Cash-rich US multinational corporations (MNCs) have been receiving savings of approximately 4%-5%, after negotiating cost of goods sold (Cogs) from suppliers and agreeing to pay back their dues at an earlier date – a move which will dramatically increase liquidity in the supply chain and provide greater certainty for suppliers’ in terms of business planning.
Victor Penna, a Hong Kong-based head of solutions and advisory sales for Asia Pacific at J.P. Morgan says that some companies have been altering their supply chain strategies in the last few months, especially since after the US Federal Reserve decided to continue running a zero interest rate policy until 2014 in order to support its domestic economy.
MNCs realised that savings obtained from negotiated COGS terms with their suppliers superseded returns obtained from spare cash placed in US dollar deposits.
“If you have got a lot of excess cash and you are well capitalised and your debt levels are low, it doesn’t make sense to be pushing your supply terms when all that is going to do is generate more cash that you cannot get a return on,” said Penna to Asiamoney PLUS in a telephone interview on February 28.
Industries operating with tight margins and supply pressures, like the clothing and footwear industries, are most likely to benefit from this arrangement, said the bank.
“There is an opportunity to redeploy cash to paying suppliers earlier and being to extract a lower cost of goods purchased as a tradeoff,” added Penna.
This arrangement is viewed as a win-win situation for all parties, especially cash-strapped small to medium-sized suppliers based in China. The MNCs’ Chinese counterparts have been planning to shorten the payment collection period in order to reduce working capital requirements, primarily amid the tightening of liquidity in the market, said J.P. Morgan.
According to Shanghai Security News, new loans extended by China's four big banks lag estimates this month amid tighter lending rules. The four state-owned lenders – Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BoC) and Agricultural Bank of China (ABC) – only extended a combined Rmb70 billion (US$11.1 billion) in the first three weeks of the month.
Restrictions on bank lending to China’s small-to-medium enterprises (SMEs) over the past few years have driven many of these businesses to seek alternative methods of financing from the shadow banking industry and larger cash-rich entities.
“A lot of smaller to mid-sized suppliers had to turn to informal markets to borrow and those markets can be very expensive,” said Penna. “That’s going to be reflected back in the cost of goods sold and suppliers would be looking to charge more for the product that they are producing.”
The bank foresees more MNCs exploring this form of cost savings in the next few years, especially cash-rich corporates with operations denominated primarily in US dollars. This strategy is after all advantageous for all parties operating in the trade industry.
“It probably makes sense to look at these couple of options over the next few years given that the level of cash for many MNCs is only going to increase whilst at the same time they have limited investment options,” declared Penna. “And because of risk concerns and safety, they don’t necessary want to invest in higher risk options.”
The underground credit market is estimated by China’s central bank and private sector analysts at Rmb2-4 trillion (US$325-650 billion), or as much as 7% of total lending. In some areas, informal lending exceeds that of official banks.