Due credit

Irena Asmundson, Economist at the International Monetary Fund, surveys the availability of trade finance.

Trade finance is not an area that the International Monetary Fund (IMF) normally covers, but when the financial crisis boiled over and started to affect world trade last year, we were concerned that this would be one of the vectors of infection from the financial markets to the real economy.

Furthermore, there is little data about the levels of trade finance freely available, which makes it very difficult to assess its health. That is why the IMF and the Bankers’ Association for Finance and Trade (BAFT) have conducted a number of surveys during the past year to get a better measure of how the financial crisis is affecting the finance of global trade.

GDP growth has fallen across most of the world in the past year, with big declines in some countries. Obviously, this has an impact on world trade. But falls in GDP growth tend to have a disproportionate effect on international trade in normal business cycles. Unfortunately, this is not a normal business cycle. It is worse than just about anything we have experienced since the end of the second world war.

So, trade tends to be much more volatile and sensitive to shocks than GDP growth, which means that countries that are much more dependent on export-led growth, tend to be much more at risk during global recessions. This explains why Germany and Japan have been so hard hit, but also indicates that many emerging markets will also be badly affected, too. Emerging markets, by their nature, tend to be fuelled by strong growth in exports and, hence, tend to be disproportionately affected by slowdowns in global growth – and that’s exactly what we have seen in the current recession.

Margin call
Trade finance used to be a relatively cheap form of finance for exporters and importers. This helped grease the wheels of commerce. But while the financing costs of the global banks have gone down – thanks to concerted interest-rate cuts in industrialised nations and other steps intended to improve liquidity – their margins have increased.

In the emerging markets, it is a lot worse, because banks’ costs of funding will not have been reduced so much – if at all – while availability of credit has markedly declined, according to all the anecdotal evidence available.

Yet in our surveys, the total value of trade finance has actually held up surprisingly well. This is surprising because if trade finance was a constant proportion of overall trade, then with international trade plummeting, trade finance should also plummet. But this does not seem to be the case.

Instead, trade finance has become increasingly important as a means of mitigating risk – by both banks and their clients – as companies look more closely at their open account activities and banks examine the instruments that they provide to their corporate customers. In both cases, trade finance has benefited from a substitution effect.

In terms of trade finance pricing, the IMF and BAFT carried out surveys in October 2008 and January 2009 to discover the extent of use of trade finance instruments and their associated costs. The data covered changes from October 2008 compared with October 2007 in the first survey, and January 2009 versus October 2008 in the second survey. These highlighted a number of significant shifts. For example, there has been an increase in demands for payment in advance by exporters, which can hit developing countries particularly hard because it can be more difficult to raise the cash in such economies. Both these shifts indicate an increase in risk aversion among corporates worldwide.

In addition, companies that previously had access to open-account financing from their partners have, because of the counter-party risk, been moved to more formalised (and expensive) trade finance instruments, such as letters of credit. In short, companies trust each other a little bit less, so they need a banking intermediary to provide reassurance.

All this comes as the eyes of governments, development banks and similar organisations have turned to trade finance. Both the European Bank for Reconstruction and Development (EBRD) and International Finance Corporation (IFC) have ramped up their guarantee programmes in order to support emerging-market trade. It remains to be seen how far this has gone towards arresting the decline in trade, but we have certainly changed our opinion since the initial sharp falls in trade were registered in October last year.

At that time, the IMF, World Bank and others were concerned that a decline in the availability of trade finance was causing some of the falls in world trade. The good news is that we no longer think that is the case. The bad news is that we think it is driven by real factors in the economy globally.

In other words, we don’t think that it is a financing problem that caused it, but it does mean that there are real structural weaknesses in the world economy that need to be rectified. Furthermore, according to research by economists, if an exporter stops exporting for one year, it is not too damaging, but the longer a hiatus in exports, the more damaging it becomes.

So, the stopwatch is ticking and we will be looking for signs of solid recovery by the end of the year.

Irena Asmundon is an Economist at the International Monetary Fund. She can be contacted at iasmundson@imf.org. Asmundson was presenting the latest IMF trade finance surveys and research at the International Chamber of Commerce’s Spring Trade Finance Conference.

IMF conclusions

■ Marked decline in value of trade finance transactions between October 2008 and January 2009;
■ The value of trade finance is down only modestly compared to the value of trade;
■ Majority of banks reported tightened lending standards in respect of both countries and sectors;
■ Bank trade finance margins are up sharply, but more than offset by declining cost of funds to banks in advanced economies (by nearly 200 basis points). This may not be the case for emerging market banks;
■ Substitution effects among forms of trade finance reflect greater risk aversion by banks and non-financial corporates;
■ IMF/BAFT surveys show banks’ margins over cost of funds rising from 20 to 50 basis points – up by between eight and 20bp in October 2008 compared to October 2007, and a further 13-32bp by January 2009;
■ IMF/BAFT surveys indicated a shift from open account to bank-intermediated trade finance (such as letters of credit); and,
■ These surveys also indicate a shift from bankintermediated trade finance to cash in advance.

Value of trade finance transactions and exports from October 2008 to January 2009

	Trade finance	Exports*
Industrialised nations	-9%	-26%
Latin America	-9%	-45%
Central Europe	-11%	-40%
Eastern Europe	-13%	-55%
Middle East/Maghreb	-5%	-26%
Emerging East Asia	-10%	-37%
South Asia	-9%	-13%
Sub-Saharan Africa	-8%	–

* Export values for larger countries in the region for which data is available
Source: IMF/BAFT Trade Finance Study: http://baft.org/content_folders/Issues/IMFBAFTSurveyResults20090331.ppt