The hot economies of major developing countries such as China, Brazil and India are all experiencing inflation, and their still developing banking systems and currency restrictions make it difficult to use traditional methods to hedge that risk.

That situation is exacerbated in China by the appreciation of the renminbi, which has ramped up production costs in recent years, along with the country's rising wages. China's government applies currency controls that limit renminbi inflows and outflows, and so inhibit the use of traditional forward contracts that require the delivery of the currency.

Non-deliverable forwards (NDFs) have become standard hedging instruments for restricted currencies, because they do not require the delivery of currency. Instead, an international bank acts as the counterparty, offsetting any foreign exchange losses or gains with a net settlement in U.S. dollars.

“NDFs should be available to any company that can use a deliverable forward contract,” says Anthony Capozzoli, a director in the strategic finance group at Credit Suisse.

NDFs and other financial instruments are, nevertheless, only short-term solutions.

Ron Chakravarti, managing director in Citibank's global liquidity and investment unit, says NDFs and other financial instruments can aid companies seeking to meet earnings and cash-flow projections for the current fiscal year. “But it's not something that can go on for years and years,” he says. “The indications are that with inflation and currency appreciation, these trends will continue.”

To address longer-term trends, companies must ultimately consider reshaping their supply chains, Chakravarti says.

In the short term, however, choosing to hedge, or not hedge, can provide advantages. “Most non-financial companies will say the purpose of the treasury department taking a hedge is to protect the company, and it's not speculative,” says Chakravarti. “But when a clear trend is recognized, a company may choose not to hedge all exposures, such as when it's importing into China while the renminbi is appreciating.”

Capozzoli says markets for financial hedges in China are developing. For example, a domestic foreign exchange market has developed that can be used by companies with a local presence. So a company that anticipates payments in six months could establish a contract at today's exchange rates, rather than risking future renminbi strengthening. “It's not an unrestricted market by any means, since a company still needs to apply for permission to establish a hedge,” Capozzoli says.

Just last month, the Chinese government announced that as of April 1, banks and companies can begin to use renminbi options in China, giving companies another choice for hedging. China says companies can only use options to hedge, not to speculate, and can only use call options, not put options.

And in July 2010, the Chinese government allowed international banks to offer Hong Kong-domiciled renminbi accounts and foreign exchange, with the code CNH. This new market allows a company located in China–whether Chinese-owned or foreign-owned–to sell a renminbi-denominated bond to international investors. “Investors can establish a Hong Kong bank account to hold the bonds, and coupons are paid in CNH,” says Capozzoli.

The new type of bond, which only a handful of multinationals so far have issued, is not primarily a hedging instrument, Capozzoli says. But it gives issuers a way to raise capital and use onshore-generated cash flow to service debt without the need to first repatriate profits.

And in China's fast growing economy, that could be a boon to companies, many of which already have stockpiles of cash that, due to Chinese government restrictions, are difficult to repatriate. “Now that there's such fast growth in China, companies are going to tend to use that cash for local capital expenditures and M&A,” Chakravarti says.