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 parts, supplies and goods at very competitive prices from China; through either purchasing already-manufactured products through a distributor or by having a factory in China produce products. No matter how a business decides to proceed in China, there is one common challenge: the foreign exchange risk associated with Chinese currency.
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. The currency of the United Kingdom would be the most comparable analogy, with "Sterling" being the official currency, and the "Pound" being the nominal unit of currency. Until 2005, the Renminbi had long had its exchange rate pegged to the United States 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 United States Dollar. Since 2006, however, the Renminbi has been allowed to float, meaning its value and exchange rate can vary within a relatively narrow band above or below a fixed foreign exchange rate that is determined by referencing a basket of other countries’ currencies. 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.
Two Sides of the Same Coin
The Renminbi is unique in that there are two fundamental markets where it is traded, and depending which market it is traded in, the currency identifier is different. When the Renminbi is being 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." Prior to 2009, the Chinese government had exceedingly strict controls on the export of the Renminbi outside of China, and its use in international transactions was severely curtailed. While transactions between Chinese companies or the Chinese government and foreign companies could occur, payments between entities had to pass through the People’s Bank of China. Chinese companies could not hold foreign currencies, and foreign companies could not hold Chinese Renminbi, with the result being that the People’s Bank of China had a monopoly on all currency exchanges into and out of China. In turn, payments and conversions were being settled at the government controlled currency exchange rate.
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. Those countries include Australia, Japan, Russia, Sri Lanka, Thailand and Vietnam.
Foreign Exchange Risks Associated With Trading in Renminbi
Liquidity is the lifeblood of any traded security, whether the security is an equity, bond, or currency. With a lack of liquidity, there is a lack of accurate pricing, and executing trades becomes ever more difficult. While the Renminbi’s liquidity has improved as China’s government has relaxed its restrictions on trading of the 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.
Advantages of using the Renminbi
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.
Other advantages also include improving the working relationship with counter-parties in China, by having direct foreign exchange transactions, allowing negotiation of more favorable payment terms, as well as engaging with a greater range of companies in China.
Conducting currency exchange in Renminbi can sometimes be complicated, but the advantages arguably outweigh the risks for most companies.