The Renminbi Exchange Rate – Reducing Risk Amid Heightened Volatility

The renminbi's exchange rate has been subjected to new market factors such as the ongoing Sino-US trade friction and differences between monetary policy in China and the US. These factors have contributed to heightened levels of volatility. These developments have attracted the attention of market players this year. To assess these new market factors and determine how Chinese companies can reduce foreign exchange risk，China Forex spoke with Li Liuyang，chief foreign exchange analyst of the financial market department at China Merchants Bank. Mr Li contends that although the renminbi exchange rate has experienced more volatility on increased trading this year，the overall trend has been steady and positive. Following are excerpts from that interview.

China Forex: Sino-US trade friction and changes in monetary policy have increased market attention on the renminbi exchange rate. What is your view of the trading environment? What new features do you see in the market?

Li Liuyang: Generally speaking，the renminbi exchange rate has displayed three new features. First，it has become more difficult to predict the renminbi exchange rate due to two-way fluctuations. The exchange rate has become more sensitive to domestic and global factors alike. Since the second half of 2016，the US dollar has shown a roller coaster pattern of appreciation followed by depreciation and then appreciation once more. Correspondingly，with the new parity calculation  mechanism，the renminbi exchange rate has basically followed the fluctuations in a basket of currencies，showing a trend of depreciation followed by appreciation and then depreciation again against the US dollar.

In the second half of this year，rising Sino-US trade friction became an important factor affecting the renminbi exchange rate. After the US unveiled its findings from an investigation of China's policies and practices related to technology transfers，intellectual property and innovation under Section 301 of the Trade Act of 1974，each development in the trade environment has had an impact on the renminbi exchange rate. In addition，this year's macroeconomic situation，changes in monetary policy in both countries，currency woes in emerging markets，European political turmoil have all had some effect on the foreign exchange market. The renminbi exchange rate is becoming more and more market-oriented，and thus susceptible to short-term swings.

Fortunately，the international balance of payments has remained stable. Domestic companies have demonstrated greater adaptability than in the past in the face of these complex factors. From the perspective of cross-border income and expenditure，the deficits in the banks' foreign exchange settlements and receipts and payments on behalf of clients have narrowed significantly this year compared with a year ago. The deficits in collections and payments on behalf of clients are much lower than those of 2015 and 2016. There has been less pressure from demand for foreign exchange. The nation's policies of opening up the capital market has encouraged international investors to increase investment in China. Greater currency swings have been evident but they have not deterred the inflow of investment funds.

Another market feature this year is that foreign exchange hedging by corporates has increased. Chinese companies with cross-border business have had a greater desire to work with banks to use exchange rate derivatives for risk management purposes. According to statistics，more than 100 companies listed on the A-share market have announced new foreign exchange hedging operations. These companies have a lot of foreign currency business in their daily operations. With the gradual shift in the renminbi towards a floating exchange rate，exchange rate risks have been growing. Many more companies have therefore conducted foreign exchange hedging transactions this year.

China Forex: In the face of new developments in the foreign exchange market，what strategies can companies adopt in order to avoid exchange rate risks?

Li Liuyang: Exchange rate movements have had a profound impact on enterprises. Exchange rate fluctuations can determine profit or loss. A company that operates in a stable fashion will not aim at generating profits from exchange rate fluctuations. Instead，companies should be seeking to avoid uncertainties caused by exchange rate movements in order to protect their profits. Many factors can affect a company's ability to achieve its annual financial targets. Exchange rate risk management aims to take appropriate measures to manage exchange rate risks.

As far as the specific strategy of exchange rate risk management is concerned，it can be divided into two strategies，namely natural hedging and market hedging.

Natural hedging refers to the exchange rate risk hedging by means of a combination of balance sheets or certain businesses that are negatively related to exchange rate risk. There are several ways to do this.

First，it increases gross profit margins by reducing production costs or increasing sales prices，providing room to accommodate exchange rate fluctuations.

Second，it is the preservation of value by price markups and value preservation by price markdowns. When signing a contract，especially a longer term contract，it is necessary to include a clause stating the right to adjust contract prices according to exchange rate fluctuations within a period of time.

Third，settlement should be made in a favorable currency. The collection of funds should be done in a currency that has a prospect of appreciation while payment should be made in a currency that could see depreciation.

Fourth，you can make use of a combination of strong and weak currencies. Especially in the long-term contracts，exchange rate risks can be hedged to some extent by negative correlation in income in different currencies.

Fifth，it is the combination of trade financing instruments，such as foreign exchange prepayments，the use of draft bills， factoring，forfaiting and the like，in orde