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Stronger yuan not likely in 1H 2010

Despite growing calls from trade partners, exchange rate flexibility will be probable only after economic conditions stabilize.

China may be facing great compulsion to widen its currency conversion band, but exporters are confident the government will not bow to pressure anytime soon.

The country's central bank has been working to maintain a 6.80 exchange rate between the yuan and the US dollar since mid-2008 to ease the effects of the global downturn on exporters. Prior to that, the yuan had appreciated from 8.27 to the US dollar in July 2005 to about 6.83 by July 2008.

Stronger yuan not likely in 1H 2010

The US dollar has continued to weaken during the past several months, causing the de facto peg to drag the yuan down against other currencies such as the euro. This, in turn, has been straining trade relations between China and its key export markets, especially against the backdrop of ballooning trade deficits in favor of the former.

Even so, there is a prevailing sentiment among manufacturers that the government will keep the yuan-dollar rate stable to support the export industry, which is still struggling to recover from the economic slump. The biggest fear is that a dramatic change in the conversion ratio could transform a profitable sale into a loss in just a matter of days.

Suppliers can find assurance in official government pronouncements. Premier Wen Jiabao himself declared China would not bend to pressure from other countries to revalue. "We will absolutely not agree to the various calls pressuring us to appreciate the yuan," Wen said in December 2009. Maintaining the stability of the yuan's exchange rate is vital not only to China's economic development but to global financial stability as well, the premier asserted.

Although there are signs of improvement, China's exports have not bounced back completely. Overseas shipments for the month of November 2009 totaled $113.6 billion, lower than November 2008's $115 billion and November 2007's $117.6 billion. Average monthly exports from January to November 2009 were valued at $97.4 billion, compared with $119.1 billion and $101.5 billion in the corresponding periods of 2008 and 2007, respectively.

Vice Commerce Minister Zhong Shan reiterated the government's stand at a recent press conference with Dow Jones Newswires and Bloomberg. He did say, however, that conversion margins could be broadened once economic recovery is certain.

This has led several manufacturers to temper their optimism, limiting projections of a stable yuan to 1H 2010. Most businesses, however, are unable to estimate when the currency will be adjusted and by how much. "Actually, there is no good way to anticipate the revaluation. We (exporters) just want the government to keep the exchange rate stable," said Lionel Lau, product manager of audio speaker specialist Shenzhen Baoan Fenda Industry Co. Ltd.

But based on market research, Fujian Rich & Fine Trading Co. Ltd sales manager Anna Xiao anticipates up to 3 percent appreciation by year-end. The company produces children's garments and shoes.

Economic sense of a stronger currency

A potential yuan appreciation brings a number of benefits. Suppliers stand to incur some savings on oil, component and raw material overseas procurements that are paid in US dollars. Aside from the reduced cost of imported manufacturing inputs, the revaluation could boost the purchasing power of local consumers and encourage overseas investment by China enterprises.

Many acknowledge that it is hard for the government to resist external pressure to allow the currency to appreciate in this era of globalization and open trade. Raising the value of the yuan is considered a wise economic policy for China in the long run, although at the expense of squeezing profit margins and potentially driving millions of people out of work. As the country's economy develops further, it is conceivable that the yuan will continue to appreciate over the next several years.

Some observers expect the currency will be allowed to strengthen again once export recovery becomes apparent, which could be as soon as Q1 or Q2 2010. The projection from some economists, including China Merchants Bank senior analyst Dongliang Liu and China International Capital Corp. Ltd macro economy analyst Zigjang Xing, is the yuan will appreciate by at least 2 percent to as much as 5 percent by Q4 2010.

But in a recent interview with Bloomberg, Goldman Sachs chief economist Jim O'Neill said Beijing is likely to relax the peg up to 5 percent anytime soon. This came after China's central bank directed large commercial banks to increase their cash reserves, an action that is meant to slow down the pace of the country's economic growth and inflation.

If the government decides eventually to loosen the yuan's peg, most suppliers prefer gradual appreciation to an immediate adjustment. The latter can harm China's economy as it could impair the competitiveness and profitability of export-oriented manufacturers, curb foreign investment, and worsen the unemployment rate.

If an immediate yuan appreciation takes effect, some suppliers trust the government to announce additional export tax rebates as a support measure for exporters. This move, however, might not bring relief to many companies. Joy Carpets Co. Ltd sales manager Joy Wu said the current 16-percent tax rebate for carpets is already close to the 17-percent ceiling.

Ready to adapt

Even as suppliers are confident the yuan will not fluctuate widely in the next four months, contingency strategies are being set in place in case the currency is revalued sooner than expected.

During the three years that the yuan appreciated steadily, exporters, particularly SMEs, dealt with the situation by cutting overhead and profit to keep product prices competitive. If the currency revaluation pushes through, manufacturers would likely once again resort to their post-2005 survival tactics.

For some businesses, this is to release new models that can generate higher margins. "With new products, we are able to set relatively higher prices and get at least 30 percent gross profit margin," Wynn He of Xiapu Joyyoung Friction Industry Co. Ltd said. The company is a brakepad maker from Fujian province.

Some suppliers have indicated willingness to absorb the impact as long as the rate increase is not substantial. "If the adjustment is less than 1 percent, our prices will remain stable," He of Xiapu Joyyoung Friction said. "We are willing to sacrifice some profit margin to keep our overseas buyers satisfied."

In addition, many companies are using financial instruments such as forward foreign exchange transactions and export bills purchase to minimize currency risks. The former entails the purchase of a foreign currency at the present rate, with payment or delivery set at a future date. In export bill purchase, makers obtain financing from a bank using the relevant documents as mortgage.

"In the past, we would take the yuan's appreciation into consideration when giving quotes to customers' said Annice Wu, export manager of Jiangsu province's Danyang Beite Electron Co. Ltd, which makes RF connectors. If the current exchange rate is 7 yuan to the dollar and we expect it to rise to 6.90 after a month when we receive payment, we will quote based on the latter value. Most of our clients accept this."

Some businesses are persuading buyers to agree to an advance settlement. Others are trying to sway customers to confirm purchases in yuan and upstream suppliers to allow payments in US dollars. This is not a common practice, however. "It is not easy to convince clients to accept price quotations in RMB," Wu of Joy Carpets said.

A few makers are intensifying the use of dollar-denominated imported material inputs instead.

Another risk management technique is the swap transaction or concurrent buying and selling of currencies that is followed by an offsetting undertaking on another date. Additional methods include negotiating with customers to fix the exchange rate for a certain period, or to settle in the euro or other currencies.

Velex Technology Ltd, a maker of car entertainment systems from Shenzhen, Guangdong province, is cutting down the effectivity of quotes. "If the exchange rate changes drastically, we may shorten the payment term and negotiate with buyers to share part of the losses," Hauer Huang of Velex said. Export prices given to existing clients, for example, would be applicable for only one month instead of the usual two.

"We make sure we add a validity period when citing prices," said Susan Zhou, sales manager of garments and textiles supplier Zhejiang Richtex Trading Co. Ltd. The time frame varies from a week to a month, depending on the product. For some high-value models, quotes can be valid for up to one year.

Erosion of competitiveness feared

Despite the apparent preparedness of manufacturers to deal with a stronger currency, the possible revaluation is unwanted because it would force exporters to raise prices, slash profit margins or do both. "The yuan's appreciation would result in price increases and increase the pressure on the export industry," Wade Jiang of Jiaxing Dirui Metal Products Fty said. The company produces hardware parts such as door hinges and handles.

Makers already have enough to worry about. For the greater part of 2009, suppliers watched helplessly as international crude oil rates rose steadily, pulling with them the cost of oil-derived raw materials.

"Lately we have declined some orders because of low prices wanted by the buyers," said Julia Li, general manager of Guangdong footwear maker Longing Shoes Manufacturer Co. Ltd. "Soaring material costs drove up our average product prices by about 10 percent in 2009. Yet, many customers still demand rock-bottom quotes."

"Current profit margins are already low at about 10 percent," Shelly Xie of Dayu Metal Products Co. Ltd said. "Any appreciation of the yuan will cut this down further. We estimate a 0.5 percent reduction for every 1 percent appreciation." The company is a Zhejiang-based manufacturer of furniture fittings.

In fact, the steady rise in the value of the currency between July 2005 and July 2008 affected the country's export industry heavily. "China makers' price advantage in the global market is no longer as prominent as before," said Calvin Luo, sales manager of Jiaxing Pengcheng Magnet Co. Ltd, a magnet manufacturer from Zhejiang province.

Note: This article "Stronger yuan not likely in 1H 2010" was originally published by Global Sources, a leading business-to-business media company and a primary facilitator of trade with China manufacturers and India suppliers, providing essential sourcing information to volume buyers through our e-magazines, trade shows and industry research.

All price quotes in this report are in US dollars unless otherwise specified. FOB prices were provided by the companies interviewed only as reference prices at the time of interview and may have changed.

Disclaimer: All product images are provided by the companies interviewed and are for reference purposes only. Those product images featuring products with trademarks, brand names or logos are not intended for sale. We, our affiliates, and our affiliates' respective directors, officers, employees, representatives, agents or contractors, do not accept and will not have any responsibility or liability for product images (or any part thereof) which infringe on any intellectual property or other rights of a third party.

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