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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 Foreign Exchange Risk ManagementARTICLE

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.

Doing business in China seems like a rewarding prospect, however, many businesses find it difficult to overcome cultural and language barriers, understand local business practices, comply with regulations and comprehend tariffs. China’s restrictive and complex foreign investment rules have hitherto made it difficult to establish businesses in China.

In June 2015, the State Administration of Foreign Exchange (SAFE) announced that Foreign Invested Enterprises would be allowed to convert Renminbi (RMB) for capital account transactions, through an authorized bank, without SAFE’s prior approval. This positive move should 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 RMB.2

Alternative Approaches To Doing Business In China

English is becoming more widely spoken in China, but Mandarin remains the principal language. However, 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. Working with a partner that has expertise in Chinese culture, politics and regulation can be invaluable.

When it comes to reaching your desired customer base in China it's hard to ignore the world's largest e-commerce market, which controls around 92 percent of global market share and in 2014 turned over $458 billion USD in sales.4 Selling goods through online portals provides access to the massive Chinese middle class in your preferred native currency.

Some businesses exporting into China may also be importing manufacturing components from China. If so, there could be a natural currency hedge, as some supplier invoices match a portion of sales revenue. In this case, it may be worth exploring an offshore bank account domiciled in China that can hold RMB denominated balances. Whilst such a facility may be difficult for some businesses to establish, it is becoming more realistic due to ongoing liberalization. Should foreign currency receipts be large and frequent, then regardless of whether or not there is a natural hedge, an RMB facility for customers to pay into has some merit.

If a foreign currency bank account is not feasible, then making transfers through an International Payments provider with outgoing and incoming payment solutions is a viable option. This can provide greater control over foreign currency receipts and payments.

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 RMB in August 2015 shows just how volatile things can be. When officials decided to lower the RMB’s trading band, its market exchange rate fell 4.4 percent in the space of a week. Exporters receiving RMB could have experienced a substantial fall in profits whilst importers possibly benefited from a reduction in cost.

Official moves towards internationalizing the RMB have led to the growth of an offshore RMB market based in Hong Kong. The offshore RMB, known as the CNH, floats freely against world currencies and is accessible by offshore entities for purposes such as trade settlement, making it ideal for importers seeking to hedge against RMB risk. Therefore, businesses can use CNH-denominated Foreign exchange risk managament tools such as FX Options, Forward Contracts or Non-Deliverable Forwards (NDFs) to smooth out currency fluctuations and reduce the risk of loss.

The Takeaway

According to the latest BIS Triennial Survey5, average daily turnover on the CNH market had grown to USD 22.3 billion by April 2013. If the trend continues to grow as many anticipate then even more businesses will welcome trade in CNH making it easier to manage currency risk, while moves by the Chinese government to liberalize the currency regime further and remove barriers to investment should, over time, make it easier to do business in China.

Jim Vrondas - The Author

The Author

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