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Doing business in China can be good for businesses if foreign exchange risk is managed well

Doing Business in China and Managing Foreign Exchange RiskArticle

By Jim Vrondas

The rise of the Chinese middle class as a major consumer potentially provides a very lucrative market for exporters into China. By 2030, an estimated 326 million new middle class people will emerge, taking the total to around 854 million.1 With per capita disposable income forecast to triple over that period, it's no wonder businesses are keen to establish an export path to China.

While doing business in China seems like a rewarding prospect, many businesses find it difficult to overcome cultural and language barriers, understand local business practices, comply with regulations and comprehend tariffs. For example, China’s restrictive and complex foreign investment rules have hitherto made it difficult to establish businesses in China; and China’s complex currency situation raises currency risk. It is therefore imperative for businesses wishing to trade in China to plan a strategy to mitigate foreign exchange risk.

Recent Events May Ease Yuan Foreign Exchange Risk

In June 2015, China’s State Administration of Foreign Exchange (SAFE) announced that Foreign Invested Enterprises would be allowed to convert yuan for capital account transactions, through an authorised bank, without SAFE’s prior approval. This move could reduce the time needed to set up a new company in China or make changes to a company's existing equity structure. In addition, at the World Economic Forum in China in September 2015, Premier Li Keqiang said that the Chinese government will "gradually achieve full convertibility" of the yuan.2

Cultural Challenges Yield Joint Ventures With Local Entities

Meanwhile, English is becoming more widely spoken in China but Mandarin remains the principal language. Yet even Mandarin is not universal, with an estimated 400 million Chinese unable to speak it and millions more far from fluent.3 Such barriers to understanding, plus pronounced cultural variation between different parts of China, can make it difficult to establish a foreign business. Because of this, many businesses choose to enter the Chinese marketplace by means of joint ventures with local entities. There are several forms of joint venture open to foreign businesses, of which the most popular is the Wholly Foreign-Owned Enterprise. However, there are restrictions on the types of business that these can undertake, and foreign businesses still have to navigate complex and opaque Chinese regulations and deal with several government agencies.

The world of online e-commerce now offers business access to sell to consumers in any market. China is the world's largest e-commerce market, and in 2014 turned over $458 billion USD. 4

Settling Overseas Invoices

Some businesses exporting into China may also be importing manufacturing components from China. If so, there could be a natural currency hedge against foreign exchange risk as some supplier invoices will match a portion of sales revenue. That eliminates currency risk for the matching portion by negating the need for currency conversion. Regardless of whether or not there is a natural hedge, China’s ongoing reforms are making it easier for businesses to establish a local yuan facility for customers to pay into, supporting the payment of foreign currency receipts.

Many businesses rely on the services of an international payments provider with outgoing and incoming payment solutions to manage this. This can provide greater control over foreign currency receipts and payments. International payment providers support the settlement of overseas invoices by Spot Contracts (also known as Telegraphic Transfers) or Forward Contracts.

Managing Foreign Exchange Risk in the Chinese Marketplace

Both exporters and importers are faced with currency risks when dealing with China, and the devaluation of the yuan in August 2015 shows just how volatile things can be. When officials decided to lower the yuan’s trading band, its market exchange rate fell 4.4 percent in three days.5 Exporters receiving yuan could have experienced a substantial fall in profits whilst importers possibly benefited from a reduction in cost.

Official moves towards internationalising China’s currency have led to an “onshore” and “offshore” split into a domestic yuan (with the symbol “CNY”) and offshore yuan (with the symbol CNH), as discussed in more detail here. This has led to the growth of an offshore market trading CNH based in Hong Kong. The CNH floats freely against world currencies and is accessible by offshore entities for purposes such as trade settlement and hedging against foreign exchange risk.

Foreign exchange risk management tools such as FX Options, Forward Contracts or Non-Deliverable Forwards (NDFs) are common ways to help manage currency risks and foreign exchange risk of loss.

The Takeaway

According to the latest Triennial Survey from the Bank of International Settlements (BIS),6 average daily turnover on the CNH market had grown to USD 202 billion (or AUD 266 billion) by April 2016. If the trend continues to grow, as many analysts anticipate, more businesses are likely to welcome trade in CNH, which will make it easier to manage currency risk. Meanwhile, moves by the Chinese government to liberalise the currency regime further and remove barriers to investment should, over time, reduce foreign exchange risk further and make it easier to do business in China.

Jim Vrondas - The Author

The Author

Jim Vrondas

With around 20 years’ experience in the financial markets industry, Jim is acknowledged as a thought leader in Foreign Exchange and International Payments. Often sought for comment by print and online media including the ABC, Sky Business, Bloomberg, 2GB Radio and Business Spectator.

Sources

1 “The rise of China’s middle class will create opportunities the world has never seen before”, Business Insider; http://www.businessinsider.com.au/chinas-rising-middle-class-will-create-opportunities-the-world-has-never-seen-before-2015-5
2 “China Faces Parlous Path Toward Yuan and Capital Liberalization”, Bloomberg Markets; http://www.bloomberg.com/news/articles/2015-09-15/china-faces-parlous-path-toward-yuan-and-capital-liberalization
3 “Hundreds of millions of Chinese stubbornly resist speaking the ‘common tongue’”, PRI; http://www.pri.org/stories/2013-12-03/hundreds-millions-chinese-stubbornly-resist-speaking-common-tongue
4 “Tmall, Yihaodian, and JD: A Comparison of China’s Top E-Commerce Problems for Foreign Enterprises”, China Briefing; http://www.china-briefing.com/news/2015/09/15/tmall-yihaodian-and-jd-a-comparison-of-chinas-top-e-commerce-platforms-for-fore
5 “China Seeks to Calm Markets as It Devalues Currency for 3rd Consecutive Day,” The New York Times; http://www.nytimes.com/2015/08/14/business/international/china-devalues-its-currency-renminbi-for-a-third-consecutive-day.html
6 Triennial Central Bank Survey: Foreign exchange turnover in April 2016, Bank for International Settlements; http://www.bis.org/publ/rpfx16fx.pdf

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