Home' A Plus Magazine : March 2016 Contents In August 2015, the renminbi stumbled.
Over three days the offshore rate for the
Chinese currency (CNH) weakened by
approximately 5 percent against the U.S .
dollar to reach 6.52 on 12 August. Many
pundits were puzzled: what did this mean
for the RMB?
RMB wars – the PBoC awakens
The volatility in currency markets contin-
ues unabated. In the blue corner, hedge
funds are openly targeting Asian currency
markets, including the RMB, trying to drive
them lower. In the red corner, the People’s
Bank of China is locking all the exits to stop
a mass outflow of its currency, including
the suspension of outbound pooling of RMB,
while buying RMB offshore to prop up the
CNH exchange rate.
What does the future hold?
That’s anyone’s guess. Can China man-
age its exchange rate lower in a gradual
fashion? If so, hedging might prove to be an
Will the PBoC allow the markets to take
a greater role in determining the value of
China’s currency, reducing its intervention
and raising the possibility of even greater
volatility? By closing several doors to
outflows of onshore RMB (CNY) this might
seem unlikely in the near term. But what if
speculators gain the upper hand and find
other ways to extract CNY, leading to the
potential for an untidy freefall, at which
point hedging might – with hindsight –
Time will tell. But in times of uncer-
tainty, forward-thinking companies often
seek to re-assess their exposure to, and
tolerance of, foreign exchange risk. How
much can they afford to lose? And if they
want to reduce their risk, what hedging
options are available?
Perhaps the simplest way to manage
currency risk is to avoid it altogether. But
in today’s world, few Asian companies
can afford to refuse to do business across
borders and currencies. Even where set-
tlement is in the company’s functional
currency, pricing in a competitive market
is often influenced by alternatives from
suppliers elsewhere. So insulating oneself
from every possible currency fluctuation
may prove unfeasible.
However, other simple strategies might
be available. For example, a company may
be able to source some of its purchases
in the same currencies as forecast sales.
Such natural hedges will mitigate cur-
rency risk, at least to the extent that such
forecasts are reliable.
Cash instruments – both bank deposits
and loans – can also be used to reduce
foreign exchange exposure. For example,
companies with large assets in China may
wish to take advantage of reduced interest
rates to draw down RMB debt. Mainland
assets may be mortgaged as security
for RMB loans, or funds raised through a
private placement in the China market. Not
only does this represent a balance sheet
hedge of RMB assets, but income gener-
ated from onshore assets may be used to
pay down the RMB debt.
Derivatives – good or evil?
For sure, derivatives have the potential to
create havoc with a company’s wellbe-
ing. Warren Buffett viewed derivatives as
time bombs, famously describing them
as “financial weapons of mass destruc-
tion.” But equally, they can be a very useful
weapon to have in the arsenal when fighting
For example, companies in China may
sell predominantly in RMB, but import raw
materials in USD. When the RMB strength-
ened, the reduced RMB value of imports
increased margins. In times of RMB weak-
ness, margins are squeezed. At some point
the business may become unprofitable.
Foreign exchange forward contracts may
be a good way to “fix” the cost of imports in
Managing currency risk
Ian Farrar explores the implications of the ongoing
uncertainty in the foreign exchange market for corporates
44 March 2016
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