Painful Conversions

As currency risk intensifies, companies of all sizes are taking steps to protect cash flows.

Kate O’Sullivan is senior editor for strategy at CFO.

Beyond the Eurozone

The next currency-risk hot spot: China

While it is the dollar’s relationship to the euro that has garnered the most attention of late, another major foreign-exchange risk — one that would affect a vast number of U.S. firms — looms: the appreciation of the Chinese yuan. The Chinese government, which has long pegged the yuan to the U.S. dollar in an effort to make its exports competitive, began to let the yuan appreciate for several years before the global financial crisis. As the markets spun out of control, it returned to the dollar peg, but experts say it is only a matter of time before China allows the currency to float — and appreciate — again.

“China’s currency is going to start appreciating sooner rather than later,” says Richard Marston, a professor of finance and economics and director of the Weiss Center for International Financial Research at The Wharton School at the University of Pennsylvania. “Over the next 5 to 10 years, the Chinese currency and other Asian currencies will appreciate substantially against the U.S. dollar, and that’s a movement CFOs have to be aware of.”

IRobot, a robotics company with approximately $300 million in annual revenue, is one of many U.S. companies that would face rising costs if the yuan were to strengthen. “It will hurt companies like us and anybody who manufactures in China,” says CFO John Leahy. “We’re monitoring it, but we’re not actively out looking at [hedging] instruments.”

China let the yuan float in 2006 and the exchange rate shifted noticeably. Will it happen again?

Even for those who do want to hedge against the risk of a rising yuan, Marston says options are few, as China strictly controls its financial markets and won’t allow the creation of forward contracts, a common hedging tool.

For now, firms that manufacture or source materials in China can only watch and wait. The timing of a move “is a political decision in China,” says Marston. “I’m really surprised they haven’t done it already.” — K.O’S.

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