Protecting your profits in emerging markets

Foreign exchange is a challenge that importers take on when trading with flourishing countries such as China, but there are ways to mitigate the risks involved. Justin Logan writes.

MARKET fluctuations, banking restrictions and payment processing are only a few factors that pose chal lenges for companies doing busi ness in an emerging market like China.

But there are ways to mitigate the risks involved, including how companies manage their foreign exchange requirements.

By understanding the key processes behind international transactions, businesses can budget more effectively, negoti ate better pricing options with suppliers and manage the risks of currency fluctuation on their bottom line.

The first option for mitigating exposure to currency fluctuation is to pay suppliers in local cur rencies, for example the Chinese Yuan (CNY).

This involves only one conver sion for an easy and transparent transfer of funds, which eases the fees that local banks charge suppliers who receive interna tional payments.

What costs might a foreign supplier face on receiving a dol lar payment?

Foreign banks are likely to leverage the fact that the benefi ciary has no opportunity to nego tiate the exchange rate.

Premiums up to 10% over interbank spot rates are not uncommon in some parts of the world, not to mention transaction fees.

The costs and delays to a for eign recipient of dollars can be substantial, which presents an opportunity for the importer to negotiate a better price by reducing the costs faced by the supplier.

Less money in the hands of the foreign bank means more money shared between supplier and importer. You could expect a dis count of 2% to 10%.

But isn’t the importer now stuck with managing any foreign exchange costs and risks?

It is important to realise that the payor has a lot more flexibili ty around associated risks.

For one, the payor can review the offerings of different foreign payments providers, and negoti ate competitive rates and fees.

However, paying suppliers in local currencies isn’t your only option.

China’s nuance

A key nuance in the Chinese market, for exam ple is that suppliers often prefer payment in US$ rather than CNY.

In some industries, the Chinese Government offers favourable tax treatment for local companies being paid in US$.

As a result, businesses are exposed to currency risk if the Yuan rises against the US$ and Chinese exporters increase prices to compensate for curren cy fluctuations.

So, the second option for miti gating currency exposure is to use a Non-Deliverable Forward Contract (NDF).

This allows you to continue to pay Chinese suppliers in US$ while hedging the risk of the CNY’s eventual rise against the dollar.

This lets you project expenses, plan fiscally and protect your bottom line.

An NDF works the same as a standard forward contract where businesses lock-in an exchange rate for a future date.

The difference is that at the time of its expiry the contract is closed-out instead of delivered, resulting in a market-to-market gain or loss for the holder.

Let’s say you lock in a Forward Contract to exchange US$1000 for CNY in three months time.

Should the Yuan rise against the dollar in that period, you receive back more than your original amount because the CNY would now be worth more US$.

An NDF balances out the appreciation of currencies like the Yuan against the dollar and ensures companies are protect ed.

With any emerging market, such as China the ability to man age your company’s risk is essen tial for improved fiscal planning and protecting your bottom line.

By understanding the options available when dealing with international suppliers, you place your business in a position to prosper.

* Justin Logan is Corporate Branch Manager with Custom House, A Western Union Company.

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