Nervous China factory owners hedge on yuan foreign exchange risk

Yuan volatility has forced some Pearl River Delta firms to hedge foreign currency threats, adding to an already challenging environment

PUBLISHED : Tuesday, 18 March, 2014, 1:11am
UPDATED : Tuesday, 18 March, 2014, 1:11am

Pauline Ngan Po-ling is considering resuming hedging foreign exchange risks by buying yuan forward contracts in anticipation of more volatile exchange rates following the central bank's unexpected move over the weekend to expand the yuan trading band.

The deputy chairwoman of one of the world's largest makers of caps, Mainland Headwear, is worried about unpredictable movements in the yuan as the People's Bank of China allows the currency to move up or down 2 per cent daily on either side of a mid-point set under the guidance of the bank.

The trading band was expanded for the third time since the currency reform in 2005. It was first doubled from 0.5 per cent in May 2007 and now doubled again from the 1 per cent set in April 2012.

I’m fine with currency liberalisation, but it has to be gradual

"Yuan is getting more volatile, but still controllable within the 2 per cent band," said Ngan. "I'm fine with currency liberalisation, but it has to be gradual."

Mainland Headwear, which produces caps and hats in Shenzhen for export to the US and Europe, stopped buying yuan forward contracts at the end of last year, when the yuan appreciated sharply against the US dollar.

Like tens of thousands of manufacturers in the Pearl River Delta's "factory of the world", the company is exposed to significant currency risks - the weaker the value of the yuan, the better it is for exporters.

Currency volatility would exacerbate the already challenging operating environment with soaring wages, protracted labour shortages and industrial reforms.

As a result of the widening of the trading band, the yuan yesterday tumbled to an 11-month low when the onshore spot rate slid 0.45 per cent to 6.1781 to the dollar in Shanghai, according to China Foreign Exchange Trade System prices.

Mizuho Bank said it expects the yuan will depreciate in the short term, but return to its usual appreciation trajectory in the second half of this year and hit as high as 6.05 to the dollar.

Tim Condon, head of ING Financial Markets Research, said: "The Saturday surprise was not a reserve requirement ratio (RRR) cut but a doubling of the US dollar-yuan trading band."

The market widely expected that a cut in the RRR, or the amount of cash banks must set aside as reserve when lend- ing, was on the cards last week when People's Bank of China governor Zhou Xiaochuan said Beijing would push more aggressive reforms in interest rates and yuan.

The central bank aims to create a market-oriented floating currency and achieve basic renminbi convertibility by 2015-2016.

The market sensed a policy change early last month when the yuan unexpectedly took an abrupt turn and sank 1.4 per cent against the dollar in February after hitting record highs between December and January.

Johnny Yeung Chi-hung, vice-president of the Chinese Manufacturers' Association of Hong Kong, said he will pass some currency risks on to clients by factoring in a higher yuan exchange rate. Yeung, also chairman and chief executive of Hong Kong-listed headphone and earphone firm Fujikon Industrial, hedges currency risks through buying forward contracts.

"We plan to fix our product prices higher because we are betting that yuan will get stronger by the end of this year, perhaps go below 6 per US dollar," he said. "Yuan movement is getting increasingly hard to predict."

Condon said the latest round of band widening will spur the US dollar-yuan offshore market through an increase in hedging activities.

"The latest move increases [hedging risks] even more, which encourages hedging activity to shift to the offshore market, where, since the band widening in April 2012, the currency pair has traded closely together."

Grant Thornton managing partner Daniel Lin said companies should consider hedging their foreign exchange risks as banks are starting to sell yuan hedging products.

"[My clients] are constantly looking at some mechanism to better hedge renminbi risks," he said. "Some of our clients had not considered that before because they might not have had access to the right products."

To offset higher costs and currency risks, Yeung said Fujikon is rolling out higher-end products. However, the company is yet to decide whether it should move outside the Pearl River Delta.

"We thought about relocating our production base elsewhere, but it's still not feasible because we depend heavily on peripheral industries and supply chain services," he said.

Additional reporting by Benjamin Robertson