The global financial crisis: A wake-up call for trade finance capacity building in emerging Asia

Wei Liu, Yann Duval, 19 June 2009

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The current financial crisis has provided a useful reminder of how essential trade finance is to international trade. The capacity to trade is significantly affected by the availability and cost of financing and the availability of instruments to mitigate the risks associated with international trade transactions (Auboin and Meier-Ewert 2003; Thomas, 2009).1

Drying up trade finance

At first, emerging economies in Asia appeared better positioned to weather the turbulence caused by the global financial crisis, thanks to their sound economic fundamentals, substantial reserves, improved regulatory frameworks, and generally robust corporate balance sheets and banking sectors.

However, with the rise in risk aversion globally, government agencies and corporations have found it increasingly difficult to obtain trade financing both from international financial markets and their own domestic financial institutions (Figure 1). Global trade finance (including aircraft and shipping) in 2008-4Q was already down 39% compared to that in 2007-4Q2 and may not recover until global economic uncertainties resolve.

Figure 1. Asian trade drops together with external finance

Source: Bond, equity and loan database of the IMF through Dealogic (Kang and Miniane, 2008) and CEIC database. Note: Authors calculated aggregated trade values of emerging market economies in Asia, namely China, India, Indonesia, Malaysia, Pakistan, Philippines, Russia, Thailand and Turkey. “Trade growth” refers to percentage change in trade from same quarter of previous year.

Rising risks and costs

The IMF Trade Finance Survey (2008) – covering 40 major banks in advanced and emerging economies – reveals that trade finance has become costlier and somewhat more difficult to obtain in emerging markets. South Asia, the Republic of Korea, and China have been the most affected. Overall, a substantial rise in the perceived risk of trade has threatened short-term credit and trade finance. Fear of default, called counterparty risk, is causing banks to tighten lending guidelines. More than 90% of the banks in advanced economies and 70% in emerging markets admitted that they had revised and tightened their lending criteria and guidelines. Many have withdrawn or reduced credit lines, raised costs, and become reluctant to confirm letters of credit in some markets.

Since “country risk” is the basis for setting minimum premium rates for transactions covered by many export credit agencies, a country’s sovereign default risk directly affects an individual exporter’s ability to obtain trade financing (Figure 2). Emerging economies in Asia may slip into higher risk categories due to the current crisis. Indeed, China, Pakistan, the Russian Federation, and Viet Nam, were added last year to a watch-list by Coface, a world leader in trade risk management, due to rising risks in various sectors.

Figure 2. Country risk classification

Source: Country Risk Classification of the Participants to the Arrangement on Officially Supported Export Credits, http://www.oecd.org/dataoecd. Note: The Country Risk Classification Method by OECD measures the country credit risk, i.e. the likelihood that a country will service its external debt. The Country Risk Classifications are produced solely for the purpose of setting minimum premium rates for transactions covered by the Export Credit Arrangement.

A host of emergency measures have been put in place

Surprised by the speed and scale of the deterioration in international trade and investment flows, individual countries and trade- and development-related international organisations have implemented a number of measures to sustain trade finance.

At the global level, G20 members committed to ensuring the availability of at least $250 billion over the next two years to support trade finance.3 At the regional level, the Asian Development Bank has agreed to a significant expansion of its trade finance facilitation programme, which is expected to provide up to $15 billion in support until 2013.

At the national level, many countries have taken emergency measures to strengthen existing trade finance institutions by increasing export credit insurance and extending the coverage of default risk.

The following are a few examples of measures taken or under consideration in the region.4

  • India is considering financial assistance to small and medium exporters by providing a 100% indemnity for insured exports, instead of the current 90%, amounting to an additional support of $25 million.
  • Asuransi Ekspor Indonesia, which provides insurance and guarantees to support Indonesia’s non-oil-and-gas export development, may obtain further capital to enlarge its underwriting capacity.
  • South Korea will increase its annual export insurance limit from $130 billion for 2008 to $170 billion for 2009 and is considering an additional capital injection of $260 million during this year.
  • Thailand will inject an additional $140 million to the Thai EXIM Bank to increase export insurance. In addition, $85 million were allocated to the Small Business Credit Guarantee Corporation so it can raise small and medium-sized enterprises' credit guarantee fund and loans. In response to increasing demands from Thai exporters, the Thai EXIM Bank also provided risk assessment services and related trainings. Familiarising small and medium enterprises (SMEs) with trade finance instruments is essential as buyer default risk has increased and SMEs are usually not protected against it (Table 1).

Table 1. Small and medium traders in Thailand have to pay in advance when importing and depend more on open account when exporting

Source: Kasikorn Bank, Thailand, 2009.

Strengthening trade finance institutions: A renewed priority

The short-term measures mentioned above are essential in times of crisis, and it is heartening to see how quickly they have been agreed upon and implemented across the region. However, many developing countries have very limited capacity to address national trade finance shortages on their own. Actions beyond the short-term emergency measures are necessary to strengthen trade finance institutions.

In the medium term, it is essential to establish or strengthen government-backed export credit insurance and guarantee institutions and/or export-import (EXIM) banks. As highlighted above, these institutions can play a major role in times of crisis. However, they are inefficient or missing in many Asian developing countries (Auboin and Meier-Ewert, 2003). Where this is the case, governments should examine different models (e.g., public-private partnerships) for the establishment of self-sustaining trade finance institutions.

Figure 3 shows credit information index scores (2007/08) that measure the scope, accessibility, and quality of credit information through either public or private bureaus in a country. The index ranges from 1 to 7, with a higher value indicating higher credit information availability. Credit information institutions are still weak or absent in many Asian countries. Therefore, establishing or strengthening domestic credit rating agencies and information-sharing and recording mechanisms – and their supervision – is critical. This would contribute to reducing the cost of trade credit and insurance, which heavily depend on how accurately the creditworthiness of the buyer or seller can be assessed. Recent research suggests that the credit information gap between emerging Asia and OECD is large and that progress in this area could significantly impact Asian trade competitiveness (Duval, 2009).

Figure 3. Credit information institutions still weak or absent in many Asian countries

Source: Doing Business Database.

In the long-term, a strong, credible, and well-developed banking and insurance sector is the key to ensuring access to a full array of trade finance instruments. Good and stable macroeconomic fundamentals, prudential regulations, and a pragmatic approach to financial sector liberalisation are essential to achieve this goal.

At a time when developed country markets are shrinking, deepening South-South cooperation on trade finance should be given particular consideration. Several developing countries with already well-developed national trade finance institutions have been proactive in this regard. For example, the Thai EXIM Bank recently opened a branch in Moscow to facilitate the financing of Thai exports to the Russian market. A number of countries have also explored ways to establish or strengthen international payment clearing mechanisms on a bilateral or regional basis, and discussions on the creation of regional and sub regional development funds for SMEs are also on-going. Such cooperation initiatives should be welcome as they would provide new ways to pool resources and expertise to tackle trade finance bottlenecks while at the same time opening up new market opportunities.

Editors’ note: The authors wish to acknowledge the comments of Shamika Sirimanne and Carlo Federico Cattani. The views expressed are those of the authors and should not be considered as reflecting the view or carrying the endorsement of the United Nations. Authors can be contacted at liuw@un.org and duvaly@un.org.

References

Auboin, M. and Meier-Ewert, M. (2003) “Improving the availability of trade finance during financial crises”, WTO, Geneva.
Dorsey, T. (2009) “Trade finance stumbles”, in Finance & Development, March 2009, IMF.
Duval, Y. (2009) “Behind-the-Border Trade Facilitation in Asia-Pacific: Cost of Trade, Credit Information, Contract Enforcement and Regulatory Coherence”, ESCAP TID Staff Working Paper, No. 02/09, United Nations.
ESCAP (2005) Trade Finance Infrastructure Development Handbook for Economies in Transition, ST/ESCAP/2374, United Nations, Bangkok.
ESCAP (2009) Navigating Out of the Crisis: A Trade-led Recovery – A practical guide for trade policymakers in Asia and the Pacific, ST/ESCAP/2538, United Nations, Bangkok.
IMF (2003) “Trade finance in financial crises – assessment of key issues”, Seminar Document, IMF Conference on Trade Finance on 15th May, 2003, Washington, DC.
Kang, K. and J. Miniane (2008) “Global Financial Turmoil Tests Asia”, Finance and Development Magazine of the IMF, December, volume 45, number 4.
Liu, W. and Y. Duval (2009) “Trade finance in times of crisis and beyond”, Asia-Pacific Research and Training Network Alerts, Issue 3, April.
Thomas, A. (2009) “Financial crises and emerging market trade”, IMF Staff Position Note, SPN/09/04.
UNCTAD (2005) “Enhancing South-South Trade and Investment Finance”, Background note, UNCTAD/WEB/DITC/COM/2005/2, Geneva.
World Bank (2009) “Regional integration to scale up supply, global integration to scale up demand”, World Development Report 2009 - Reshaping Economic Geography, pages 262-273, Washington, D.C.


1 Trade finance is provided by commercial banks, official export credit agencies, multilateral development banks, insurance firms, suppliers, and purchasers. Trade finance can take many forms and may include for example the provision of working capital loans or letters of credit (L/Cs) - a trade finance instrument whereby the bank of the importer guarantees payment to the exporter or its bank upon satisfactory delivery of a shipment. For more details, see ESCAP (2005).
2 For details, see Dealogic (January 2009). Note: Global trade finance (excluding aircraft and shipping) in 4Q 2008 was down 32 per cent compared to 4Q 2007.
3 The new IFC World Bank group Global Trade Liquidity Pool should provide up to $50 billion in trade liquidity support over the next three years.
4 Berne Union Press Release, November 2008, http://www.berneunion.org.uk/ accessed on March 27 2009; Bangkok Post, accessed on March 29 2009.

 

Topics: International trade
Tags: crisis, emerging Asia, Trade finance

Chief, Trade Facilitation Unit, Trade and Investment Division, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP)

Associate Economic Affairs Officer at the United Nations Economic and Social Commission for Asia and the Pacific