Finance throws sand in wheels of trade
Trade finance, a basic lubricant for the global economy, is becoming much more expensive and tougher to get, accelerating an already harrowing downturn.
Banks are reluctant to allocate scarce capital to trade finance, which funds cross-border buying and selling, and are very wary about being caught short by defaults by other banks which write letters of credit or by the importers and exporters themselves.
While not the prime cause of a slowdown in global trade, which is being buffeted by declining consumption and tighter finance to households and businesses, tough conditions for the obscure but crucial corner of finance that funds goods and commodities between dispatch and delivery is sand in the wheels.
Stunningly bad trade figures from China underlined the problem. China had been expected to show double digit growth in trade last month as compared to November 2007, but the data showed exports falling 2.2 percent from a year ago and imports down 17.9 percent.
“Global demand for Chinese products is vanishing,” said Gene Ma, an economist at China Economic Monitor, a Beijing consultancy. “Secondly, the credit freeze in importing countries has made it hard for Chinese exporters to sell abroad. I heard some Chinese exporters had to cancel shipments as they were worried about getting paid by their buyers.”
Chinese banks have been very nervous about accepting letters of credit from abroad, making it tougher for imports to China to get the needed financing. China and the U.S. pledged $20 billion to fund trade with developing countries last week, but that is a tiny balm for a huge market.
The rule of thumb is that 90 percent of global trade requires financing. Karl Alomar, chief executive of China Export Finance, estimates that letters of credit which had accounted for about 70 percent of Chinese trade finance in 2007 might now only have 30-40 percent of the market, in part due to concerns about international banks.
Many deals that would otherwise go through will inevitably be scrapped, while many more will be less profitable. The World Trade Organization Director-General Pascal Lamy said in November that some transactions that charged a “spread” of 80 basis points over bank benchmark rates a few months ago were now charging 500 basis points.
It may well take concerted international action by central banks and governments to bring trade finance back to life. But this is far from an easy ask; there are many calls on governments for capital and guarantees already and it could prove politically easier to prioritize “purely domestic” issues like automaker bailouts over trade.
For the weakest importers like British high-street retailer Woolworths, denial of trade finance can hasten a death spiral. “Woolworths is one of the better examples of that,” said Panmure Gordon banking analyst Sandy Chen.
“Because they couldn’t get the credit insurance to effectively fund their pre-Christmas inventory stocking they couldn’t put orders into shippers in the Far East. Because shippers couldn’t get the assurances on whether or not Woollies could pay they wouldn’t ship.”
Woolworths Group was forced to put its retail and distribution business in administration.
Even putting counterparty risks aside, trade finance is vulnerable in the current situation. Banks, and crucially many non-bank finance companies, are having their own difficulties raising funds and are being forced to pay more. They are also under considerable commercial and political pressure to channel what resources they have to areas that either have a big payoff or, like mortgage lending, win points with their government regulators and shareholders.
Trade finance, though it is vital in aggregate, doesn’t tick too many of those boxes. It is also fairly easy to pull back from without enormous immediate repercussions for the banks as it is short-term.
Difficulties with trade finance have also contributed to a 94 percent decline in the price for dry commodities space on large ships.
The Baltic Exchange’s chief sea freight index, which tracks prices to ship resources like coal and iron, is close to a 21-year low. Importers and exporters of commodities and their banks are simply worse risks than they used to be, making finance more expensive and scarcer.
The chilling thing about the trade finance situation is not its impact in isolation but the way in which it illustrates how easy it is to send a very highly integrated global economy into reverse.
“If there are significant increases in perceived counterparty default risks leading to a shut-down of one part of the supply chain it rapidly moves on to the rest of the chain,” Chen of Panmure Gordon said.
“It’s a cycle that feeds on itself.”
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on here. —
For full coverage of the crisis in credit, click here.