The question on the minds of China CFOs is how much further the yuan will depreciate against the US dollar? After a decade of gains the picture is starkly different today, with all the drivers that made the yuan strong having reversed.
We expect another 9% fall for the yuan towards 7.5 to the US dollar in the next three to four years. For 2017, a mild depreciation to 7.0 is forecast due to the positive economic carry-over from last year’s stimulus spending and the threat of a US-China trade war.
While China has the largest forex reserve in the world, it only accounts for 14% of China’s money supply, implying high vulnerability to capital flight. Market surveys show that 10% of household assets would go offshore if permitted. In 2015, upon relaxing years of tight capital controls, rapid yuan outflows showed the extent of pent-up demand for global diversification amongst Chinese corporates and residents.
The pressure of continued foreign reserve depletion will lead to tight capital controls, curbs on outbound investment in non-strategic sectors such as property and entertainment, and efforts to bring shoppers back to China to narrow the trade deficit in services. Practically speaking, CFOs now have to navigate tight rules not just on cross-border US dollar transactions, but on cross-border RMB ones as well.
Typically, MNCs have three financial hedging options: the onshore hedge (the CNY forward); the offshore hedge (the CNH forward); and the non-deliverable forward (futures contract). No one option is suitable for all. As one CFO at a recent China Management Forum meeting put it, ‘One cannot say it is always good to do CNH or CNY for hedging; it depends on one’s business, on the specific market situation, and liquidity in the market at that time.’
Firms can also look at the way their business is structured to reduce exposure to China’s currency risks. One member found that making his firm’s forex risk visible to executives on a regular basis spurred fresh thinking about their options. He found that, ‘Something changed when the financial department published the forex exposure business-by-business on a weekly basis – automatically new ideas came out.’
Several operational tools can be used to reduce forex exposure: working capital polices; intercompany loans; procurement policies; and reducing exposure in the supply chain.
Depending on what is imported, payment terms with suppliers can be shifted between RMB and USD. At times, the best ideas might go against long-held beliefs (such as increasing inventory denominated in US currency) because it is the cheapest hedge available. When ideas for operational hedges surface, global or regional headquarters’ support may be necessary if the solutions go to the heart of the business.
IMA Asia members can read more in-depth highlights from the discussion via login.