Tips to make the RMB work in your favor when buying from China
When I starting doing business in China 20 years ago, the RMB (also known as Chinese Yuan or CNY) was pegged to the USD at 8.26. While some foreign governments considered it predatory exchange rate manipulation, as an international buyer, I like the stability of a pegged RMB and everybody sourcing loves a favorable exchange rate!
In 2005 the peg was removed but the exchange rate of the RMB against the USA was tightly regulated by Beijing to a band of just ½ of a percent. Meaning it could only go up or down so much in a day’s trading. Later that bandwidth was increased. Why is this important to know if you are sourcing from China? Read on to discover the answer and how you can go about making the RMB work for you!If you are placing a PO to China in USD, your supplier is factoring their exchange rate risk into the price of the goods sold. The larger the band, the larger the risk for the supplier. The longer the time between the PO and delivery, the larger the risk for the supplier.
Even in periods where the RMB is depreciating, Chinese suppliers still commonly embed a “buffer” into dollar-denominated contracts to guard against possible RMB appreciation. To protect themselves, many supplier build in as much as 8% for the buffer to cover their risk. And unless you have negotiated in advance, don’t expect the supplier to give you a credit if the exchange rate goes in their favor! It’s really a win-win for the seller in most cases. If the exchange rate band is maxed out over the course of the delivery, they have they have their risk covered. If the exchange rate band is not maxed out or the RMB gets weaker, they win big.
How to flip the tables and have the RMB work for the buy side?
1. Consider having the supplier quote in RMB
The seller’s internal expenses are in RMB, so setting an RMB price removes the need to build a buffer on the sell side. I often have the supplier quote RMB, but pre-agree that payment can be made in any major currency at the day’s exchange rate. That way, even if you don’t hold RMB in your bank account, you can still avoid having the buffer inflate the price.
2. Settling in RMB removes the risk for the seller but transfers the risk to the buyer as the buyer
Say for example, your order takes 3 months to produce and you agree to pay in RMB or in USD at the day’s RMB exchange rate. If the exchange rate changes during this time, the risk is on the buy side. Luckily, the RMB’s exchange rate is tightly controlled by Beijing and we haven’t seen many major short term fluctuations.
At the time of writing, we are witnessing a period of RMB depreciasion after a long period of appreciation. The current trend of past few months is great for China sourcing. I doubt we’ll get back to 8.26 anytime soon, but today’s 6.7 is a lot better than last year’s 6.1!
I don’t have a crystal ball and both the exchange rate AND the system Beijing uses for controlling the exchange rate, can change on a moment’s notice, but the Chinese government has announced that it plans to have the daily exchange bandwidth based on a basket of currencies rather than linking the band to the day’s USD-RMB exchange rate.
That could be good news if you are importing into the USA from China, as most economists and talking heads in the media believe that the USD would appreciate against the RMB if the RMB exchange rate was based on a basket of currencies.
Paying in RMB is one way to avoid the need for the seller to build in a buffer, but only certain banks in a handful of cities allow you to set up an RMB account in your home country. So if you bank in these cities and do business with China, you should set up an appointment with your banker before your competition beats you to the punch! But beware that the exchange rates for RMB account overseas are not nearly as attractive as the rates inside China or in HK.
So if your orders are large, you should consider setting up a HK company or even an entity in China.
If your bank doesn’t have the facilities to hold RMB on your behalf and/or the exchange rate is not attractive, know that service providers like PassageMaker accept USD/AUD/Euro and other major currencies and on behalf of their clients, then pay the client’s Chinese suppliers in RMB. Because PassageMaker has full import/export rights and banking facilities in both PRC and HK, PassageMaker can often help the client doing business with their suppliers in a way that reduces risk and keeps costs down.
The post is originally written by Mike Bellamy of PassageMaker Solutions. It is featured here as part of Smart China Sourcing’s promotion of China Sourcing Academy’s courses. Check out their courses here.