Forex losses lay bare China's lack of hedging expertise

By Lu Jianxin and Saikat Chatterjee

SHANGHAI/HONG KONG (Reuters) - Many major Chinese companies are only now beginning to get to grips with a problem that offshore rivals have been managing since the birth of modern international finance - currency risk.

Until this year, Chinese firms lost little sleep over where the yuan was heading and many felt the risk of an unexpected move was so slim as not to be worth hedging. The currency had been appreciating slowly against the dollar for almost a decade, and before that it was pegged firmly to the greenback.

That all changed in February when the central bank unexpectedly moved to weaken the yuan. It forced Chinese firms to book heavy foreign exchange losses and exposed their lack of hedging expertise - a deficiency investment bankers are lining up to address.

"We have seriously begun thinking about doing hedging via derivatives," said a treasury official at Air China, the country's flag carrier, which booked 515 million yuan ($83 million) in foreign exchange losses in the first quarter.

Like other companies with foreign currency exposures, Air China is now looking at hedging through the forwards market - where currencies are bought and sold at fixed exchange rates for a future date - to protect themselves against unpredictable moves in yuan.

"In previous years, the yuan's appreciation had brought us currency gains and under these conditions, it was not reasonable for us to hedge dollar risk via forwards because that would mean giving up exchange rate gains," the Air China official said.

Airlines, which typically count both costs and revenues in a mix of currencies, have been among the hardest hit in China by the yuan's 3.3 percent fall against the dollar in the first four months of this year - the biggest sustained drop since it was depegged in 2005.

Chinese airlines have racked up 2.44 billion yuan in foreign exchange losses in the first quarter, official media have said, citing Civil Aviation Administration data. A year earlier, the airlines had reported a collective gain of 800 million yuan.

Other listed companies to suffer big foreign exchange losses in the first quarter include Baoshan Iron & Steel Co and China International Marine Containers Group .

On Thursday, the government said it would increase the currency's flexibility and let market forces have more sway over the yuan's value - and called for banks to develop tools for companies to hedge currency risk.

CORPORATE LOSSES, BANKER PROFITS

Chinese firms had not only seen little need to hedge their exposure to the yuan's exchange rate, some had instead been tempted to do the exact opposite: increase their exposure by placing bets on the currency's seemingly inexorable rise.

And with only a few minor hiccups, the bets paid off, with the yuan climbing by more than 30 percent since 2005.

With companies and other speculators pouring money into derivative instruments that benefited from a rising yuan, the market became lopsided, according to Eric Yum, head of offshore China and Hong Kong dollar trading at JP Morgan in Hong Kong.

That ultimately pressured the People's Bank of China (PBOC) to send a clear signal that the yuan should be a two-way bet. With the economy slowing and the entire market still betting on a stronger yuan, it engineered a depreciation in February, then followed up with a widening of the trading band against the dollar and, finally, another round of yuan weakness.

A lack of knowledge and experience of hedging among Chinese firms has been a boon for investment bankers in Hong Kong, who say there has been a huge pick-up in enquiries from corporate clients and an increase in the use of currency forwards.

"We are talking to our clients and educating them on what measures they can take to increase their currency hedges, such as using forwards, as this is a completely different environment for many of them," said Carmen Ling, global head of RMB solutions at Standard Chartered Bank in Hong Kong.

And these enquiries are turning into real business.

Trading volumes in yuan/dollar forwards have picked up, and Chinese banks have turned into net buyers of dollars for an eighth straight month, according to official data which suggests companies are hedging more.

($1 = 6.2291 Chinese Yuan)

(Reporting by Lu Jianxin and Saikat Chatterjee; Editing by Nachum Kaplan and Mark Bendeich)