Today as the international trade situation changes dramatically, in the context that the Federal Reserve System (FED) from time to time adjusts the monetary strategy resulting in great changes to the monetary exchange rate of some popular markets for home appliance exports, how to avoid the exchange rate risk has become the problem that every enterprise needs to solve.
In 2020, Chinese Yuan currency went through a wave of “first depreciation and then increase in value” trend. In 2021, Chinese Yuan currency is still going up. On January 4, the onshore CNY exchange rate against the US dollar rose nearly 800 points in a single day. On January 6, CNY continued to increase, with the central parity rate upregulated by 156 basis points against US dollar to 6.4604, creating a new highest record since June 20, 2018. On the morning of January 20, the central parity rate of CNY against the US dollar was CNY 6.4836, increased by 47 basis points from CNY 6.4883 on the previous trading day. Notably, although CNY ushered “good start” in early 2021, the appreciation of CNY also parallel with increased pressure to foreign trade export enterprises.
“The appreciation of CNY gives pressure on our company, and the fluctuation of the exchange rate narrows the profit margin to some extent.”, said by the principal of a private export enterprise in Zhejiang province to the reporter of China Economic Times.
It is showed that the US dollar today accounts for 60% of the global foreign exchange reserves, 44% of international payments and 90% of financial derivatives, and additionally over 70% of cross-border trades are settled in the US dollar. With the appreciation of the CNY, this will make foreign trade enterprises receive many dollar currencies, but converted CNY will be “shrunk”.
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Include exchange rate risk into cost control
Since the exchange rate fluctuates generally between 3%-5%within a certain period, this range is taken into account for quoting. At the same time, an agreement can be made with the customer, where if the rate exceeds this figure, the risks will be shared, and any profit loss caused by exchange rate fluctuations will be jointly borne by the buyer and seller. Alternatively, for example, the quotation period of 1-3 months may be reduced to 10-15 days, or even the quotation is updated every day with the exchange rate fluctuations.
Moreover, different quotations for the same product can also vary according to different payment methods, for example, by payment with letter of credit, 50% prepayment and 100% prepayment, at the options of buyers.
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Trade financing is the most common measure that current enterprises can take to avoid risks. The main reasons include:
First, trade financing can better solve the problem of capital turnover for foreign trade enterprises. With the rapid growth of China's foreign trade export, this will increase the competition among export enterprises, and extend the period of foreign exchange collection. It is urgent for enterprises to solve the problem of cash flow in the period between export delivery and the period of foreign exchange collection. By means of short-term trade financing, such as export bill, export enterprises can obtain funds from banks in advance to effectively solve the problem of capital turnover. At the same time, enterprises can also accelerate the amount of foreign exchange to avoid the risks from CNY exchange rate fluctuations;
Second, the cost of trade finance is relatively low. Among the composition of trade financing approaches, import and export bills account for a high proportion (about 80%), mainly because the period of export bills is short (usually less than 1 year), and can better alleviate the shortage of working capital for foreign trade enterprises. In addition, some companies also use longer term trade finance, such as forfaiting.
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Use of financial derivatives
After the exchange rate reform, China's foreign exchange market has been accelerated in the development, improved and expanded the subject and scope of CNY forward transactions, and launched financial derivatives including foreign exchange swaps. At the same time, a series of supporting measures have been taken in foreign exchange management to broaden the financial channels to avoid exchange rate risks.
Enterprises use financial derivatives representing the following features:
First, there are multiple instruments for forward foreign exchange settlement. After the exchange rate reform, the business scope and subjects of forward foreign exchange settlement have been expanded. The interbank CNY exchange rate forward transactions have been launched, and commercial banks have expanded their services for enterprises in avoiding exchange rate risks, which facilitates the forward foreign exchange settlement transactions to a larger extent, and further meets the needs of enterprises to avoid risks. The investigations indicate that the use of instruments for forward foreign exchange settlement accounted for up to 91% in financial derivatives.
Second, some enterprises use foreign exchange swaps and offshore CNY non-deliverable forward (NDF) instruments. Some companies in Fujian, Guangdong, Jiangsu, Shandong provinces and Tianjin have tried to use this new financial derivative since the exchange rate swap business was launched, after the reform. Although the business volume accounts for a relatively small proportion, the development prospect is promising. Some foreign-invested companies and China-invested companies with branches or partners abroad also avoid exchange rate risks by using offshore CNY NDF instruments.
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Pricing and settlement in CNY
After CNY was included into SDR, China has been gradually transformed from an economic and trading power into a currency power, and CNY assets became more attractive in the global market. The loans of many international financial organizations and multilateral development institutions and the liabilities of many countries are amounted in SDR, and their allocated CNY assets are also going up steadily. In addition, with the increasing attraction of CNY assets, the demands at home and abroad for active allocation of CNY assets have also increased significantly.
The use of CNY for pricing and settlement can basically eliminate the exchange rate risks. Enterprises should know the trends of relevant reforms and policies, considering CNY within the scope of policies.
Key points of exchange rate risk prevention:
Before risks occur, try best to prevent them, for example, to correctly choose the pricing currency, the approaches of receiving and paying foreign exchanges and settlement, and to make sufficient expectations for exchange rate fluctuations;
At the time when a trade contract is concluded, the exchange rate is fixed, and no matter what happens to the exchange rate in the forward, the payment is still made at the exchange rate stipulated in the contract, maintaining an insurance for the settlement and payment of the order;
At the time when a trade contract is concluded, the exchange rate of payment is not fixed, but it is agreed that each party should bear half of the losses when the exchange rate changes;
Actively look for financial instruments to avoid exchange rate risks. Derivatives including forward foreign exchange settlement and export invoice discount can be considered to avoid exchange rate risks;
Optimize the composition of export products, increase their technological content and added value, and enhance industrial competitiveness;
Implement approaches of differentiation and branding;
Accelerate export realization, reduce the occupation of foreign exchange accounts receivable, and use the most favorable settlement methods and conditions;
Use foreign exchange swaps, foreign exchange options and other transactions to avoid risks.
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