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China's retail industry tackles revalued currency
FOLLOWING THE INITIAL CONFUSION, RETAILERS AND SUPPLIERS ARE ASSESSING IMPLICATIONS OF THE CHANGE. RETAIL ASIA'S ROVING CORRESPONDENT JAYANTHI IYENGAR REPORTS.
AFTER nearly a decade, China has abandoned the renminbi (RMB) peg against the dollar. At the end of July this year, the country announced that it was tying up the value of the RMB to a "basket" of currencies, the composition of which would be kept a secret.
This effectively means that the modalities for arriving at the exchange rate are opaque and the Chinese government would be able to manage the value of the RMB against any of the currencies in the basket to its advantage.
The long-standing change was brought about by external and internal pressure, particularly from the US, the multilateral agencies, international banks and investors as well as China's own monetary regulatory authority, who were concerned about the runaway growth of the economy which had, at its peak, crossed 9% per annum.
Such a high level of growth raised the fears of a bubble economy that is likely to burst, an eventuality that the government, foreign investors and China's trading partners could not even consider.
Following the opening up of its economy, the populous nation had integrated itself so well with the global economy that a Chinese meltdown might take down half the world with it.
The government was reluctant to abandon the RMB's peg against the dollar, which had rendered imports from China cheap and made foreign investments in the country attractive. This explains, to a great extent, why the shelves of US retail stores are being filled with "made in China" goods, while the Middle Kingdom's foreign currency reserves swelled to over US$625 billion over the past decade.
Hence, China attempted to contain the runaway growth by adopting several non-interventionist measures such as directing its banks not to lend to the overheated sectors such as infrastructure, cement, steel and real estate. However, when these steps were inadequate to slow down the economy to the extent it considered desirable - about 7%-8% growth of the economy annually - the government resorted to a revaluation of its currency against the dollar as well as broad-basing the peg to a basket of currencies.
Four months have gone by since this change was made. What does this change mean and how would it impact retailers investing in and sourcing products from China?
The first reaction on the ground came from the Simon Property Group. Within days of the announcement of the revaluation and China's new exchange rate policy, the large US-based real estate and shopping mall developer announced that it had formed a partnership with US investment bank Morgan Stanley and a stateowned Chinese company to develop about a dozen shopping centres in China.
The companies did not disclose their investment in the shopping centres, all of which would be anchored by Wal- Mart outlets. However, analysts estimated that the projects could cost as much as US$700 million to develop, which would make the deal one of the largest foreign realestate investments ever made in China.
On the foreign exchange markets, the dollar fell by 2% against the RMB on the very first day of trading following the announcement. James Zhang, general partner, Eguo China Retail Group, who believes that China's new foreign exchange policy's overall impact would be small and is unlikely to change any of the foreign retailers' investment and expansion plans, provides an overview of the situation. "The dramatic failure of the huge mass-discount retailer Price Smart in China has clearly exemplified both the potential and challenge facing retailers in China. Solid fundamentals and great opportunities of China's retail market remain the same," said Zhang.
He maintained that although certain segments such as malls and department stores have been overbuilt in the short run in some urban regions of China, market for speciality chains and e-commerce are tremendous. "Management, capital and technology are the major differentiators. As biased labour cost and real-estate cost continue to rise and are likely to be so in the long term, increased barrier to entry and substantial capital requirement for retail operation would be a positive factor for large and well-established retailers," he said.
James Lee, vice-president of Corporate Affairs, Legal & Administration, Wal-Mart, China, echoes Zhang's view. "The adjustment announced so far is small and has been expected for some time. [We] sense that our suppliers have been anticipating this change and preparing for it."
Lee explained that Wal- Mart sources goods from more than 70 countries and, hence, the global retailer is used to dealing with changing exchange rates every day. "We do not expect the change in the valuation of the renminbi to have a material impact on our business."
The possibility of some of Wal-Mart's suppliers shifting out of China does exist, but Lee argues that the current level of change is small. "But, overall, Chinese suppliers are very competitive and we expect them to continue to be so," he said.
Carson Wen, partner in Heller- Ehrman, a Hong Kong-based firm of solicitors and international lawyers, elaborates that the revaluation of the RMB would obviously make imported products more competitive in China. Simultaneously, RMB earnings from the retail operations in China, if converted, would yield more US dollars, thus contributing more in profits in US-dollar terms. On the expense side, RMB expenses would cost foreign-owned stores more in US-dollar terms.
"Hence, the impact on the bottom line of foreign retailers would in a way depend on whether they are in the investment mode or profitmaking mode," said Wen. Considering that most foreign retailers are currently in the investment mode, a revaluation of the renminbi would add to the costs, at least until the foreign retailers make enough profits to repatriate it back home in US-dollar terms.
The gradual revaluation of the renminbi would also affect the domestic retailers. For them, imported products would cost less. This would allow them to cut retail prices, which could push up sales as retailers pass on the benefit of the exchange-rate advantage to customers, inducing them to buy more.
Alternatively, the domestic retailers could settle for a higher margin, particularly for price-inelastic products, such as branded goods and exclusive labels that have a snob appeal. "Even a 2% increase in margin goes a long way in the retail trade," commented Wen.
However, many trade experts believe that the 2% revaluation is just the beginning, and that China would allow its currency to float upwards by about 10%. Others, particularly those in the US, argue that even a 10% revaluation over time is not sufficient to discover the real rate of exchange. Instead, the upward revision would have to be far larger as the renminbi is still undervalued against the dollar by about 30%.
Phillip F Zeidman, senior partner specialising in International Franchising and Distribution Law, with special interest in China, at DLA Piper Rudnick Gray Cary US LLP, has another take on the issue. "The partial unpegging of the dollar in the near term will not mean a great deal to global retailers. But this policy should lead to a substantial appreciation of the renminbi over a longer period. If so, for retailers in China, this could be a favourable prospect, because Chinese consumers' power to purchase foreign products will increase."
The law firm was recently named the Global Firm of the Year by an international Who's Who of Franchise Lawyers, while Zeidman was named the Global Lawyer of the Year by the same publication.
If, indeed, the predictions of a carefully calibrated revaluation of the RMB over a period of time by experts is correct, then the move would have the impact of pushing up the value of other Asian currencies, which had also been kept artificially low thus far.
Consequently, manufacturers, both foreign and domestic, who tended to source cheap raw materials from East Asia, added value in China and exported them to the West, particularly the markets in the US, would lose their cost advantage, depending on the level of correction.
Similarly, with the dollar becoming weaker against the RMB, US manufacture would become more competitive as compared to the "made in China" products. Consequently, there could be larger exports from the US to China, turning the terms of trade in favour of the former. Further, as the cost advantage of manufacturing products in China erodes, there could be an outflow of dollars from China, as foreign investors, particularly new ones, look at more attractive markets to park their investments.
This could erode the size of the Chinese foreign-exchange reserve. However, this outward flow would be offset by inflows from Chinese nationals who have illegally stashed their wealth in dollars overseas, who would bring this wealth home before its value is reduced by a further decline of the dollar. Theoretically, this should be the situation, but Zeidman has a telling point to make. "The notion that China's role as one of the most important sourcing origins for supply chains will disappear is simply not realistic; there are few other viable alternatives - and no others with comparable scale," he said.
That may explain why foreign retailers continue to invest and expand in China, despite the possibility that the long-overdue exchange-rate correction would ultimately erode their cost advantage.