Download How Should the Foreign-directed Enterprises Face the Impact of RMB Appreciation?

How Should the Foreign-directed Enterprises Face the Impact of
RMB Appreciation?
LI Jialong 1, 2
1.Economics and Management School, Wuhan University, Wuhan, 430072, P.R.China
2.Economics and Management School, Shenzhen Polytechnic, Shenzhen, 518055, P.R.China
[email protected], [email protected]
Abstract
Since July 21, 2005, the exchange rate of RMB has accumulatively increased by 17.3%.
It is the direct impact of RMB appreciation on the foreign-directed enterprises, especially the exporting
companies, that it weakens their exports price advantages and restricts their exporting scales. The
situation is extremely hard for those exporting companies with very little profit margin. In order for
the foreign-directed enterprises to be adapted to the trend of RMB appreciation, and to exist and develop,
the article here systematically expatiate the topic “How Should the Foreign-directed Enterprises Face
the Impact of RMB Appreciation?” in 3 aspects: the formation of RMB appreciation trend, the impact of
RMB appreciation on foreign-directed enterprises and the meeting tactics applied by foreign-directed
enterprises. Through the text, the evidence description of the relative cases is much valuable when
foreign-directed enterprises choose the meeting tactics.
Key words the impact of RMB appreciation, Foreign-directed Enterprises, the meeting tactics
Introduction
The pressure of RMB appreciation comes from the continuously rapid growth of China’s economy,
the strong impetus of China’s export and the upgrading friction of international trade while China’s trade
surplus growing. Since July 21, 2005, the exchange rate of RMB has accumulatively increased by
17.3%. The appreciation trend of RMB will certainly influence the development of China’s economy,
foreign trade and industries. From different aspects, Many scholars studied and analyzed both the
active and negative influences of RMB appreciation on China’s macro economy and industries.
However, a few of them analyzed the topic from the visual angle of foreign-directed enterprises.
Therefore, the article here systematically expounds the topic “How Should the Foreign-directed
Enterprises Face the Impact of RMB Appreciation?” in 3 aspects: the formation of RMB appreciation
trend, the impact of RMB appreciation on foreign-directed enterprises and the meeting tactics applied by
foreign-directed enterprises.
1 The Formation of RMB Appreciation Trend
The rapid growth of a country’s economy will bring strength to the country’s economy, but also
bring the appreciation pressure to the country’s currency. Therefore, the appreciation of a currency
reflects a country’s economy strength. It is also the same with RMB..
From the international experience, the rapid growth of a country’s economy usually brings about
the pressure of home currency appreciation. For instance, Germany and Japan both experienced the
pressure of home currency appreciation with the appearance of rapid growth in home economy. Since
the “Reform and Open” policy applied 30 years ago, China’s economy has been growing rapidly, which
increased China’s integrated strength and formed the basis of RMB appreciation. Entering the 21st
century, China’s economy has been increasing notably by two digitals, accompanying China’s export
rapid growth. During recant 5 years, China’s export has been increasing by 30% annually, which
brings China the lasting trade surplus and rapid mounting up of foreign exchange reserve. By the end
of June 2008, China’s foreign exchange reserve has increased USD280 billion from the previous year in
the growth rate of 35.73%, with the balance reaching USD1,808 billion. [1]
The rapid growth in foreign trade promotes China’s economy, at the same time causes a lot of new
problems, such as international trade friction which increases the pressure of RMB appreciation.
The pressure of RMB appreciation mainly comes from the severe international trade friction
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between China and the western developed countries, mainly United States, Japan and Britain. The
main reason for the western developed countries to push China appreciate RMB is that the under-value
of RMB promotes China’s export and trade surplus, and finally will threaten the employment of U.S.
and Japan. And also the large export volume of China’s cheap products will cause world deflation and
affect world economy development. In fact, the real reason of the western developed countries is that
they want to use RMB appreciation to ease the high unemployment and economy depression in U.S.,
Japan and Europe, and to limit China’s export and reduce China’s economy development. [2]
How to reply to the pressure of the western developed countries? How to reduce International trade
friction, stabilize the world economic conditions and balance China’s international incomes and
expenses? All the above problems should be solved when China government deals with international
multi-party economic and trade relations and stabilize domestic economic conditions. In the
above-mentioned situation, China government continued the reform in foreign exchange control system,
increased RMB value by 2%, and pursued supervised floating rate system. From now on, the exchange
rate of RMB is more gradually flexible.
The continuous high growth of China’s economy, the strong tendency of China’s export, the lasting
increase of China trade surplus, the pricking up of international trade friction, the high pressure of RMB
appreciation from western countries, the continuous inflow of international investment funds and so on.
All the above-mentioned factors made the appreciation of RMB become a long-lasting trend. On July
21, 2005, the exchange rate of RMB was USD1.00 : RMB 8.11 (middle price, all the following
mentioned is middle price), increasing in value by 2% than the previous day’s rate which is USD1.00 :
RMB 8.2765; Up to the end of 2005, RMB (vs. USD) increased by 2.49%, reaching USD1.00 :
RMB 8.0702; Up to the end of 2006, RMB (vs. USD) increased by 3.24%, reaching USD1.00 : RMB
7.8087; Up to the end of 2007, RMB (vs. USD) increased by 6.46%, reaching USD1.00 : RMB
7.3046; On June 30, 2008, the exchange rate of RMB reached USD1.00 : RMB 6.8591; On
August 25, 2008, the exchange rate of RMB reached USD1.00 : RMB 6.8397. Since July 21, 2005,
the exchange rate of RMB has increased 17.3% for the past 3 years (see Table 1. The Exchange Rates of
RMB From the End of 2004).
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Table 1. The Exchange Rates of RMB From the End of 2004
Date
USD (1.00)
EUR (1.00)
JPY (100)
HKD (1.00)
2004-12-31
8.2765
11.2588
8.0572
1.0641
2005-7-20
8.2765
9.9914
7.3132
1.0637
2005-7-21
8.11
10.0641
7.3664
1.0638
2005-12-30
8.0702
9.5797
6.8716
1.0403
2006-6-30
7.9956
10.1313
6.9467
1.02942
2006-12-29
7.8087
10.2665
6.563
1.00467
2007-1-15
7.7938
10.0669
6.49
0.99945
2007-6-29
7.6155
10.2337
6.1824
0.97436
2007-12-28
7.3046
10.6669
6.4064
0.93638
2008-4-17
6.9895
11.1318
6.8605
0.89698
2008-6-30
6.8591
10.8302
6.4468
0.87917
2008-8-25
6.8397
10.0728
6.2038
0.87602
Source: Based on “The Chart of RMB Exchange Rate”. The Web of People’s Bank of China, 2008/08/26.
http://www.pbc.gov.cn/huobizhengce/huobizhengcegongju/huilvzhengce/renminbihuilvjiaoyishoupanjia.asp
From the reform of China foreign exchange rate system, the exchange rate of RMB can fluctuate in
two directions according to the supply and demand relations in money market. It means that the value
of RMB does not always increase, but sometimes can decrease. However, the continually rapid growth
of China’s macro economy provides the basis of the moving direction of RMB exchange rate.
Therefore, the appreciation of RMB appears to be the longer trend in future 2-3 years. What is the
affection of RMB appreciation to China’s economy, especially to the foreign-directed enterprises? It
will attract the attention of all levels of government, scholars and most foreign-directed enterprises in
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the future 1-2 years.
2 The Impact of RMB Appreciation on Foreign-Directed Enterprises
The foreign-directed enterprises refer to the companies whose product exchange activities directly
face the international market although their basic production process are mainly located domestically.
They actively participate in international division and competition, and take exporting as their business
direction. As compared with internationalized enterprises, foreign-directed enterprises have broader
extension which includes both the higher grade foreign-directed business (i.e. the internationalized
enterprises indicated with direct foreign investment and trans-national business) and the lower-grade
foreign-directed business (i.e. the companies indicated with the transformation of their market from
internal to external). There are four kinds of foreign-directed enterprises, including a) Processing
Trade, b) Direct Exporting, c) Joint Venture or Cooperation, and d) Reverse Investment. [3]
What effect will RMB appreciation trend impress on foreign-directed enterprises? In reply to the
question, a lot of experts and scholars carry through thorough analysis, but the results of their analysis
are not the same.
Some scholars think that the products made in China have great price advantage. RMB
appreciation will not threaten the product price advantage, but can increase the profit margin of relative
companies. [4] In the weak competitive industries, RMB appreciation will reduce export volume in short
term, but in long term, it can wash out the companies lack of competitiveness, increase the concentration
of industry and upgrade the international competitiveness of the relative companies. [5]
RMB appreciation will compel enterprises to turn to the industry with higher profit margin, and
consequently upgrade China’s industries. [6]
Some other scholars argue that the exports of China mainly belong to labor concentrated and
highly substituted products, therefore, RMB appreciation deteriorates the business situation for
foreign-directed enterprises. [7] In the deteriorated situation, companies will compete each other
harmfully and break the industrial environment, which will hurt their competition ability cultivation and
long-term development. In the end, the deterioration of foreign-directed enterprises will seriously
affect China’s employment status and national economic development. [8]
The impact of RMB appreciation on Foreign-directed enterprises cannot be concluded without
exception. As to the first two kinds of foreign-directed enterprises, the impacts are different. [9]
2.1 There is no significant influence on processing trade companies.
During the appreciation of RMB, the import price of middle products will reduce, which will
change the cost composition by lowering the level of import cost. The more a company imports raw
materials, the more obvious for the effects. For example, a car processing company imports all the
material and parts it needs. The total import cost is USD1 billion or RMB 10 billion (at the rate of
USD1=RMB 10), the increment of processing is 20%, i.e. USD0.2 billion or RMB 2 billion. The
total manufacturing cost is RMB 12 billion. The composition of manufacturing cost is RMB 2
billion: RMB 10 billion or 1: 5.
If RMB appreciates by 20%, the exchange rate is USD1=RMB 8, the import cost of USD1
billion becomes RMB 8 billion. With the processing cost unchanged, The total manufacturing cost is
RMB 10 billion, and the composition of manufacturing cost is RMB 2 billion: RMB 8 billion or 1:
4. When the above situation appears with import cost reduction and RMB appreciation at almost the
same extent, the said company does not need to increase its exports price. Therefore, its export volume
is not affected.
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2.2 Weaken the price competitiveness and affect the export volume for direct exporting
companies.
RMB appreciation has negative influence on direct exporting companies. It increases the price of
China’s exports as the exports price is expressed in foreign currency, accordingly reduces the price
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competitiveness of China’s exports and limits to certain extent the export volume of the direct exporting
companies. In short term, the affection will be “obviously negative” to small and medium sized direct
exporting companies. For example, on July 21, 2005, the exchange rate of RMB increased 2%, saying
USD1.00 : RMB 8.11 instead of USD1.00 : RMB 8.2765 on the previous day. If an exporting
company had USD1 million cash deposit and settled up changing USD into RMB, it would lose RMB
0.16 million than the previous day settlement.
On June 30, 2008, the exchange rate of RMB reached USD1.00 : RMB 6.8591, has increased
accumulatively by 17% since June 21, 2005. The appreciation is fateful to most exporting companies
in Zhejiang Province, especially serious to the exporting companies with profit margin under 10%.
The lighter production in Wenzhou, Zhejiang Province, accounts for about 80% of that of international
market. RMB appreciation affects the lighter production in Wenzhou greatly. For instance, Zhejiang
Big Tiger Lighter Co. ltd. produced metal anti-wind lighters at the profit margin of 10% in 2005. Later,
their profit margin reduced to about 5% as the material price increased. Now they cannot continue
their production of metal anti-wind lighter while RMB appreciating 17%.[10] According to statistics, in
the first half of 2008, the increase rate of Guangdong textiles and garments exports reduced by 53.7%
comparing with the same period of last year.; the increase rate of toy exports reduced by 25.4%; that of
plastic products exports reduced by 22.4%; that of lamp exports reduced by 14.2% and that of travel bag
exports reduced by 12.6%.[11]
RMB appreciation reduces the imports price urging companies use more foreign materials and
equipments, accordingly increases China’s import of foreign materials and equipments. On the whole,
RMB appreciation will restrain China’s export of general products, but enlarge China’s import of
equipments and raw materials, and in the end will reduce China’s trade surplus level or enlarge its trade
deficit. Anyhow, the situation will not last long. In long term, the imports content more technology
which will improve productivity, upgrade industry level, increase the exports’ technology contents and
advance the related companies’ competitiveness.
From the above analysis, we can understand that RMB appreciation will bring foreign-directed
enterprises both the opportunity and the challenge. In 2006, Wang Qiwei and Chen Yu did the
conclusive analysis by using computer simulation. They insisted that the best choice be keeping the
exchange rate unchanged, any appreciation, no matter big or small, would hurt industries. Therefore,
the steadiness in RMB exchange rate is favorable to industry development. Any appreciation will
impress negative influence on all industries, restrain production volume, reduce industrial profit margin
and lower commodity average price.[12]
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3 The Meeting Tactics Applied by Foreign-Directed Enterprises
RMB appreciation trend has both active and negative influence on China’s foreign-directed enterprises.
As for foreign-directed enterprises, especially direct exporting companies, what kinds of tactics should
be adopted in responding to RMB appreciation? Here are some of them for related enterprises and
individuals to consider.
3.1 Foresee the alteration of exchange rate.
It is the basic countermeasure that foreign-directed enterprises should foresee the exchange rate
risk, establish export cost plan in order to face the alteration of RMB exchange rate. In face of the
adjustment of RMB exchange rate, foreign-directed enterprises should give up the preference to fixed
rate, learn to anticipate the movement of exchange rate and take initiative measures. During recent 3
years, RMB has accumulatively increased in value by 17%. A foreign-directed enterprises should
recognize whether RMB will continue to appreciate and to what extent, and accordingly make export
cost plan setting the future purchase plan and exporting price. For example, according to the 10%
appreciation of RMB in the first half of 2008, RMB exchange rate may reach to USD1.00 : RMB 6.48
in the second half of the year. Accordingly a foreign-directed enterprise makes its export cost plan for
the following seasons.
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3.2 Optimize the exports’ cost composition, increase the technology contents and appending value
in exports.
Optimizing the exports’ cost composition and increasing the technology contents and appending
value in exports are the two basic processes to reduce export costs, in which the basic approaches
include increasing R & D, improving product quality and raising products’ appended value. RMB
appreciation favors importing more raw materials and foreign advanced equipments, which provides the
opportunities for the enterprises to optimize their export cost composition, to expedite their technology
and innovation development, to increase their production efficiency, to reduce middle consumption and
production cost, and therefore, to maintain exports profits and evade exchange rate risks.
Here is an example. Taisheng Furniture Company (Dongguan, Guangdong Province) is the
largest furniture manufacturer in Asia, exporting USD600 million annually. During the three years’
period of RMB appreciation from 2005, the profit of the company has kept increasing all along. One
of their important measures is to increase the imported materials’ proportion in their product costs
continually under the conditions of RMB appreciation. Up to now, almost 100% materials are
imported. The reason for them to take the above-mentioned way is that buying materials in USD is
much cheaper than in RMB. [13]
3.3 Stick to difference, high quality and famous brand.
China lacks famous brands. In face of the branding competition in the world, Chinese enterprises
should heighten their exports level, upgrade branding contents and designing capacity in their products,
establish branding advantage for their exports and track the road of famous brand. Only in this way
can foreign-directed enterprises lighten radically the pressure of RMB appreciation. In international
market, branding products are not priced according to their costs, but according to their brand value.
Therefore, people will consider it reasonable that a pair of Nike sport shoes is sold at RMB 600 while
a pair of common sport shoes is only sold at RMB 80. But their cost difference is not so big.
Therefore, Sticking to difference, high quality and famous brand is the ultimate outlet for the enterprises
to reduce the risks of RMB appreciation as these measures bring the enterprises much more higher profit
than the loss from the alteration of exchange rate.
On Guangzhou Autumn Fair in 2007, a lot of exporting companies chose one of the
above-mentioned measures. Qingdao Shuangxing Imp. & Exp. Co. tracked famous brand road.
Because of RMB appreciation, their exports average price increased 7%-8%. They insisted on the
adjusted price for their export on Guangzhou Fair. Their old customers understood their situation and
accepted their price without any deduction of orders as they knew well about their quality guarantee and
their brand value. [14]
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3.4 Remold the export market structure and exploit new export markets.
Exploiting new markets is an important approach for an exporting company to increase its
competitiveness. With the sky price of oil, middle-east countries have strong importing ability. In
recent years, RMB is generally accepted for its value in the border countries and regions. Therefore, in
order to reduce the risks of RMB appreciation, it is a good chance for Chinese exporting companies to
exploit the markets in middle-east countries or the boarder countries and regions.
Rebaca Company is a good example of exploiting new market. The company is the largest
manufacturer of hair products in China, and its scale in the line is No. 1 in the world. Previously the
company mainly exported its products to North America, West Europe and Asia. In face of the rapid
appreciation of RMB, Rebaca Company exploited Africa market successfully in 2007. The growth rate
of exporting to Africa is much higher than to America and Europe, and the profit margin is also much
higher. The company continued to enhance their exploitation in Africa market as the population of
black people, who are the main consumers of hair products, in Africa is over 700 million, much larger
than that (which is 30 million in number) in America. The export volume to Africa keeps the
company’s scale advantage as the largest hair manufacturer in the world. [15]
3.5 Transfer to overseas and apply the comprehensive export strategy by turning simple product
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export to trans-national operation.
RMB appreciation provides a reasonable choice of trans-national investment, motivates the
domestic related enterprises to walk out the boarder to invest overseas and participate in trans-national
operation. [16]
The investment conditions are improved much in South-east Asia countries, such as Vietnam,
Cambodia and Thailand. Chinese foreign-directed enterprises should invest in the said regions to
establish production bases. They can follow the process of receiving orders, carrying through R & D
and designing at headquarters, producing goods at overseas low-cost production bases and selling their
goods to the markets all over the world. It is the commonly adopted pattern for the trans-national
corporations to operate business. In face of RMB appreciation, Sichuan Rainbow Electric Appliance
Co. implements the products, personnel, investment and brand “4 walking out” overseas development
strategy; it conforms its resources purchases overseas assets, transfer its production bases to lower cost
countries and establish its global production and exchange system. [14]
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3.6 Make use of financial instruments to prevent the risk of exchange rate
To prevent exchange rate risk, the financial instruments nowadays commonly used by domestic
enterprises include the following: foreign exchange futures, foreign exchange future options, future
settlement and sale, swap deal, granted L/C, export mortagage, pack loan, foreign exchange bill discount,
import mortagage, and international settlement guarantee and so on. Foreign-directed enterprises
should understand the function and characteristics of the financial tools, make choices according to your
risk enduring ability and the expected return ratio, and choose the appropriate opportunity to conduct the
business.
Many enterprises in Shenzhen have strong consciousness of exchange rate risk and actively adopt
financial instruments to face RMB appreciation. As the study report by Shenzhen Center Branch,
People’s Bank of China shows: in 2005, Shenzhen foreign trade companies conducted, through all
commercial banks in Shenzhen, the future settlement and sale business of USD2.52 billion, increasing
8.5 times than the previous year. The big quantity of financial business helps foreign-directed
enterprises to prevent effectively the risks of RMB appreciation. [17]
Conclusion
Depreciation of one country’s home currency is favorable to expand the country’s export. However, a
country’s real strong economic competition ability cannot be achieved only through home currency
depreciation. During the continuous appreciation of home currency can a country strengthen its real
economic competitive ability. RMB appreciation reflects the fact that China’s economy becomes
stronger, conforms the need of China to strengthen its real economic competitive ability, favors the
improvement of China’s trade terms, promotes the rapid development of enterprises’ technology and
represents the transformation trend of China’s economic and foreign trade growth pattern. Anyhow,
RMB appreciation directly reduces the price competitive advantage of foreign-directed enterprises,
especially the direct exporting companies, restrains their business scales, which is particularly vital to
the companies with very little profit margin. Therefore, if foreign-directed enterprises want to upgrade
their real international competitive ability and contents, they should adapt themselves to the conditions
of RMB appreciation, survive, develop and strengthen themselves in the changing variety of
international environment. Presently in face of RMB appreciation, the most important strategy for
foreign-directed enterprises to implement is to take their “internal work”, choose the suitable one from
the above text mentioned 6 tactics, or in the practice of international operation find the most fitting
measures to reduce the negative influence of RMB appreciation and to strengthen themselves in the
complicated international surroundings.
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