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Supply chains to pay price due to Chinese currency devaluation

China’s recent currency drop now sees the Chinese yuan trading at more than 7 renminbi (or yuan) to the U.S. dollar, a low not seen since 2008 sending markets into temporary chaos. Though things have somewhat rebounded since supply chains may still have to suffer.

Chinese currency devaluation
Figure: China’s currency fluctuation could pose an even greater disruption to the industry than the tariffs would.

This weaker yuan makes Chinese exports more competitive, or cheaper to buy with foreign currencies. Despite China’s Central Bank’s denial, speculation says the devaluation is designed to offset the cost of President Trump’s promised 10 percent tariff hike on another $300bn (£247bn) of Chinese goods to further burden the apparel, footwear and textile sectors set to go on the effect from the 1st of September.

The currency fluctuation could have a manifold impact on sourcing costs. While it appears a win for consumers around the world- who can now buy Chinese products more cheaply, it carries other risks.

For price breaks, some Chinese suppliers are offering discounts but it is not big enough to account for what the tariffs could do to costs. In fact, factories are so far only giving back the same 2 percent rate that the fluctuated since the announcement of tariffs.

On a media call hosted by Tariffs Hurt the Heartland on 8 August, Win Cramer, CEO of consumer electronics company JLab Audio said, “Certainly currency did fluctuate on Monday (August 5)…and we’re seeing our factory partners’ willingness to renegotiate on account of that, but it’s just 2 percent. We’ve still got 8 percent to worry about.”

With Chinese factories agreeing to concede just 2 percent on price in accordance with the currency shift, a 10 percent tariff on Chinese goods would still leave U.S. importers paying an 8 percent increase they’ll have to offset by reducing overhead in other ways to avoid margins taking a hit.

Recently, the People’s Bank of China set the official midpoint reference for the yuan at 7.0136 per dollar, the weakest level since April 3, 2008. That midpoint serves as the daily anchor for the country’s currency, marking the central point from which the renminbi (RMB) can strengthen or weaken by up to 2 percent within a day. Still, some economists have said that to offset a 10 percent increase in tariffs, the dollar-yuan exchange rate would need to weaken further to between 7.1 or 7.2 to the American dollar. Analysts forecast the yuan will weaken further.

Oanda market strategist Edward Moya said, continued yuan depreciation “should be expected” and we could “see another 5% before the end of the year”. Capital Economics now expects the yuan to end the year at 7.30 per US dollar, compared with previous forecasts of 6.90.

If the currency weakens to 7.5 or even 8 renminbi to the dollar, that would significantly weaken the effect of Trump’s tariffs, as it would be considerably cheaper for U.S. companies to buy Chinese goods.

“Most of the products we import from China have much of their cost in dollars because of their import content—things such as oil, raw cotton and the like. In fact, the local Chinese content can be as little as one-third of the cost, so there is not a lot of financial room for many suppliers to discount based on yuan devaluation,” Wade Miquelon, president and CEO of Jo-Ann Stores told Sourcing Journal.

As far as discounting goes, Miquelon, agrees that while Chinese factories may modify prices, it won’t be by much.

And because many companies, the craft and fabric firm included, have developed their China-based supply chains over decades, certain products simply lack non-China alternatives.

“It often is a take-it-or-leave-it situation until viable alternative supply chains are developed,” Miquelon said. “If you’re the only game in town, you have leverage regardless of the RMB.”

That means if Trump sticks to his plan to put the new tariffs in place—and the renminbi doesn’t weaken much further—sourcing costs likely still will rise. And that means most brands and retailers are prepared to pass the costs along to consumers.

Pointing to the impact the Tranche 3 tariffs had on the business and the price hike it created Miquelon said, “We’ve had to take up some prices, and where we’ve had to take up prices, we’ve certainly seen hits from the customer.” He said, “If you extrapolate that more broadly to what we’re going to see in list 4…it could create a vicious cycle of higher prices, less demand, higher prices, less demand.”

Acknowledging his agreement, Lance Ruttenberg, CEO of American Textile Company, said, “There’s no free lunch.”

“At the end of the day, an increase in cost is going to harm somebody in the supply chain, whether it’s the manufacturer or the retailer,” he said. He also warned, “As prices increase and features and benefits don’t, the demand will decrease.”

David French, Senior Vice President of government relations at the National Retail Federation, said, the new tariffs could ultimately cost American consumers $4.4 billion more each year on apparel alone. He said on  Tariffs Hurt the Heartland media call, “I think the tariffs so far have only been on the margins of the consumer economy, so what has happened to date is not a good indication of what will happen in the future,” According to the Chief Executive Officer of  Kasper Rorsted, China’s currency fluctuation could pose an even greater disruption to the industry than the tariffs would.

“We do 25 percent of our total business in China, 20 percent of our manufacturing capacity in China, so for us we can still move the rest out of China and have no impact,” Rorsted said, addressing the potential effects of the impending tariffs on Bloomberg TV, following Adidas’ second-quarter earnings release recently. But the much bigger impact in the current economic war is the fluctuation in the Chinese currency, and that is where his concern lies.

“The moment you start having a weaker RMB, this will hurt all regions in all countries, and it’s an illusion to think this will be a win-lose scenario. This will be a lose-lose scenario,” he said. “So I think when you look upon the macros of it…the currency war is much more severe, with much bigger consequences than the tariffs.”

With regard to how the currency devaluation — which made China’s currency weaker than 7 yuan to the dollar for the first time since the global financial crisis in 2008 — affects the market outlook, IHS Markit Chief Economist, Nariman Behravesh says the move adds even more uncertainty, and it’s either going to have little impact at all or major ramifications for the global economy.

According to Behravesh, “China’s recent devaluation is relatively small in the whole scheme of things. If it stops there, and neither the U.S. nor China takes any other actions that would give markets a fit, then this episode will probably blow over. On the other hand, if this is the beginning of a new and dangerous phase of the trade war, then all bets are off, and the ensuing financial firestorm could push the U.S. and global economies into a recession.”

Will this tailspin in the market come to normal or aggravate? Well, we need to wait and see.

To check the real-time U.S. dollar to the yuan exchange rate, click here: https://tradingeconomics.com/china/currency

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