In June this year China’s premier Wen Jiabao and Brazil’s president Dilma Rousseff signed an agreement cementing the global significance of Brazil and China’s trade partnership and committing to mutual investment in the mining, industrial, aviation and infrastructure sectors. The agreement is supported by currency swaps, which are designed to overcome current credit and future liquidity constraints and allow both countries to issue loans in their local currencies up to the equivalent of US$29.46bn.
The signing of this accord is evidence of the economic significance of a trade connection that began as a one-way flow of commodities from Brazil to China, sparked by China’s huge appetite for raw materials. This appetite, fuelled by mass infrastructure investment, saw China’s imports from Brazil increase at a compound annual growth rate (CAGR) of 46.9% between 1999 and 2011. Such was the demand for Brazilian commodities, in particular, iron ore, grains and hydrocarbons, that China overtook the US as Brazil’s leading trade partner in 2009, and remains Brazil’s largest export market.
The relatively recent growth of the middle class in both China and Brazil has been a key factor in the evolution of the unilateral trade flow into a two-way exchange. During this same 12-year period of 1999 to 2011 Brazil’s imports from China grew at an annual rate of 37.8%, largely as a result of Brazil’s expanding middle class. Since 2004 some 35 million Brazilians, or 17% of the population, have been lifted into class ‘C’, which represents Brazil’s official socio-economic category for the middle class. The resulting increase in demand for consumer goods has created a significant (and convenient, given the trade ties already in place) market for Chinese products.
So too has the spate of infrastructure projects in Brazil, which has fuelled the country’s demand for China’s capital goods and equipment. Worth US$21bn in the first three quarters of 2011 alone, China’s exports to Brazil constitute a strong flow of trade in their own right, making the Brazil-China trade relationship a strong contender for the most significant trend in emerging market development so far this century.
Trends in Trade Finance
This economic relationship, like others, has been subject to changes and trends taking place in the realm of global trade finance. While letters of credit (L/Cs) have been, and still remain, the trade tool of choice for intra-emerging market – or ‘south-south’ trade – the needs and expectations of corporates in developing markets have been shaped by the rise of open account trade terms at a macro level.
Open account trade is more cost-effective, flexible and efficient than L/Cs, and so widespread is the appreciation for its attributes that over 80% of global trade is now conducted on open account terms. Given this trend it is likely that Brazilian and Chinese counterparties, at least once they have cemented their trade relationships, will increasingly look to conduct business on open account.
Indeed, even those that choose not to migrate to open account and instead prefer the risk-mitigating properties of the L/C will come to expect the increased processing efficiency that open account settlement offers and modern cross-border trade demands.
This, of course, significantly changes the demands placed on the local banks, necessitating greater automation and flexibility. While Brazil has strong banks, the sophistication, flexibility and innovation that corporates will require as they look to deepen existing trade connections and form new ones will require these banks to address new issues of cost, compliance, and risk.
Advanced transaction capabilities will also be required to meet the rising demand for working capital management tools and techniques. Certainly, the growing sophistication of emerging market corporates is reflected in their increased interest in discounting receivables into the forfaiting market. This is particularly the case in Brazil, where corporates have reacted to the Asian demand for longer payment terms by seeking greater efficiency in their cash flows.
For this reason electronic trade platforms, which can speed up the process of discounting receivables and bring greater transparency to the supply chain, will be of growing importance as the markets develop. Such electronic capabilities are a core element in the offering of global providers, so Brazilian banks will need to invest in their development to keep pace.
Currency and Cash Management
Going forward, Brazilian banks must also address the rise of the Chinese renminbi (RMB). Although Brazil-China trade is still predominantly conducted in US dollars, the RMB is on its way to becoming the world’s third reserve currency, and is already the primary currency for 10% of China’s global trade flows. It therefore seems only a matter of time before Brazilian corporates require local access to RMB processing capabilities. As Brazil-China trade ties strengthen, Brazilian companies that can invoice and settle in RMB may find themselves at a competitive advantage, as they will be able to remove all foreign exchange (FX) risk and cost from transactions.
Many Brazilian banks are currently focused on growing their regional footprint, with Mexico being a key country of interest, and establishing a presence in the US. However, developing trade finance platforms and multicurrency solutions that can handle trade in RMB must be carried out at the same time, increasing the demand on time and resources. Given this necessity, many Brazilian banks may explore working in collaboration with a global partner bank to support their medium and long-term strategies. For instance, Brazilian banks can leverage a global partner’s technology and international network to address their corporate clients’ evolving transaction banking and treasury management needs, and to support the expansion of their trade relationships.
Looking to the Future
Although economic growth in both countries has recently lost some momentum, both remain committed to future development, and there is reason to remain positive. For example Brazil has seen its inflows of foreign direct investment (FDI) reach record levels, rocketing from US$5bn in 2007 to over US$70bn in 2012. This flood of foreign money is ensuring substantial investment in infrastructure, itself the foundation of future growth.
Admittedly Brazil still has some way to go in this respect, but the construction of a steel-exporting plant – the result of a single US$7bn investment – is indicative of things to come. When such investment is considered in conjunction with upcoming events such as the 2014 World Cup and 2016 Olympics, which will encourage a focus on infrastructure, and the mutual agenda of investment established in the recent trade agreement, it is apparent that Brazil is in a strong position to make the necessary changes to expand its role in international trade.
One such necessity is to build on the already impressive level of local bank sophistication to cater to the increasing number and diversity of trade relationships. This is where global banks can play a key role in helping local banks to secure the strength of trade flows, support new developments and drive the Brazil-China trade relationship to new levels of commitment and success.
Indeed, the setting in stone of Brazil and China’s trade relationship is not just an acknowledgement of the previous decade’s rampant growth, but an active commitment to maintaining and developing the bilateral trade flow in future. With the joint efforts of local banks and global providers, the trade community can ensure the relationship remains the model for intra-emerging market trade for many years to come.
To read more from BNY Mellon, please visit the company’s gtnews microsite.
The implementation date of Europe's revised Markets in Financial Instruments Directive, aka MiFID II, is fast approaching. Yet evidence suggests that awareness about the impact of Brexit on MiFID II is, at best, only patchy and there are some alarming misconceptions.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.
Politicians have united in urging the Reserve Bank of Australia to lend its backing to the digital currency by officially recognising it.
In the aftermath of the Brexit referendum, it was feared that the consequences would be catastrophic. Now, 14 months on, we’ve seen how the UK has weathered the storm – at least in the short term.