Published: January 01, 2000
Exports are an important catalyst for economic growth. Yet, in times of economic contraction, the actions necessary to grow exports—such as allocating liquidity and assuming risk — can contradict what companies view as mission critical to survival: that is safeguarding liquidity and conservatively managing risk. Trade finance resolves this dilemma by helping businesses grow exports to capture the demand of buyers located outside their country, while minimising the impact to their liquidity and risk profile. This, in turn, supports a broader economic recovery.
This article explores:
The Keynesian savings paradox asserts that what’s good for the individual can be bad for the economy. Namely, where an individual may succeed in saving more, a collective attempt to save — based on lack of economic confidence — will trigger lower demand and a decline in economic output. This creates a downward spiral that thwarts collective success at saving.
The exports paradox is this: liquidity conservation, risk reduction, and cost containment have been tools of survival during the financial and economic crisis. Today these have become an institutionalised discipline for many businesses. However, a commitment of liquidity and capital, risk assumption, and a willingness to spend on regulatory compliance and other supply chain costs are essential to stimulating export-led growth — both for individual firms and the global economy.
Conditions are ripening around the globe for a continued and permanent shift towards more exports.
This creates an ongoing tension for companies seeking to increase exports as a new source of growth. Trade solutions for financing, risk mitigation and process optimisation alleviate this tension by satisfying the challenges and concerns of individual companies, thereby supporting the conditions for export-led economic growth.
Conditions are ripening around the globe for a continued and permanent shift towards more exports. At the height of the financial and economic crises, from fourth quarter 2008 through second quarter of 2009, sluggish demand, depressed commodity prices, capital and liquidity constraints and a sudden lack of availability of trade finance triggered a steep decline in global trade.[1] Today the opposite dynamics — i.e. resurgence in demand, increasing commodity prices, and availability of credit, liquidity, and trade finance — are coalescing to support a resurgence in global trade.
High demand coupled with a weak local currency
For a number of years, higher consumer spending in the US bolstered domestic demand and had been providing the fuel for growth. However, in recent years net exports have become an important driver of growth for an economy as the growth from foreign demand has exceeded domestic demand for goods and services. This has been augmented by a sharp decline of the local currency, especially the dollar vis-à-vis other currencies in the last few years. According to the Peterson Institute, a 1% decline in the US dollar’s real effective exchange rate translates into a $20bn increase in US exports after two to three years. This coupled with higher export growth can help offset stagnant domestic demand. This was evident recently as exports from Germany rose 8% in the second quarter of 2010, helped in part by the euro’s approximate 20% drop against the dollar this year to June 2010. There has been rising demand for raw materials such as steel and raw cotton in emerging manufacturing hubs in Asia, which is benefiting natural resource-rich countries of the world like Brazil, the United States, Australia and Russia. Fast developing economies in return are demanding at a rapid pace finished products like high end consumer goods and electronics to meet the vast demand created by a strengthening local currency, and strong growth in income and standard of living in these countries in recent years.[[[PAGE]]]
Increasing commodity prices
Commodity prices were sky-rocketing in 2006-07 on the back of huge global demand just prior to the financial crisis. However, they hit new lows within months during the peak of the crisis in 2008-09. Lately, these are again trending on the upside and if they sustain — coupled with ever increasing demand — they will bolster the growth of exports globally. For example, the high price of steel is projected to continue for the foreseeable future. This will benefit the US, which is one of the largest exporters of steel. These factors, combined with the projected longer-term continuation of the depreciation of the US dollar, present commodity exporters, including US steel exporters, with an opportunity for sustained growth.
The availability of credit, liquidity, and trade finance
Economic growth in many countries relies on trade, particularly in a globally interconnected ecosystem of supply chains characterised by the financial interdependency of their members. Exports are an important driver of GDP growth. According to the Bureau of Economic Analysis, Net Exports accounted for approximately 1.9 percentage points of the 5.0% GDP growth rate in the fourth quarter of 2009 for the US. This has been a repeating trend in recent quarters and in other countries as well.
Governments understand the linkage between GDP growth and exports and are providing stimulus to foster the export sectors of their economies.[2] For example, the US government is supporting exports to catalyse growth, with a goal of doubling US exports within five years. The National Export Initiative (NEI) is a government strategy to promote exports through increased funding, focus, and cabinet-level coordination. Core to the programme is the link between US access to global markets, economic growth, and the creation of new jobs.[3] A key focus is on emerging markets like China, India, and Brazil. The initiative gives special attention to supporting small and medium-sized enterprises (SMEs) including: providing education on overseas opportunities, connecting SMEs to new customers and advocating for their interests, improving their access to credit and enforcing international trade laws to support free and fair access to foreign markets.[4]
Under the initiative, President Obama has called on the Export-Import (EXIM) Bank to increase financing available to SMEs by 50% — from $4bn to $6bn — over the next year. According to the International Trade Administration, $1bn in agricultural exports supports more than 9,000 jobs, spanning urban and rural areas and a range of businesses, while creating an additional $1.4bn in economic activity.5 So far this programme has yielded positive results; for the first six months of 2010 US exports have risen 17.7% over the previous year.
Similar government-led policy efforts are being replicated in other economies to support the growth of exports. In the global arena, a pledge by G-20 members to provide $250bn in short-term trade finance through 2010 further underscores the linkage between trade finance and economic recovery.
There has been rising demand for raw materials such as steel and raw cotton in emerging manufacturing hubs in Asia.
As consumer demand is expanding in high-growth markets like Brazil, Russia, India, and China (BRIC) — and other emerging markets — new trade corridors are developing. There has been a shift away from unilateral trade flows — emerging markets exporting to the US and Western Europe — and growth of intra-regional trade flows and trade between developing markets. For example, a number of Latin American countries have benefited from Asia’s demand for commodities, and China, India, and other Asian countries have developed markets for their consumer goods in Latin America.
New trade lanes, reflecting the development of new trading partners, could more evenly distribute supply and demand among interconnected economies. Along with economic recovery, this could support the emergence of a fundamentally stronger global economy.
According to the World Trade Organisation (WTO), for the first six months of 2010 world merchandise trade rose around 25% compared to the same period in 2009. The WTO projects a rebound in global trade for 2010, with 9.5% growth over 2009. Exports from advanced economies are expected to increase by 7.5% in volume terms, and in emerging economies are expected to increase by around 11%.6 According to a trade survey of more than 5,000 SMEs in 17 global markets, three out of five respondents (58%) expect continued growth in trade volumes in 2010, a 17% increase from a similar survey in 2009, reflecting a stronger awareness among SMEs of trade as a growth opportunity.[7]
Within the US and other advanced economies, such as those in Western Europe and Australia, a sluggish recovery with low domestic demand is causing many companies to seek new growth sources. As a result, many businesses — including SMEs — expect to increase exports as a share of their business activities.
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… yet challenges remain Despite the ripening conditions for export-led growth, the reality of implementing an export growth strategy is complicated for many companies. Export growth requires a commitment of liquidity, risk assumption, and a willingness to spend on regulatory compliance requirements and other expenditures. However, the market continues to focus on managing working capital metrics, i.e. lowering days sales outstanding (DSO) and days inventory outstanding (DIO) and extending days payable outstanding (DPO), to optimise liquidity and safeguard its use. A heightened focus on risk remains, as does continued attention to cost-cutting and process efficiency.
Working capital
Liquidity — the lifeblood of daily operations — has become a priority for many companies amidst tight credit during the financial crisis. The conservative use of liquidity and credit are now an institutionalised discipline. Working capital management has moved beyond the treasury function to become a priority across all organisational functions that drive cash efficiency. However, export growth requires the use and availability of adequate liquidity. Global supply chains typically lengthen payment terms, thereby extending DSO. In the current economic climate, buyers want to extend payment terms to optimise working capital. Specific payment terms are used in certain industries or due to historical reasons. Changing them creates relationship risk. Trading partners may be unwilling to change terms as most terms favour either the buyer or the seller. Some buyers are seeking to extend terms unilaterally from 30 or 60 days to as much as 90 or 120 days, based on their strength in the relationship, thereby affecting cash flow for exporters.
Risk
Exporting by nature has an inherent risk as it deals with rules and regulations of different countries, currencies, languages, and standards. The financial crisis amplifies the focus on risk. Continued vigilance over counterparty risk creates tension with export growth, since doing business with buyers in countries around the world requires the assumption of risk on multiple levels, for example:
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Cost-cutting and process efficiency
Regulatory compliance, extended payment terms, document discrepancy fee, counterparty due diligence—these are just some of the costs associated with exporting. As a result of the recession, organisations were tasked with increasing process efficiency to reduce cost and improve productivity—despite already thin staffing. Companies looking to grow exports need cost-effective and cost saving solutions that increase efficiency around global trade and supply chain processes.
Bank-facilitated trade solutions for trade finance and risk mitigation resolve the conflict between a company’s fiscally conservative stance and export growth objectives. Supporting them are technology-enabled solutions that streamline trade processes for greater transparency and cash flow visibility, in support of risk reduction and working capital optimisation respectively, and cost-efficiency.
Exporting requires a much greater level of compliance with customs and other goverment regulations than selling domestically.
The spectrum of trade solutions ranges from short-term oriented traditional trade instruments, such as letters of credit (LCs), documentary collections or open account, to more complex and tailored medium-to-long term structured trade financing solutions that include support from export credit agencies (ECAs) and multilateral development agencies.
Financing
Trade finance is generally more readily available than some other forms of working capital financing, since banks consider it to be asset-linked, short term and self-liquidating.
Trade financing solutions range from vanilla letter of credit discounting on presentation of compliant documents to other traditional working capital financing solutions to pre- and post-shipment solutions such as performance-based financing, which analyses the track record of a buyer-seller relationship based on analysis of historical trade flows to provide supplier financing.
In the last few years, supply chain financing — which is a collaborative form of financing that lowers the overall cost of working capital in the supply chain — has been available to the sellers as an avenue for financing non-LC related shipments. This involves balancing the working capital needs of sellers and buyers by reducing the funding costs for sellers while extending payment terms for buyers.
Risk mitigation
Opaque markets, which lack ready access to information for assessing the financial stability of counterparties, present higher credit risk to exporters. Bank solutions can help mitigate the risks of payment default and delay. These include traditional commitment-to-pay services such as letters of credit, which shift the risk from the buyer to the buyer’s bank; letter of credit confirmations, which eliminate country and bank risk by shifting the commitment to pay to the exporter’s local bank; and document purchase services which eliminate documentary risk.
Streamlined processes
Technology continues to play an important role in providing visibility into and streamlining financial processes, including automating document preparation and exchange from purchase orders and shipping documents to invoices. This solution set applies automation and process optimisation to trade processes — between the exporter, its bank, and its counterparties —to increase efficiency. Automation improves accuracy by eliminating manual touch points, speeds up processing, reduces costs and increases process transparency to reduce the risk of noncompliance and payment default, which in turn reduces DSO and improves cash flow forecasting for exporters.
Visibility
End-to-end process transparency, in turn, improves visibility of informational flows. All supply chain members gain access to data in the same format in real time. This enables the financial supply chain to integrate more tightly with the flow of physical goods, information, and cash. This strong linkage provides the seller with the opportunity to finance a transaction at various points in the supply chain while the goods and documents are still in movement. At the same time, it gives the bank the comfort to finance as it also is able to see exactly where the goods and the documents are in the supply chain.This in addition facilitates a more precise view of cash flow, supports better cash forecasting and the use of effective tools to unlock working capital trapped in the supply chain to improve working capital efficiency. This is the underlying premise for electronic document presentation and payment and supply chain financing solutions.[[[PAGE]]]
Embarking on an export growth strategy has its share of complexities. An organisation must choose the right strategic provider that supports an integrated approach to financing, risk mitigation, and process optimisation that addresses its needs within the broader context of the supply chain. Such an integrated perspective and approach requires intellectual capital — experience and expertise in global solutions and local nuances — specific to each unique circumstance.
Attributes to expect from a banking provider include:
Global coverage. An ideal provider knows counterparties on both side of a transaction (i.e. buyers and sellers), and, from this position, can work to facilitate payment, mitigate risk, provide cost-effective financing, and resolve disputes that impede timely payment. This requires an ability to obtain business intelligence through on-the-ground staff located in a buyer’s country and all around the world.
Complementing this ability is an extensive network of correspondent banking relationships that enable your provider to extend reach beyond its physical footprint. Also vital are strong relationships with export credit agencies and multilateral agencies in multiple regions across the globe.
Financial strength and stability. Of crucial importance are the size of a bank’s balance sheet, its global credit standing and its ability to assume credit risk on behalf of the exporter, the buyer, and your buyer’s bank. A bank should exhibit a reasonable and appropriate country risk appetite to help mitigate supply chain risk.
Trusted advisor capacity. The ability to be a trusted advisor should span the range of trade scenarios, from simple, short-term transactions to complex structured trade financing solutions. A bank should be able to apply its intellectual capital to replicate best practices around the world. It takes decades of experience, knowledge and expertise to gain the necessary track record to serve in this capacity.
The ability to be trusted advisor should span the range of trade scenarios, from simple, short-term transactions to complex structured trade financing solutions.
Export growth in the US, Western Europe, Australia, and other regions reflects a shift in focus of globalisation primarily for cost reduction – through the labor arbitrage associated with low-cost sourcing and off shoring – to the pursuit of higher growth markets as a driver of top line growth. Export-driven economic recovery is good not only for exporters, but importers as well, who benefit from renewed domestic growth.
It could also reflect the beginning of a reversal in the long-standing role of America, Western Europe, and other developed economies as net importers, which, longer-term, could correct the balance of trade among nations. Like a balanced budget, a reduction of trade deficits could strengthen the global economy by more evenly distributing supply and demand among interconnected economies. This could increase economic stability and reduce the severity of global economic shocks over time.
The notion of exports driving growth is supported by favourable economic conditions and governmental policy changes. For an organisation implementing an export growth strategy, trade solutions exist today that address the internal issues of working capital, risk, and efficiency.These micro- and macroeconomic factors combine to provide a timely opportunity for exports to lead the global economic recovery.
1. Tower Group ViewPoint
2. ibid.
3.Department of Commerce International Trade Administration press release, "Commerce Secretary Gary Locke Unveils Details of the National Export initative", February 4, 2010.
4. ibid.
5. ibid.
6. www.wto.org
7. World Trade 100, "The Brave New world of Trade Finance"
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