International Finance Team Himmat Kalsi Development Prospects Group Room 4-366 August 5th, 2003 3-0796 International Finance Briefing Note: #29 43340 Trade finance for emerging markets · Commercial banks have become an in- Trade finance from market-based sources creasing source of trade finance $ billion 25 · The process of financing trade has be- come less conventional over years 20 · Trade finance has been resilient and a 15 particularly important source of finance for marginalized countries 10 5 A growing source of finance Trade financing plays a crucial role in facilitating 0 international trade for emerging market econo- 1980 84 88 92 96 00 2003 mies, which in turn has a positive impact on their economic performance and external liabilities. Cross-border financing for trade can take place Trade finance and growth in emerging markets' trade through official sources (such as Export Credit $ billion Percent Agencies), commercial banks and via direct 25 40 Growth in trade funding arrangements between trading partners. 30 This note focuses on funding from commercial 20 banks. For a description of methodology used to 20 compile data see box on the next page. Trade 15 10 financing from other sources would be dis- 0 cussed in subsequent briefing notes. 10 -10 Over the past two decades, abstracting from 5 Trade finance -20 short-run cyclical patterns, trade finance for 0 -30 emerging markets has been rising (upper chart, 81 85 89 93 97 01 right). The level of trade financing has undergone a structural adjustment. Financing quadrupled Oiling the wheels of trade from an annual average of around $4 billion Trade finance through commercial banks has dollars between 1980 and 1990 to an average of helped oil the wheels of trade for emerging $16 billion between 1991 and 2000, and has held markets. For the most part since the early at around $20 billion in 2001 and 2002. 1980s, trade finance has coincided with the pattern of trade for emerging markets (lower International financing for trade is particularly chart, above). During the 1980s, most of the important for countries that typically have limited growth in emerging market trade came from the access to foreign financing, as well as during Latin America and Caribbean region. However, times of economic stress when countries having undergone a debt crisis, trade finance to usually lack access to foreign capital markets. the region declined significantly from the early International Finance Team Himmat Kalsi page 2 Development Prospects Group Room 4-366 August 5th, 2003 3-0796 1980s to mid-1980s. Thus the growth in trade Growth in trade finance and trade finance to Latin America accounted for only a Percent of total growth; annual averages small part of the growth in trade finance to 1981-90 1991-95 1996-02 emerging markets as a whole during 1980s. Trade finance Most of the growth in trade finance during this Europe & C. Asia 2 380 8 period came from East Asia and Middle East and East Asia & Pacific 91 -17 33 North Africa. In the mid-1990s, as the growth in South Asia 1 9 11 trade shifted to Europe and Central Asia, so did Latin America -9 -112 -26 the growth in trade finance to emerging markets. Mid. East & N. Africa 32 -210 28 Since the late 1990s, as the growth in trade Sub-Saharan Africa -16 50 47 spread out over various regions, so has the Trade growth Europe & C. Asia 8 99 15 growth in trade finance (table, right). East Asia & Pacific 14 -3 46 South Asia 2 5 6 The changing face of trade finance Latin America 42 -2 10 Until the 1990s, nearly three fourths of trade Mid. East & N. Africa 24 -4 22 financing took place through conventional means Sub-Saharan Africa 10 6 2 that entailed a series of steps and procedures for the various parties involved (see exhibit on the next page). Export credit, a financing facility Buyer Credit, which involved a bank in the used by the purchaser of the exported goods, supplier's country extending a payment facility to was the most commonly used means, and a bank in the purchaser's country (or to the accounted for almost 80 percent of the conven- purchaser directly), was the second most tional mode of financing trade (table, next page). commonly used means of financing trade. Also, Methodology for trade finance data The trade finance data used in this note comprise financing of trade via conventional instruments plus through general bank credit arranged explicitly for the purposes of trade. The conventional instruments refer to methods that have been traditionally used for financing trade, and empha- size hedging against non-completion and foreign exchange risk typically associated with cross-border trade. Included in this category is lending primarily via Buyers Credit, Export Credit, Supplier Credit, Letter of Credit, Bill Facility, Guarantee and Lease Facility, Promissory Note Facility, and other facilities for purchase and issuance. With the evolution in finance and trade, however, not all financing takes place via conventional means. Thus, added to conventional methods is financing via revolving lines of credit, Term Loans, Co-financing facilities and Bridge Loans that are arranged solely for the purposes of trade. Over time the definition of trade financing has become murkier. Part of international financing for projects that relate specifically to cross-border purchase or sale of goods may also be considered as financing trade. Such financing is not included in the data used in this note, as it is likely to lead to double counting, as for example in the case of infrastructure project financing. The data compiled for this note take into account only financing through syndicated credit, and only that part which has been reported in the markets. While a part of these data does refer to financing guaranteed by public sources, such as Export Credit Agencies of countries, not all trade financing via public and official sources is captured, as many financing arrangements take place bilaterally. The market source data, however, do provide an opportunity to analyze various aspects of trade financing for emerging markets, and should provide insights into the comprehensive trends in trade financing. In addition, such data are available on a timely basis and have the advantage of providing information on the covenants of such financing. International Finance Team Himmat Kalsi page 3 Development Prospects Group Room 4-366 August 5th, 2003 3-0796 up until the early 1990s, the official sector (Ex- Breakdown of trade finance from market-sources port Credit Agencies) played a major role in % of total 1980-85 1986-90 1991-95 1996-02 facilitating trade finance for emerging markets. Conventional 77 91 62 32 Buyer credit 10 22 28 4 Since the early 1990s, however, trade for emerg- Export credit 67 68 30 19 ing markets has come to be financed increas- Letter of credit 0 1 3 8 ingly from the private sector, specifically through Other 0 0 1 0 general bank lending via Term Loans and Re- Term loan 12 8 33 62 volving Credit facilities. Term Loans specify a Revolving credit 9 1 5 5 fixed amount of financing that can be used by the Other* 2 0 0 1 borrower for a specified period of time, over * Includes Note purchase, issuance and promissory facility. which the principal is repaid at regular intervals. in both data on bank lending from market Revolving Credit allows borrowers much greater sources, as well as claims of BIS banks on flexibility in drawing down and paying back the emerging markets). After the resolution of the principal sum on the loan. These general forms debt crisis of the early 1980s, banks were of bank lending have become more popular encouraged to increase exposure to emerging because of the growth of multinationals, im- markets. However, the importance of trade provement in technology and monitoring capabili- finance for emerging markets is manifested by ties, and partly because they circumvent the the resilience that such financing has shown lengthy procedures associated with more con- during periods of stress and its increased ventional forms of bank lending. contribution to supporting bank lending to emerg- ing markets: Resilience through periods of stress · During the debt crisis of the 1980s, when bank The increase in trade financing has taken place lending to emerging markets dropped from $57 alongside the upward adjustment in the overall billion in 1981 to $21 billion in 1987, the share level of bank lending to emerging markets (seen of trade financing in total bank lending almost A typical conventional method of trade finance Source: Multinational Business Finance, Eiteman and Stonehill. International Finance Team Himmat Kalsi page 4 Development Prospects Group Room 4-366 August 5th, 2003 3-0796 doubled from 8 percent to 15 percent during Trade financing compared to total bank lending the same period (upper chart, right). $ billion Share of total bank credit (%) · From 1988 onwards, banks increased their 180 30 exposure to emerging markets throughout Trade financing most of the 1990s, to a peak of $165 billion in 25 1997. In part, this was driven by an increase in 140 20 financing for trade. The share of bank lending devoted to financing emerging market trade 100 15 increased from a yearly average of 15 percent during the mid-to-late 1980s to an average of 10 60 Total bank 20 percent between 1988 and 1997. credit 5 · Since 1997, despite the retrenchment of banks from emerging markets, leading to a drop in 20 0 lending to $85 billion in 2002 (from $165 billion 1980 84 88 92 96 00 in 1997), the share of trade financing has in general been rising and has held stable on Distribution of trade finance by credit risk category Percent of total emerging market trade finance; 1980 - Apr 03 average at around 20 percent of the total bank 30 lending to emerging markets. 25 Outreach to marginalized countries Trade financing via commercial banks has 20 reached emerging market economies that are 15 marginalized both in terms of their credit risk (or its perception) and share of international trade. It 10 is even more widely spread out than general bank lending, which unlike other forms of mar- 5 ket-based financing is much more widely acces- 0 sible by emerging markets. Using the Institutional 61-70 51-60 41-50 31-40 21-30 11-20 10-NR Investor credit rating spectrum (the largest rating Institutional Investor credit rating (Scale: Best=100 - Worst=0) spectrum for emerging markets covering about 100 economies), a little over 25 percent of total Changes in distribution of trade finance trade finance for emerging market economies Average between 1980 and April 2003 went to countries 1986 1987-89 1995 1996 1997 1998 that were rated at the lower end of the credit Total ($ bn) 6.0 4.9 19.5 14.0 24.2 16.1 spectrum (middle chart, right). In comparison Percent of total emg. mkt. trade finance only 9 percent of the total bank lending went to Rating these countries during the same period. 61 - 70 0 1 3 2 2 2 51 - 60 68 19 34 28 15 28 41 - 50 8 16 18 19 23 11 Of particular importance has been the availability 31 - 40 2 8 11 14 30 19 of trade finance to marginalized countries during 21 - 30 8 9 10 7 8 10 periods of stress and credit retrenchment by 11 - 20 1 8 14 11 7 13 banks. During the three major episodes of 0 - 10 0 10 0 0 0 0 Not rated 12 29 9 21 14 18 decline in total trade finance to emerging mar- kets, countries with high credit risk (low credit above). Countries with credit ratings of less than ratings) fared quite well in terms of their share in 20 (on the Institutional Investor rating scale), or total trade financing arranged for emerging those not rated at all, fared particularly well markets from international capital markets (table, during years of shrinking overall trade finance.