A slowdown in China and a rapid devaluation, as well as the introduction of a new valuation methodology in August, have injected new volatility into the renminbi (RMB). That volatility has spilled over into other Asian markets as well as the emerging markets as a whole.
In the RMB market, “volatility has spiked,” according to Stephen Jonathan, currency market specialist at Bloomberg. Corporate treasurers are already on alert. They’ve already seen an impact on earnings from increased FX volatility throughout last year. According to the most recent report from FiREapps, in the third quarter of 2015, 353 North American and 46 European companies suffered from negative currency impacts. The effects of FX applied mostly to revenue, and totaled $24 billion. That’s three times as much as the quarter before.
Of all factors, according to Amol Dhargalkar, managing director at Chatham Financial, China has been the biggest exporter of market volatility. While its currency has weakened some, it’s not really about the first order effects. “It’s the fact that the Chinese government is indicating that there’s an economic slowdown,” he said. That may be less of an issue for China than it is for other economies. Five steps for treasury1. Think about risk holistically.
From a corporate perspective, companies need to look at their supply-chain and emerging market exposure as a whole, according to Jonathan. “The weakness may originate in China, but it’s spreading across the emerging markets,” he said. He advised treasurers to consider the impact on their entire supply chain, cost of goods sold, pricing and revenues. According to Jonathan, outside of Asia, the impact has been just as forceful. 2. Don’t overreact.
The decline in the RMB has been well telegraphed by the Chinese, noted Scott Bilter, partner at Atlas Risk Advisory. While the currency has depreciated, it’s basically back where it was five years ago. “It strengthened slowly for three years and then at first weakened at about the same gradual pace, before picking up the pace in the last few months,” he said. However, overall, the entire move has so far been within a range of 10 percent—far below the volatility of most emerging market currencies. 3. Consider onshore vs. offshore hedges.
“I think one of the more interesting things is the widening spread between the offshore and onshore FX markets,” said Jonathan. The offshore CNH does not trade within an announced band and in theory is not subject to PBOC intervention. According to Dhargalkar, some companies that have been using the CNH market as a proxy while booking their rate in the CNY market are more concerned because the two are less correlated. The spread between them is at an all-time high so the CNH is not an effective offset for CNY exposures. That’s why companies need to check whether they use the same rate in their hedges and booking currencies. They can often change the hedging rate more easily than changing the rate in their ERP. 4. Take a measured approach.
For treasurers, hedging the RMB doesn’t need to be handled any differently than hedging any other significant exposure, according to Bilter. The best approach is to layer in hedges over time, e.g., 20-25 percent each quarter going a year or more out. “The duration of the program varies from business to business and also depends on the quality of the exposure forecast,” he said. “You have to be comfortable that you’ll have the cash flows, and going too far out can be very expensive in terms of forward points.” Companies that have not hedged should not try to go in and hedge their entire exposure in one fell swoop, Bilter advised. Rather, they should start with a portion and then systematically layer in more hedges on a monthly or quarterly basis. 5. Ask the right questions.
Ultimately, the biggest questions financial executives should ask are not necessarily around currencies but rather how the events in China and other emerging markets will affect their business going forward. According to Dhargalkar, that means both treasury and FP&A need to rethink their forecasts for revenue and expenses in the region. How will the volatility and downturn affect consumer demand? How will it affect cost of goods sold (COGS)?