MARKET fluctuations, banking restrictions and payment processing are only a few factors that pose challenges for companies doing business in an emerging market like China.
But there are ways to mitigate the risks involved, including the ways in which companies manage their foreign exchange requirements.
By understanding the key processes behind international transactions, businesses can budget more effectively, negotiate 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 currencies, for example the Chinese Yuan (CNY).
This involves only one conversion for an easy and transparent transfer of funds, which eases the fees that local banks charge suppliers who receive international payments.
What costs might a foreign supplier face on receiving a dollar payment?
Foreign banks are likely to leverage the fact that the beneficiary has no opportunity to negotiate 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 foreign 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 discount 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 flexibility around associated risks.
For one, the payor can review the offerings available from different foreign payments providers, and negotiate to make sure they receive competitive rates and fees.
However, paying suppliers in local currencies isn’t your only option.
A key nuance in the Chinese market, for example, is that suppliers often prefer payment in US dollars rather than their own currency, CNY.
In some industries, the Chinese Government even offers favourable tax treatment for local companies that are being paid in US dollars instead of in CNY.
As a result, businesses are exposed to currency risk if the Yuan rises against the US dollars and Chinese exporters increase prices to compensate for currency fluctuations.
So, the second option available for manufacturers mitigating currency exposure is to use a Non-Deliverable Forward Contract (NDF).
This allows you to continue to pay Chinese suppliers in US dollars while hedging the risk of the CNY’s eventual rise against the dollar.
This also lets manufacturing businesses project expenses, plan fiscally and protect their 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 being delivered.
This then results in a market-to-market gain or a 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 would receive back more than your original amount. This is because the CNY would now be worth more US dollar.
An NDF balances out the appreciation of currencies like the Yuan against the dollar and ensures companies are protected against loss.
With any emerging market, such as that of China, the ability to manage your company’s risk is essential for improved fiscal planning. It is also essential to protecting your business’s bottom line.
By understanding the options available to you when dealing with international suppliers, you inherently place your business in a position to prosper.
* Justin Logan is corporate branch manager with Custom House, A Western Union Company.