Part of the collapse of world trade is due to problems with trade credit financing. Since statistics on this are scare, it is impossible to be precise about the most immediately salient and challenging feature of the financial crisis from a trade perspective – the supply of trade finance.
Trade credit financing
Trade finance is at the low-risk, high collateral end of the credit spectrum but this has not insulated it from the crunch (US Dept of Commerce 2008). Some 80% to 90% of world trade relies on trade finance (trade credit and insurance/guarantees), mostly of a short-term nature. The potential damage to the real economy of shrinking trade finance is enormous (IMF 2003). International supply chain arrangements have globalised trade finance along with production. Sophisticated supply-chain financing operations – including for small- and medium-size companies – have become crucial to trade.
Concerns about the scarcity of trade finance for developing and low-income countries have been identified as an issue in the WTO since the Asian financial crisis, as such countries are prime victims in the general reassessment of risks and liquidity shortages that characterise periods of financial crisis (Auboin and Meier-Ewert 2008). At the request of member governments, the WTO is seeking to encourage the revival of the complex links and networks of actors involved in the trade finance market in order to keep finance flowing for trade, thereby mitigating at least one reason for the shrinkage of trade flows.
As early as 2003, the perceived need to work at an inter-governmental institutional level to find global solutions to trade finance challenges led the Managing Director of the IMF, the President of the World Bank, and the Director-General of the WTO – in the context of the WTO Coherence Mandate – to convene major players to find ways to improve flows of trade finance (for example, letters of credit and other documentary credit) to developing and least-developed countries. Particular emphasis was placed on encouraging regional development banks and the World Bank to expand innovative, WTO-compatible ways of financing trade operations. Since then, the main players, including inter-governmental multilateral organisations (the WTO, World Bank, IMF), regional development banks, the Berne Union of Credit and Investment Insurers, and leading private sector banks, have met regularly at a high but informal level in the format of the WTO "Expert Group on Trade Financing". The group meets as needed and reports to WTO Members through the Director-General and Secretariat. Since 2005, longer-term efforts to boost trade finance for developing countries through better infrastructure for supplying trade finance – such as the development of competitive banks and export credit agencies – have been carried out under the Aid-for-Trade mandate.
How bad is the problem now?
One clear lesson from the Asian financial crisis is that, in periods prone to herd behaviour and a lack of trust and transparency, all actors – including private banks (which account for some 80% of the trade finance market), export credit agencies, and regional development banks – should pool their resources as much as practicable (IMF 2003). Strong links among the various players are also important because of an absence of comprehensive and reliable data on trade finance flows. This means that the main channel for making a reasonable assessment of the market situation is via the collection of informed views and partial statistics from various institutions. This has been a key aspect of the activities of the WTO Expert Group.
While trade finance is generally sound finance (underwritten by long-standing practices and procedures used by banks and traders, strong collateral and documented credit operations), and seemed to have "resisted" rather well throughout 2007 and the beginning of 2008, it became clear over the course of 2008 that the overall liquidity squeeze was hitting trade credit supply. The refinancing of such credit was becoming more difficult, and lending was also affected by the general re-assessment of risk linked to the worsening global economic climate. Spreads on short-term trade credit facilities soared to 300 to 600 basis points above LIBOR, compared to 10 to 20 basis points in normal times. A market gap has emerged among the largest suppliers of trade finance, estimated by the main private Wall Street banks to be around $25 billion in November 2008 – out of a global market for trade finance estimated at some $10 trillion a year. Large banks have reported on several occasions that the lack of financing capacity has rendered them unable to finance trade operations. Recently, for example, a $1 billion bilateral trade contract between the US and China was dropped due to a lack of finance.
The liquidity problem has spread to developing countries, which account for one-third of world trade and are now facing the same problems of opening letters of credit and other trade financing instruments in their local markets. According to a survey conducted jointly by the IMF and the Banker's Association for Trade and Finance that will be released soon, flows of trade finance to developing countries seem to have fallen by some 6% or more year-on-year – significantly more than the reduction in trade flows. If such numbers were to be confirmed (at least local bankers seem to agree on them according to the survey), that would mean that the market gap could be well over the $25 billion estimate mentioned above.
The scarcity of trade finance is very likely to accelerate the slowdown of world trade and output. There is mounting evidence of supply chain operations being disrupted by lack of financing for developing country suppliers, particularly in Asia.
At present, the WTO is doing its utmost to mobilise public-sector actors to shoulder some of the risk from the private sector and to do more by way of encouraging co-financing between the various providers of trade finance. With the support of WTO members, the Director-General has convened the WTO Expert Group for Trade Finance twice in 2008, aiming to (i) find collective short-term solutions, notably by mobilising government-backed export credit agencies and regional development banks, and (ii) develop technical measures allowing for better interaction between private and public sector players in the short- and medium-term. The latter encompasses projects developed by the International Chamber of Commerce, the IMF, the IFC, and the Berne Union, all of which aim at removing the obstacles to co-risk sharing and co-financing by various institutions.
Ongoing policy efforts
The response of public-backed institutions has been positive, and three types of activity are currently in play:
- Regional development banks and the IFC have recently enhanced their trade facilitation programmes: the IFC from $1.5 billion to $3 billion, the Inter-American Development Bank (from $0.5 billion to $1 billion), the EBRD (from $1 billion to $2 billion), and the Asian Development Bank (from $0.4 billion to $1 billion). This has brought the total capacity to $7 billion on a roll-over basis, financing potentially some $30 billion or so of trade involving small countries and small amounts ($250,000 on average by transaction).
- Export credit agencies stepped in, essentially with programmes for short-term lending of working capital and credit guarantees aimed at small and medium enterprises. This includes new programmes put in place by the US, Germany, Japan, France, the Nordic Countries, Hong-Kong, China, Chile and others. For certain countries, the commitment is unlimited in amount (Germany). In other cases, cooperation is developing to support regional trade, in particular chain-supply operations. To this effect, the APEC summit announced the establishment of an Asia-Pacific Trade Insurance Network to facilitate intra- and extra-regional flows and investment through reinsurance cooperation among export credit agencies in the region. Japan's NEXI is establishing itself as the leader and main underwriter of this collective re-insurance system. The US and China agreed that their respective import-export banks would make an additional $20 billion available for bilateral trade, and the US and Korea made a similar commitment for $3 billion.
- The central banks in countries with large foreign exchange reserves – and/or which for one reason or another are facing a shortage of liquidity in dollars (due to the fall in remittances, export receipts, and the depreciation of the local currency against the dollar) – have been supplying dollars to local banks and importers through repurchase agreements. Since October, Brazil’s central bank has provided $10 billion to the market. The Korean central bank has pledged $10 billion of its foreign exchange reserves to do likewise. The central banks of South Africa, India, and Indonesia are also engaged in similar operations. Unfortunately, such facilities are unavailable to developing countries with fewer foreign exchange reserves, unless they swap foreign exchange against local currency with their main trading partners. This has happened in some cases (both with the Fed and the ECB).
There is little doubt that the trade finance market will experience difficult times in the first half of 2009. But efforts continue, including through the WTO’s advocacy and mobilisation work, to find durable solutions to what otherwise is yet another source of economic contraction.
Editors' note: This column is a Lead Commentary on Vox's Global Crisis Debate page; see further discussion on Vox’s Global Crisis Debate page.
Auboin, Marc and Moritz Meier-Ewert (2008). “Improving the Availability of Trade Finance during Financial Crises,” WTO.
IMF (2003). “Trade Finance in Financial Crises: Assessment of Key Issues”, December 9, 2003.
Leach, Peter T. (2008) “Weak link,” 22 December 2008, Journal of Commerce.
US Dept of Commerce. (2008). “Trade Finance Guide: A Quick Reference for US Exporters”.