Monday, 12 December 2011

Business Line : Features / Mentor : Eliminating Chinese competition in trade

Business Line : Features / Mentor : Eliminating Chinese competition in trade

While China's policy favours exports and lowers risk, it denies exporters gains from a good exchange rate.
Ilango is the Managing Director of a fully-integrated automobile component manufacturing unit that exports automobile components to various countries, with a major chunk of it going stateside. The business involves the import of raw materials (scrap as well as other material) for production of these components.
Ilango was involved in trading activities till a few years ago, when he realised the fact that the Indian economy was going to be more stable and steady as compared to Western economies.
The investment of Rs 100 crore in an integrated manufacturing facility was justified, considering the global business pattern.


Most of the transactions involved export and import, and thereby the company stood exposed to substantial Forex risk. While the Board Room discussions of a majority of the companies involving imports was regarding the depreciating rupee and appreciating dollar, Ilango has a different issue to handle.
A depreciating rupee, the appreciating dollar, the European debt crisis and overall recessionary patterns across the globe have made headlines almost everyday during the last few weeks. With some foresight and some luck as well, here is how Ilango converted this situation into an opportunity and an advantage. Before we go into how Ilango converted a seemingly bad outlook into an opportunity, let us also analyse what happens on the Chinese competitor's side.
China follows a policy of managed float — the Yuan is allowed to fluctuate against the USD in a very narrow band, predetermined by the Chinese central bank. While this makes Chinese exports favourable and keeps exchange risk at a minimum, it also means that where other currencies stand to reap huge gains, the opportunity of benefiting from a good exchange rate is denied to the Chinese exporter. And so, as far as Ilango's competitor is concerned, his revenue is fixed or nearly fixed, thanks to the exchange rate (assuming, of course, that the volume of export doesn't change). His ability to offer discounts or use some other promotion tools is also limited.


Ilango typically imports scrap and pays for it in USD — he began by hedging his import contract so he could pay at the predetermined exchange rate when payments became due.
On the revenue side, he decided to not hedge his exports — there was, of course, a risk involved, but given the steady appreciation seen in the dollar during the last quarter, Ilango didn't expect something drastic. All cues pointed to a further upward movement.
Ilango's net revenue improved nearly 15 per cent, major import costs were pegged because of the hedge, and he was able to offer a 5 per cent discount to his clientele in USA, thus upping the ante and increasing his volume share of supplies.
When importers here (most of whom didn't hedge the risk) are trying hard to minimise costs, Ilango is busy discussing with the windmill suppliers to invest his profits / surplus in windmills, to reduce tax on the additional profits.
One must, however, note that this isn't a typical situation — some smart hedging and shrewd assessments resulted in a higher margin of profits, but the situation also has the downside effects on two major situations. While raw material prices are set to increase and scrap, especially, is affected both by increasing base prices and exchange rate fluctuations, any expansion or increase in Capex will also become more expensive if it has any imported component.
The current scenario offers hope for uncompetitive firms by giving them an opportunity to re-establish themselves through additional cash flows and prudent management of costs and hedging of risk.
(The author is a Coimbatore-based chartered accountant & the Managing Director of GKM Inc.)

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