Risk ManagementCorporate FinanceGlobalization
China’s regulators like to play it safe when it comes protecting the renminbi--often at the expense of the dollar
By Duncan Wood
The State Administration of Foreign Exchange is China’s currency watchdog. The acronym is perfect: SAFE by name and it would seem by nature as well, zealously scrutinizing any transactions that could erode state control of the renminbi and undermine China’s export-led economic boom. The problem for SAFE is that things are not so safe at the present.
The dollar continues to move south and economic forces have prevented the renminbi from following: In June 2006, one dollar would buy just over eight renminbi.
Today, it buys just over seven. Only intervention by Chinese regulators has kept the rate of currency appreciation manageable, but a treasury executive with one U.K. corporate that has built a large business in China argues that an inflexion point is coming: “If you look at what China is doing onshore, they are artificially holding down the renminbi in order to protect exports. That’s a situation that just can’t last.” And if it can’t last, Chinese authorities will have to give local companies more freedom to manage their own cash and risks.
Not surprisingly, the government’s first response has been to split the baby by tightening control, while simultaneously setting up experimental pooling projects with a few trusted multinationals. In December, the Chinese central bank topped off its round of rate hikes by slapping limits on the amount of money that the nation’s banking sector can lend, in an attempt to regulate runaway growth. In conjunction with existing restrictions on converting foreign capital for renminbi, the net result has been to make local currency funds much harder to obtain.
Of course, companies with an existing presence may already have a positive renminbi balance, but moving cash from one entity to another falls foul of Chinese rules that forbid corporates from making loans, even if the money is going to another part of the same group.
However, there are reports that a few multinationals have gained approval from the local regulators to use a rudimentary form of cash pooling. “It involved a lot of dialogue with the authorities and it was definitely a time-consuming process, but the company we advised thought that it was better to make the effort than to continue with the status quo,” explains Jane Jiang, a Beijing-based senior associate with law firm Allen & Overy. Jiang refuses to identify the company in question, but General Electric has confirmed to Treasury & Risk that it is one of the handful of corporates involved in what appears to be a pilot scheme.
In most other respects, China’s controls remain as strict as ever – for example, hedging the renminbi remain a major headache. “You can do forwards, swaps and options in other currencies as long as there is a genuine underlying exposure to be managed, but the renminbi is different. Any foreign currency transactions involving renminbi require a de facto currency conversion and that has an impact on monetary policy,” says Allen & Overy’s Jiang.
The solution favored by many foreign corporates is to use offshore markets instead. Banks in Hong Kong and Singapore are doing a roaring trade in non-deliverable forwards (NDF), which don’t involve an exchange of different currencies but do allow treasurers to hedge against price movements by betting that the rate will rise or fall by a certain date and then, when the contract matures, settling the difference between the predicted rate and the actual rate in cash—so, treasurers who believe that the renminbi is going to rise have been seeking to offset the expected impact by entering into an NDF contract which would pay out if the currency does appreciate.
Unfortunately for corporate treasurers, it’s becoming more and more expensive to put on this kind of trade, principally because there is no realistic prospect of the renminbi reversing direction against the dollar says Peter Wong, founding chairman of the International Association of CFOs and Corporate Treasurers, China (IACCT China): “That’s making it more costly to hedge. Three months ago, buying renminbi forward already looked expensive—but now those rates would seem relatively cheap.”
The alternatives are either untested or risky. One option is to look for a proxy hedge—a way of offsetting a renminbi exposure with a matching, reverse exposure to another currency. The key here is to find a currency which can be relied upon to closely mirror the behavior of China’s currency.
Until recently, it had been relatively common to see corporates use the Malaysian ringgit as a proxy for the renminbi. Tim Pagett, a partner with PricewaterhouseCoopers in Beijing, says that this technique represents a viable alternative hedging strategy but he warns that proxy hedges can go horribly wrong if the relationship between the two currencies changes: