businesses wishing to transact in the currency need to be mindful and we are working more and more with UK SMEs looking to mitigate the risk of Renminbi price instability. The more open currency market means that mitigating against currency risk is easier. Deliverable forward contracts are now an option for businesses looking to lock in a given rate ahead of an agreed payment, or series of payments, in the future. Using such approaches, our clients are rightly looking to achieve as much certainty regarding cashflows as possible. The temptation can be to try and beat the market, picking exactly the right moment to buy and sell currency and extend any margins on a transaction in doing so. Timing the market, though, is a hugely difficult task. Even those solely focused on currency trading often get it wrong and so the long term chances for SMEs to benefit from any kind of currency speculation are minimal. Businesses will do far better to establish good trading relationships with their Chinese partners – many, though not all, will be looking for a Renminbi transaction – and adopt a safe and suitable approach. Forward contracts provide a guaranteed exchange rate for future income. Options offer a more sophisticated means to hedge against currency volatility – effectively allowing a business to exercise a contract if currency prices move unfavourably or buy at the market rate if it is better priced. Whatever solutions businesses choose, it’s obvious that the opportunities to trade with China are too great to ignore. As the Chinese government loosens its capital controls, taking advantage of those opportunities should become easier. SMEs need to be smart, though, and adopt a currency policy that works best for them and their trading partners in the long term.
Guido Schulz is global head of strategy of AFEX, a non-bank provider of global payment and risk management solutions.Image source
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