Asia: Enjoy the Rewards, But Remember the Risks

With trade flows rebounding strongly and gross domestic product (GDP) forecasts being revised upwards, the picture for Asian economies has been steadily improving throughout 2010. But, as many look forward to a brighter future in Asia, it is important not to forget the lessons of the past.

As the credit crisis took hold, many Asian traders – who had enjoyed a decade of strong growth – believed it would not affect them. Decoupling, they thought, meant that the buoyant economies of China and India could carry on regardless, with intra-Asian trade flows making up for any loss in external demand. Of course, it did not work out like that. Customers ran down their inventories instead of placing new orders, while the banking crisis made credit scarce and expensive.

As a result, many suppliers went out of business. It is estimated that between 20,000 and 30,000 small and medium-sized enterprises (SMEs) went bust in China during the peak of the global slowdown. That pattern, if not the magnitude, was repeated right across Asia. The survivors found themselves operating in a far more risk-adverse environment. Buyers, seeing the pressure suppliers were under, had less faith in them to deliver. Suppliers, operating under tight credit restrictions, found it difficult to fund the production and delivery of goods.

This may already seem like ancient history, but it illustrates how much – in a truly global economic world – we are all affected by risks, even if they are far from home. So what are the risks still out there?

Weakness in the West

Between April 2009 and July 2010 the International Monetary Fund (IMF) upgraded its forecast for growth in the world economy from 1.9% to 4.6%. This steadily improving picture is highly reassuring. However, growth remains weak in most western economies and there are fears of a double-dip recession. Many western governments have borrowed heavily to support their economies and, as growth improves, they are now raising taxes and cutting spending to pay back debt – which will affect the ability of consumers to buy goods. High levels of national debt (many European countries have borrowings equivalent to two-thirds or more of national GDP) are another concern. As some rating agencies threaten downgrades, the possibility of a sovereign debt crisis has been raised. This is undermining confidence in currencies, particularly in Europe where the euro is seen as under threat.

There are, of course, grounds for thinking that if another crisis occurred, the impact would be less severe. The systems are already in place for national and multinational intervention, many negative risks have been flushed out of the system and liquidity is strong. We should recognise that another banking crisis is highly unlikely, and that a return to recession in the West is seen as a possibility rather than a likely outcome. However, even if the risks are smaller, there are issues that need to be addressed if global supply chains are going to operate smoothly.

Supply Chain Solutions

So, what can traders do to ensure that they can keep trading successfully even if the economic climate changes for the worse? Following the credit crisis, many suppliers that were operating on open account switched to using letters of credit (LCs). As some of the most secure instruments available to international traders, they provided greater certainty of payment and can improve cash flow. However, even with the assistance of banking partners to simplify and automate processes, they remain relatively costly and labour intensive. As conditions improve, we have seen a drift back to open account trading. Instead, the emphasis of many companies in this stage of the cycle is on improving efficiency and optimising resources within the supply chain.

This is one of the reasons JP Morgan has been investing heavily to provide local services while drawing on its worldwide strength and expertise. By connecting well-proven treasury and trade finance processes with global risk management and financing capabilities, JP Morgan is helping corporates to re-engineer their supply chains to drive out inefficiencies and balance risk. While credit margins have come down since they spiked during the credit crisis, corporates have learnt that the days of cheap money are over. Instead, operations need to be structured to both reduce the need for financing and ensure it can be accessed at the lowest cost. In addition, cash within the supply chain and corporate accounts can be managed so that liquidity is maximised.

Working Capital

This trend towards better use of working capital through supply chain optimisation looks set to accelerate as corporates build protection against the external risks discussed so far in this article. For example, with economic recovery still patchy in the West, demand may become more difficult to predict. In this context, the ability to react quickly to changing demand is vital. Building and managing a supply chain that has the capacity to increase or reduce quantities without time lags or non-essential costs will be valuable. Within these supply chains, as sellers come under pressure they will look to collect receivables more quickly, while buyers will want to extend payment terms. The only way for both parties to achieve their objectives is through a liquidity buffer – such as supply chain financing.

For example, a major US-based clothing brand, which sources many of its fabrics from Asia, had invested a significant amount of time and money building up a supply network based on offshoring and low cost sourcing. Many of these suppliers were struggling as local finance dried up and demand dropped. Not wishing to risk losing its suppliers – nor wanting to pay a premium to keep them afloat – the retailer enlisted the help of JP Morgan. By leveraging the retailer’s strength as a buyer, we were able to help improve their key suppliers’ credit terms and cash flow.

The strength of economic growth will also affect the price of commodities, creating challenges both for those who sell raw materials and those who require them to make finished goods. Here, risk can be mitigated by hedging strategies that enable buyers and sellers within the supply chain to trade at a pre-agreed price. Similar strategies can also be used to mitigate currency risk, a particularly important issue as the eurozone struggles to accommodate weaker nations and the US economy impacts on the dollar’s ‘safe haven’ status. Closer to home, the value of the renminbi (RMB) may, of course, also rise as China’s economic strength continues to build.

Weak Links, Strong Chains

If economic conditions deteriorate again, suppliers could once more become vulnerable and companies will need to revaluate their supply chains to identify and support key partners and reduce the number of potential ‘weak link’ suppliers. However, this must be balanced against the need to ensure continuity of supply. Corporates will want to ensure that vital components can be sourced from multiple suppliers to keep their production lines going. Here the ability of the weakest link in the supply chain to access the financial strength of the buyer can be vital in keeping the supply chain moving.

While the processes described above can offer major benefits for corporates, they are also a good fit for the banks. While appetite for more exotic forms of lending remains constrained, the relatively quick and closed lending cycle of supply chain finance is popular with banks. Even in those cases where banks do not have appetite for a particular corporate, they can work with state and multilateral credit insurance agencies to share risk.

Another positive for banks is the opportunity it gives them to add value through a range of services across transaction, trade finance, treasury and risk management. This enables banks to work more closely with their clients to deliver a complete, tailor-made solution.

It’s clear that the range of challenges outlined in this article, and the number of services required to meet them, mean that demand for trade solutions will rise. And indeed, when countries finally fully recover from recession, rising trade flows will also increase take-up. To meet this demand, many banks are building capacity in the region.

Faced with a greater choice of providers and increasingly complex and global supply chains, companies will look for a banking partner with the scale and resource to deliver a full range of products and services across currencies, countries and continents – yet with the people on the ground to understand the needs of each individual client.

The Road Ahead

We cannot, of course, know what risks lie ahead. But we can learn from the past, anticipate the future and build strategies to match. The need to move swiftly as demand falls or rises, to negotiate changing currency and commodity prices and to ensure that working capital is used efficiently, are all key to negotiating whatever risks are to come. Those that are well-prepared will prosper; those that are not risk falling behind.

The good news, however, is that the actions corporates take today to protect themselves against risk will drive business efficiency and position them well for the future, whatever it holds. Global banks can help them achieve these efficiencies and play a key role in creating lean, just-in-time supply chains with excellent transaction processes and working capital management. With those processes in place, Asian corporates’ bright future looks set to continue.

To read more from JP Morgan, please visit the company’s microsite.

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