In the long run, a fully convertible renminbi will make things easier for global companies doing business in China. Shorter term, treasurers face hard choices.
Although officials in China remain committed to liberalizing the renminbi, their ham-fisted approach isn’t exactly furthering the cause. Indeed, the People’s Bank of China’s idea of a fully convertible currency doesn’t quite square with more accepted notions. The PBOC says it intends to maintain strict controls on the outflows of capital. Pan Gongsheng, deputy director of the PBOC, has termed the strategy “managed convertibility.” It is not clear if such a thing is possible. Moreover, the central bank’s surprise 1.9% devaluation of the reminbi—also known as the yuan— in August triggered a plunge in the currency’s value against the dollar. Chinese officials have warned of more “two-way”volatility.
The takeaway here is that treasurers at multinational companies doing business in or with China should be prepared for more bumps along the way. Protecting against this volatility while preparing for a free-floating yuan could prove to be tricky. The key, some observers say, is to acknowledge that the renminbi will eventually become a global reserve currency. “The situation we have witnessed in recent months is a distraction from the main game,” says David Olsson, a Melbourne-based lawyer in the China practice of King & Wood Mallesons. “Over the last year China has actually picked up the pace of financial market liberalization and deregulation. The internationalization of the renminbi is an irreversible trend.”
It certainly seems so. China first approved using the yuan for cross-border trade settlement in 2009. As of the end of 2014, SWIFT data shows the renminbi was the fifth-most-used currency for international payments. Ian Farrar, corporate treasury leader for PwC China/Hong Kong, believes the pace of yuan liberalization will come down to Chinese banks—and how prepared they are for a fully convertible renminbi. So far, domestic financial institutions have had to contend with fixed or capped interest rates.“As the banks gain experience, and as they tackle some of their problems with nonperforming loans, that will be the time that things can speed up further,” says Farrar.
The International Monetary Fund’s inclusion of the yuan in its Special Drawing Rights basket will also push things along. The IMF is expected to make the move next year. The Fund’s imprimatur will go a long way in establishing the renminbi as an internationally accepted reserve currency.
The internationalization of the renminbi is an irreversible trend.
~ David Olsson, King & Wood Mallesons
BENEFITS FOR TREASURY
A fully convertible yuan will clearly make it easier for corporate treasurers to boost working capital and better manage cash both in China and their offshore operations. In addition, the costs of treasury functions—from hedging to administrative tasks—are likely to go down. It will also be easier for treasurers to streamline financial flows as they incorporate China into their global liquidity management structures. “One possible impact of liberalization that treasurers are all looking forward to, though this is not yet our case, is the potential ability to more efficiently utilize cash generated in China in order to provide intercompany financing to affiliates that operate outside of China,” says Michael Connolly, vice president and treasurer of Tiffany & Co.
Enterprise-resource-planning giant SAP manages its working capital in China with few intercompany payments per year and invests surplus cash conservatively. But Andreas Hartmann, head of front office and regional treasury for the German company’s global treasury group, says a more open market in the People’s Republic of China (PRC) will have definite benefits for the software maker.“It keeps administrative workload low, speeds up external and internal approval processes—for example, in financing capital expenditures—as well as its execution and implementation.”
The liberalization of the renminbi is also likely to lead to an explosion of products for treasury tasks conducted in the Chinese currency. Software makers have been slow to develop such programs, owing in part to the many restrictions placed on the currency. “With the eventual full convertibility of the renminbi,” notes Kelvin Ang, director of the treasury advisory group of Citi Treasury and Trade Solutions, “corporate treasurers can look forward to standard global treasury practices such as unrestricted cross-border cash pooling and unrestricted capital market accessibility, both onshore and offshore.”
A free-floating renminbi does present some challenges, however. Consultants point out that, in the past, treasurers at many corporations haven’t seen much reason to hedge their currency exposure in China. The thinking: Beijing would keep the yuan closely aligned with the US dollar, thus limiting swings in the exchange rate. “Hence, there was really no pressing need to actively manage their values against the dollar, especially since China was expected to outperform the rest of the world and the ascribed long-term value of the renminbi would naturally be up,” says Benny Koh, treasury advisory leader for professional
services firm Deloitte Southeast Asia. “Its recent devaluation has certainly taken market participants by surprise and challenged that view.”
The wake-up call will likely see treasurers draw up more aggressive strategies to manage currency risk in China. “For companies with renminbi cash deposits,
treasurers could look at structured deposits, which incorporate derivatives to hedge against movements in interest rates of foreign exchange,” says Olsson. “Companies with excess renminbi liquidity can also explore liquidity management structures to optimize their onshore renminbi working capital amongst group entities as a way to reduce external bank lending onshore.”
Treasurers may want to review their business models to further reduce their yuan exposures. “If a company has been invoicing and collecting renminbi based on its sales but paying suppliers in other currencies,” Ang notes, “it may want to review its terms with Chinese suppliers to price, invoice and settle in renminbi so as to create offsets.” Treasurers should consider renminbi loans to offset long-term investments in the PRC.
Corporate finance executives must adjust to a world where the value of the yuan shifts more often—and more dramatically. But Beijing’s resolve to stay the course could temper such fluctuations. “Going forward, there will be even more volatility, and I wouldn’t be surprised by further depreciation,” says PwC’s Farrar. “But I don’t think we are going to see wild swings in the currency.”