While there has been no improvement in either overall trade volumes or values, costs have gone up for emerging and poor economies due to shrinking trade finance
Chinese entrepreneur Jack Ma is known for pithy sound bites. At this year’s Davos gathering, he left behind a freshly minted saw: if trade stops, war starts. Sounds like a truism, except it seems prescient: it’s already got bloody and it promises to get bloodier as the US and China engage in a fierce trade war. US President Donald Trump is the proverbial bull in the global trade shop: dialling up hostilities at regular intervals, tampering with the global trading system’s pressure valves (such as blocking appointments to the World Trade Organization’s, or WTO’s, dispute settlement body) and reversing hard-won peace deals (reinstating Iran sanctions). Unfortunately, India and other emerging economies are this war’s collateral damage.
In reality, trade is unlikely to stop; it’s just going to get more difficult. Persisting gaps, inefficiencies and costs in trade finance will make it more challenging. A series of events have adversely affected Indian exporters. Demonetization and teething problems in the goods and services tax (GST) have resulted in working capital logjams, leading to sclerotic export margins. Just when things were getting sorted out, Punjab National Bank’s letter of undertaking (LoU) scandal once again upset the trade finance equilibrium with international banks refusing to accept and honour trade finance documents from Indian institutions.
Dissenters might point to data—exports grew 8% during January-May 2018 over the 2017 corresponding period—to reject suggestions that exporters face problems. While they might be partially correct, the truth is slightly more nuanced. Serendipity has played a role. Higher oil prices have partially contributed to increased export receipts; for example, in May 2018, India’s oil exports in dollar terms was 104% higher than May 2017.
Even the government seems to be acknowledging, albeit indirectly, that exporters face trade finance problems. A recent The Times of India story said the government is exploring ways to ensure exporters get access to dollar credit. This story seems to suggest that government is aware exporters face funding problems which, if left unresolved, could reverse the nascent pick-up in exports.
Trade finance has been stagnant globally for some time, especially after the 2008 financial crisis. There are many reasons for that: heightened regulatory requirements (relating especially to anti-money-laundering and know-your-customer rules), higher Basel-III capital requirements, attendant risk aversion and, consequently, higher volume of paperwork. Natalie Blyth, HSBC Holding’s global head for trade and receivables finance, told a November 2017 trade finance conference: “The average trade transaction now requires manual checking of 65 data fields from 15 different documents, with 40 pages to be reviewed."
JP Morgan’s 2017 Trade Outlook said with trade activities requiring an average of 36 original documents, 240 copies and the involvement of 27 entities, Fortune 500 companies were spending an additional $81 billion annually on working capital.
The situation is worse for micro, small and medium enterprises (MSME). According to the Asian Development Bank (ADB), there’s a $1.5-trillion gap between demand and supply of trade finance, half of which arises in developing Asia and 70% of which relate to MSME units and mid-cap companies.
The WTO has identified myriad reasons for shrinking trade finance volumes, but regulatory tightening tops the list. Stricter regulation led to a reduction in correspondent banking relationships, especially in the world’s poorest parts. This is one of the ironic fallouts from the financial crisis: the Financial Stability Board’s directives on banking regulations, prompted by the excesses of western banks, have actually squeezed banks and companies in poor countries.
There’s another paradox that needs consideration here. The 2013 WTO ministerial at Bali saw rich countries—led by the US, UK, European Union, Japan and others—force-fitting trade facilitation into the agenda as a pre-condition to finalizing lasting solutions for agriculture trade. The irony is trade facilitation, that too only for merchandise, is now here to stay but solutions still elude trade in agriculture products.
In addition, trade finance was kept outside the scope of trade facilitation for a variety of reasons. The results are there for all to see: while there has been no improvement in either overall trade volumes or values, costs have gone up for emerging and poor economies due to shrinking trade finance.
A white paper from Hyderabad-based Institute for Development and Research in Banking Technology uses blockchain technology to structure a proof-of-concept model for trade finance. However, there have been many proof-of-concept structures so far; the real efficacy of a distributed ledger will be known through live transactions and via scaling up. That still seems 24-36 months away.
Clearly, other alternatives must be explored. One option is to reinforce the emergent cooperative spirit among multilateral development banks (MDBs), regional development banks, export credit agencies and national development financial institutions to fill in the breach vacated by commercial banks. For example, MDBs are expected to support $35-billion of trade transactions during 2018, against only $22 billion in 2016. ADB supported more than 2,800 SMEs in 2017. This also fits with India’s support for multilateralism, a necessary foil for growing unilateralism.
Rajrishi Singhal is a consultant and former editor of a leading business newspaper. His Twitter handle is @rajrishisinghal.