Risk Management in Chinese Business

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Table of Contents

Country Risk Assessment
Impact of Revaluation of the Chinese Yuan
References

Country Risk Assessment

Risks Associated With Doing Business in China

China is one of the most populous nations in the world with a population of about 1.3 billion. The country accounted for about 13% of all manufacturing across the globe. It is expected that the country will surpass the US as the leader in manufacturing. This can be attributed to low-cost labor and raw materials. Despite these favorable factors that may attract multinational companies, China faces several risks. Politically, the rules and regulations of the country are not transparent. This can be attributed to the fact that the communist party has total control over economic institutions and legislation. Therefore, a new foreign business may face several bureaucracies and regulations. In order to penetrate the market, a company from the west has to create a social network with members of the communist party to help make the entry smooth. The reshuffling of the political process, at a time when the economic performance is deteriorating, has led to labor unrest and social tension. This has a negative impact on the business environment (Warner & Pierce, 2016).

China faces economic instability. The financial system of the country heavily relies on the income generated from exports within the manufacturing industry. Since the Yuan is no longer pegged to the US dollar, the fluctuations of the exchange rate have highly affected the GDP of the country. As a result, the profitability of multinationals that are doing business in China has been affected. The growth of the economy as reported in the past years has led to a growing demand for skilled labor. This has contributed to an upsurge of labor cost, thus increasing the cost of operations. The country has experienced a slowdown in economic performance between the years 2014 and 2016. The rate of economic growth declined during this period.

In 2017, the economy is not expected to rebound. This can be attributed to a number of reasons. First, the People’s Bank of China implemented tight monetary policies that seek to restrict speculation of housing prices. These policies have an effect of slowing down the economy. Consumption accounts for about 67% percent of the GDP. Consumption expenditure has been lethargic. However, it is expected to pick up due to the low inflation rate and expansionary fiscal policies, such as reduced taxes. Further, private investment is expected to slow down due to increasing corporate obligations and overcapacity concerns. This will result in a reduction of profits that are generated by this sector. The slowdown of the global economy is also expected to cause a drop in revenues that are generated from exports. These factors explain why the economic performance of China in 2017 and beyond is expected to drop (Goyals & Goyal, 2013).

Public demonstrations and protests are the social risks that China faces. The social unrest is caused by a number of factors such as income inequality, high unemployment level, lack of development in the rural areas, lack of public security, political tension, and poor safety standards at workplaces. Some of these factors require government intervention. Capital risk in China is quite high. This can be attributed to the high level of local debt, which has grown tremendously over the years. For instance, in 2008, local debt was about 160% of GDP. In comparison, the debt was high at 260% of GDP in the year 2016. A large percentage of this debt is held by state-owned corporations. Further, the thriving shadow banking in the country has reduced the ability to evaluate the debt levels of entities that are not state-owned. The increasing number of nonpayment on the Chinese bond market has also increased capital risk. Slightly more than ten companies have defaulted since the beginning of the year 2017. If the trend persists, then it can distort the capital market because banks will be exposed to the risk of declining asset quality (Warner & Pierce, 2016).

Important Factors to Consider Before Investing

There are a number of factors to consider before expanding operations into China. The most important items to take into consideration are the tough business environment, political, and economic uncertainties. The company should also ascertain whether it has adequate resources that will finance the venture. These factors are vital because they determine the ability of a company to enter the market and do business with ease. They also determine the ability of the company to generate profit in the new market (Jacque, 2013).

Impact of Revaluation of the Chinese Yuan

Exports and Standard of Living

The decision to leave the Yuan to float freely implies that the exchange rate between this Chinese currency and other currencies is determined by the forces of demand and supply in the foreign exchange market. The fixed regime under which the Yuan operated before 2015 caused an undervaluation of the currency. This created the need to revalue the currency after it was left to float freely. The revaluation has had significant consequences on various aspects of the economy. The People’s Bank of China lowered the currency value by 1.89%. This had an effect of making the currency cheaper. Therefore, the exports were less expensive as compared to the products of other countries. Thus, the revaluation of the currency led to a growth in export sales. This has been one of the key drivers of growth in GDP in the recent past. With the growth in export sales, the manufacturing sector experienced remarkable expansion. This has led to an improvement in the standard of living of Chinese citizens.

U.S. Multinationals

The revaluation also had an effect on multinationals that do business in China. For instance, the lowering of the currency helped the US multinationals to develop a better association with the trade partners in China. This can be attributed to lower transaction costs. The US multinationals experienced growth in earnings because of the cost benefits. However, multinationals that had their foreign operations dominated in U.S. dollars did not experience the cost-benefit (Graham, 2014).

Inflation and Purchasing Power Parity

Inflation, which refers to the persistent rise in prices in an economy, is affected by the value of a currency. The appreciation of the Yuan will eventually lead to lower prices in the economy. Thus, it will cause deflation due to downward pricing pressure. In terms of purchasing power parity, the revaluation of the currency will increase the purchasing power of Chinese citizens. This is based on the fact that the cost of domestic consumption will be made cheaper. Further, locally manufactured goods will appear less expensive than imported goods. Thus, there will be a decline in consumption of imported goods and an increase in consumption of locally manufactured goods (Horner, 2013).

References

Goyal, V. K., & Goyal, R. (2013). Financial accounting (4^th ed.). New Delhi, India: PHI Learning Private Limited.

Graham, A. (2014). Hedging currency exposure (2^nd ed.). New York, NY: Routledge.

Horner, D. (2013). Accounting for non-accountants (9^th ed.). Philadelphia, PA: Kogan Page Limited.

Jacque, L. L. (2013). Management and control of foreign exchange risk (2^nd ed.). Norwell, MA: Kluwer Academic Publishers.

Warner, J. B., & Pierce, D. (2016). Managing foreign exchange risk. South Jordan, Utah: GPS Capital Markets, Inc.

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