A few weeks ago, I had the pleasure of attending the Agenda trade show in Long Beach, California. While perusing the various booths filled with the latest and greatest from within the action sports industry, I noticed however, that most of the products exhibited were made in China. Digging deeper, I further learned that many of these Chinese manufactured products had been invoiced and paid for using U.S. dollars; thus, I felt the need to disclose the truth behind Chinese invoices in USD and provide a list of alternative options.
In 2011, China opened the doors allowing government approved banks and select manufacturers to directly settle foreign payments in the Chinese Renminbi (RMB); however, all payments had to travel through Hong Kong first. Then, in the beginning of 2013, China loosened restrictions even further which allows foreign financial institutions to now settle direct payments straight to mainland China, streamlining the process. So what does this mean for you? Well, according to a representative survey by Deutsche Bank in August of 2012, reports showed that companies were able to lower prices in negotiations with Chinese business partners by an average of 4.8% when switching invoice settlements to the RMB. Another report by J.P. Morgan found a majority of their customers requesting duel invoices – one USD and one RMB- that the USD invoice amount was averaging 3-5% higher than those of RMB. Why the hefty variance? Well, let me explain.
When a U.S. company signs a contract with a Chinese supplier, the negotiated price is almost always done in USD. These contracts can vary; some pricing is negotiated on a per order basis while others may involve a number of orders over a period of time. If you run off a monthly ordering cycle, and have negotiated a fixed rate in USD, the Chinese suppliers know the rate of exchange can fluctuate and hedge their risk by marking up their invoices between 3-5%, adding to the total cost. The longer a contract lasts, the more FX risk a supplier has, and the more an invoice will be priced up. Unfortunately, the only way to determine the exact markup amount is by requesting invoices in both USD and RMB. By switching invoiced to local RMB currency, both the vender and supplier can benefit.
The cost savings opportunity of switching invoicing to CNY are present and will likely increase as the Chinese government continues to reduce its restrictions on foreign banks. However, results will vary depending on the nature of your business and the products you buy. Before speaking with your supplier about switching payments to local Chinese currency here are a few things you should know:
• The generic term to Chinese Currency is Renminbi (RMB); however, the real name is the Yuan.
• China has two tradable currencies: CNY (mainland currency) and CNH (off-shore currency). Until 2013 companies were required to settle CNH payments in Hong Kong, but, because of recent events select financial institutions are now able to send CNY payments directly too approved mainland banks.
• Paying Chinese manufacturer invoices in CNY allows for more transparency and reduces the amount of hidden fees and add-ons
• Paying in CNY directly to the manufacturer can speed up the payment process by as much as 4-6 days.
• By managing the FX risk on the buyer side, buyers are able to enhance their protection against any currency fluctuations through the use of hedging. This will become increasingly necessary since experts believe the Yuan is approximately 40% undervalued against the dollar and has yet to reach its equilibrium market price.
Currency Summary August 1-12
The U.S. economy continued its slow rebound the past two weeks as reports indicate the nation's debt levels have decreased and gross domestic product has expanded at a 1% annualized rate. However, this could change following the Federal Reserve Board's meeting this week to discuss its monthly $85 billion buy back policy. If things keep on tract, this should help the dollar significantly. Meanwhile, in Canada, the Canadian Dollar (CAD) has reached the highest level in a month as the price of crude oil, which is their largest export, remains above the $100 point for the 18th day straight. South of the boarder in Mexico, the Peso (MXN) has rebounded from its sharp decline, also on rising crude prices. Meanwhile, the Brazilian Real (BRL) is still currently trading down versus the dollar, as the central bank resumes currency swap auctions.
The euro has been in a steady uptrend since the start of July. The ECB also reports interest rates tomorrow. Meanwhile, across the pond, the British Pound (GBP) is expected to drop as rate differentials indicate that it is currently overvalued. This could change though if demand for a stronger currency continues. The Bank of England will be reporting monetary policy this week and releasing its inflation report next week. These are things worth bringing up.
The Chinese Yuan (CNY) dropped the most in 3 weeks today over concerns that China's government will intervene once again and devalue the currency in order to revive economic growth. Favorable forward rates provide an opportune time to hedge against the Yuan. In Japan, the Japanese Yen (JPY) jumped slightly upwards as the demand for safe haven currencies has increased. This should help their local venders with A/P in USD. Down south in Australia, local bonds are speculated to start re-bounding as the Reserve Bank of Australia hints at lower borrowing costs. Spurring foreign interest which should strengthen the Aussie dollar (AUD) during the next few days. If you live in Australia and have USD A/P, pay them now because this boost will most likely be short lived. Check back in on the 15th for further updates and reports.
ABOUT THE CONTRIBUTOR: Nathan Carroll was a professional surfer in Hawaii for over 10 years and has always been passionate about global economics and international markets. When he retired from surfing he joined the FX Sales &Trading team at GPS Capital Markets, Inc. (www.gpsfx.com), a Corporate Foreign Exchange Firm. Currently, he is working with a variety of global action-sports brands helping them improve their processes surrounding FX transactions. Through identifying and managing their foreign currency risk, these companies are better protected and adapted to the volatile market conditions.