FX AND REPATRIATION
Managing Appreciation: Treasury's Role in Preparing for Currency Change
March 6, 2008
Christopher Bjorke, AFP

Wolfgang Koester is CEO of Rim-Tec Inc., a firm specializing in foreign exchange risk. As an observer of currency movements, he has been following the accelerating appreciation of China's currency, the yuan, and spoke with Asia-Pacific Forum on ways firms can manage their exposures.

China is indicating a faster revaluation than the course it has followed so far. How far do you think it could go this year?

My No. 1 concern is that there is going to be an increased amount of volatility in the Chinese currency. Directionally, that might make sense because the market now is looking for an appreciation of up to 10%. But I think that given other markets' influences and risk factors, you're going to see volatility, but I don't think it's a sure bet to go to 10%.

I personally think you're going to stay more at the 7% level. I think the Chinese government is going to get very uncomfortable at that rapid 10% appreciation. I think it's less than 10%.

The reason for that is the volatility that I think a lot of people are not taking into consideration, which are the risks involved in China. You're starting to have inflationary fears. You have restrictive credit and you have a questionable banking system.

The large, world banks, whether they're the U.S., whether they're Hong Kong banks or whether they're U.K. or French banks, they're having a credit crunch, as we all know. If you have that problem already in the well-established banking system, what is going to happen in the Chinese banking system?

So with that risk, I think people are not going to be as aggressive in taking the bet to have a 10% appreciation in the next 10 to 12 months.

What should companies do to prepare for this appreciation?

The No. 1 thing is that they really need to understand their exposure. Exposure often isn't as simple anymore as dollar-China. Do they truly only have a dollar-China exposure, or do they have a China-Philippine exposure? Do they have a Thai baht-China exposure?

And then if they understand that exposure, what type of exposure do they want to manage? Do they want to manage economics, or do they want to manage accounting volatility? Then the other question is, Are they net long or net short, one currency against the other?

Right now, economically, it almost pays, because of the interest rate differential, to hedge by selling China forward. If you believe that the currency is not going to appreciate 10% but maybe only 7%, you're going to get paid on the hedge up 10%, on the interest rate differential. Most corporates are saying that if I have revenues coming in from China, I'm just going to let them appreciate.

And the last thing you have to figure out is if you hedge as simple as hedging dollar-sterling, in that you have tax implications affecting you because you have to make the decision whether you hedge on shore, i.e. in China, or do you hedge off-shore, i.e. in the United States with an NDF.

What should be treasury's role in preparing for a currency change?

There are questions we need to answer to put an almost-China policy separate from what we have or additional to what we have in our general foreign exchange risk policy.

The foreign exchange policy may say we will only trade with counterparties at single-A or higher rating. If you are trading with a subsidiary of a bank in China, that credit rating may well not be single-A. So your basic question is I can't even do that under the foreign exchange policy. I can't even do an NDF on shore in China because my credit policy doesn't allow this. China is almost its own policy right now because it's still very different, which is why a lot of people aren't doing it yet.

Is there is an awareness in treasury departments of what they're facing in terms of FX in China?

In the U.S., corporations at the higher levels are nowhere near as prepared as the Europeans. And that makes a lot of sense to me, because in the U.S. the continuously declining dollar has created a lot of windfall profits for U.S. corporates, and therefore they aren't as sensitive as the Europeans, who've gotten continuously hurt by their appreciating currency. So they in general have more sensitivity to currency risk.

What do the other currency exposures in Asia look like?

I think that in general, with the exception of the Korean won, you're seeing continuous appreciation in the region, and given how those governments like Thailand have been hurt in 1997, some of those governments are well-prepared to invest and make sure that in a very controlled fashion they see appreciation in the currency.

I am pretty bullish on the appreciation of currencies within Asia. I think that they will in numerous countries, they will really try to ensure that volatility will not go beyond a certain pain threshold, though they're not there right now. But in Korea, I'm a little more concerned about the Korean won, which I'm not as strong on, just because of the political risk factors that are involved there that you're really not seeing as much in Thailand or the Philippines and some of the other countries around there.

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