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Trading in Chinese currency is advantageous and foreign exchange risk can be avoided.

Trading in Chinese Currency – How to Avoid Foreign Exchange RiskARTICLE

By Phillip Silitschanu

There are two types of companies out there: those who currently do business with China, and those who soon will. We all know there are tremendous opportunities to source Chinese parts, supplies and goods at very competitive prices, whether purchasing already-manufactured products through a distributor or having a Chinese factory produce products to your specifications. Yet no matter how a business decides to proceed in China, there is one common challenge: the foreign exchange risk associated with Chinese currency.

The Renminbi and its Exchange Rate

There is often confusion around the difference between the renminbi (RMB) and the yuan. Basically, the renminbi is the official currency of the People’s Republic of China ("renminbi" translates to "people’s currency"), while the yuan is a unit of that currency.1 Until 2005, the renminbi had long had its value pegged to the U.S. dollar. This meant that the Chinese government had tightly controlled the supply of the currency, in order to keep its foreign exchange rate very closely aligned to a fixed exchange rate with the U.S. dollar. Since 2006, however, a couple of things have changed. First, the renminbi has been split into “onshore” and “offshore” versions that are essentially the same with the following exception: the onshore version continues to trade within a narrow (2 percent) band around a midpoint set by China’s government, while the offshore version is allowed to float more freely – meaning its exchange rate can vary more widely.2 Second, in December 2015 China changed its “peg” for the onshore (domestic) version of the renminbi to a basket of many currencies, not only the U.S. dollar.3 Though some argue the currency has devalued slightly, the Chinese government’s diligence at keeping its exchange rate stable, along with its increased popularity have led to the inclusion of the renminbi in the International Monetary Fund’s (IMF) 2016 basket of world currencies.4 There it joins the British pound sterling, U.S. dollar, Japanese yen and euro.

Two Sides of the Same Coin

But because of the onshore/offshore split, the renminbi is unique in that it has two fundamental trading markets. When renminbi is traded in mainland China, for example in Shanghai, the currency identifier is "CNY"(for Chinese yuan). When it is traded outside mainland China, for example in Hong Kong, the currency identifier is "CNH." The set-up enables China to maintain greater control of its domestic currency and protect its U.S. dollar reserves, while supporting trade between Chinese companies or the Chinese government and foreign companies.5 Foreign companies doing business in China can accept CNY for payment, and then exchange it in Hong Kong at the CNH rate, which is usually more favourable.6 In 2009, the Chinese government began an experimental program where some transactions between businesses in the Guangdong and Shanghai provinces and, with other counterparties located in Hong Kong, Macau and a few other select Asian countries were allowed to be settled directly, circumventing the People’s Bank of China. This was slowly expanded in the years following, and today, businesses in all of China’s provinces are able to engage in cross-border transactions. A few countries have also signed agreements with China allowing settlement of currency exchanges with those countries to be settled in renminbi, without having to first convert the currency to U.S. dollars.7 Those countries include Australia, Japan, Russia, Sri Lanka, Thailand and Vietnam.

Foreign Exchange Risks Trading in Renminbi

Liquidity is the lifeblood of any traded security, whether the security is an equity, bond or currency. With lack of liquidity comes volatile pricing, and executing trades becomes more difficult. While the renminbi’s liquidity has improved as China’s government has relaxed its restrictions on trading of renminbi, there is still a long way to go before the renminbi is a truly global currency. And while there are still tight regulations on the trading of the renminbi, with complex policies in place, numerous companies turn to the renminbi in order to conduct their business with companies in China. Despite hurdles, the renminbi is steadily growing in volume and liquidity, and China’s government is striving to make the renminbi a truly global currency with a stable exchange rate.

Direct Trading with Renminbi to Combat FX Risk

Utilizing just one currency, like the renminbi, to execute foreign transactions with one exchange rate, instead of executing multiple transactions across different currencies and exchange rates, reduces foreign exchange risk by limiting exposure to multiple currencies. In other words, it is advantageous to an Australian company to exchange renminbi directly to AU$, rather than first for US$ and then changing US$ to AU$.

Other advantages include improving the working relationship with counterparties in China, by having direct foreign exchange transactions, allowing negotiation of more favourable payment terms, as well as engaging with a greater range of companies in China.

The Takeaway

Conducting currency exchange in renminbi can sometimes be complicated, but the advantages may outweigh the risks for many companies.

Phillip Silitschanu

The Author

Phillip Silitschanu

Phillip Silitschanu is the founder of Lightship Strategies Consulting LLC, and CustomWhitePapers.com. Phillip has nearly 20 years as a thought leader and strategy consultant in global capital markets and financial services, and has authored numerous market analysis reports, as well as co-authoring Multi-Manager Funds: Long Only Strategies. He has also been quoted in the U.S. Financial Times, Wall Street Journal, Barron's, BusinessWeek, CNBC, and numerous other publications. Phillip holds a B.S.in finance from Boston University, a J.D. in law from Stetson University College of Law, and an M.B.A. from Babson College.

Sources

1. "What’s the difference between the renminbi and the yuan? The answer to this and other questions in ‘Renminbi Internationalization’", Brookings Institution Press; http://www.brookings.edu/blogs/brookings-now/posts/2015/08/renminbi-internationalization.
2. "China's Yuan Devaluation And Its Impact On Global Exchange Rates & Businesses", American Express FXIP Blog; https://www.americanexpress.com/au/content/foreign-exchange/articles/china-yuan-devaluation-the-impact-on-exchange-rates/.
3. "China to Track Renminbi Based on Basket of Currencies", The New York Times; http://www.nytimes.com/2015/12/12/business/international/china-to-track-renminbi-based-on-basket-of-currencies.html.
4. "IMF Survey : Chinese Renminbi to Be Included in IMF’s Special Drawing Right Basket", International Monetary Fund; http://www.imf.org/external/pubs/ft/survey/so/2015/new120115a.htm.
5. The Connecting Dots of China’s Renminbi Strategy: London and Hong Kong, Chatham House; https://www.chathamhouse.org/sites/files/chathamhouse/public/Research/International%20Economics/0912bp_subacchi_huang.pdf.
6. "The Difference Between The Confusing Onshore And Offshore Renminbi Market", Business Insider; http://www.businessinsider.com/difference-between-onshore-and-offshore-renminbi-2013-2?IR=T.
7. "China Expands International Use of the Renminbi", China Business Review; http://www.chinabusinessreview.com/china-expands-international-use-of-the-renminbi/.

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