Supply chain financing powers the rise of South-South trade

Over three decades, China has risen to become the world’s second largest economy, emerging as a mega-trader that, alongside India and the creation of the World Trade Organisation (WTO), has powered the rise of South-South trade. Emerging market trade has more than doubled since 1990 to make up nearly 50% of all trade, with China accounting for 11.5% of exports.

China’s economic growth model has changed over the past five years. As the country moves up the value curve and rising wages challenge the low-cost model that has brought companies to China in the past, the centre of gravity for manufacturing for an increasing number of multinationals is shifting.

It is moving westward to the Association of Southeast Asian Nations (ASEAN) region, to South Asia and eventually to Africa. As these companies consider moving capacity to cut costs, they are looking more favourably at ASEAN as a possible substitute for China’s Pearl River Delta (PRD). Markets such as Vietnam, Cambodia and Indonesia are targeting exports.

Along with reducing costs by moving production from the PRD into ASEAN, manufacturers can also benefit from the region’s high growth and rising middle class by capturing a share of a large and growing intra-regional consumer market, fueled by a population that is expected to grow to around 700m by 2020.

Beyond this expansion in ASEAN, the emergence of consumerism in the South-South corridor between ASEAN and South Asia will also lead to further expansion in trade flows between these two regions. Since Africa has not been fully touched and consumerism is growing there too, companies will also move in that direction. China’s ‘one belt, one road’ initiative will give further impetus to massive investment from Indonesia and Malaysia on through to the Middle East and into Europe.

The net result for companies will be further expansion in South-South trade that takes advantage of lower costs in ASEAN, growing labour forces, increasing consumer incomes, rising gross domestic product (GDP) and greater urbanisation to expand their business.

The financing challenge for SMEs

As multinational corporations (MNCs) shift location and move to new markets, they are looking for their suppliers to accompany them. These partners – many of which are small and medium enterprises (SME) – have worked with the larger corporates for many years and have a track record of being able to deliver on quality, on performance and on time over lengthy periods.

Among the biggest challenges for SMEs as they follow their MNC clients and set up their own operations in new places where they have no track record up front is that their relatively weak financial position makes it difficult to obtain financing. Indeed, the results of the latest Global Trade and Finance Survey (2014) from the International Chamber of Commerce (ICC) suggest that while trade finance availability has risen recently overall, there is still a shortage of financing availability for SMEs.

While SMEs may have long-standing banking relationships in their home market, their banks may not be present in the smaller towns and cities where they set up operations when entering new markets. If an SME moves from China to set up operations in a remote location in Thailand – where labour costs are lower, for example – they may well not find their Shenzhen-based bank following and will need to form new banking relationships. Low transaction volumes and small business sizes make it difficult for banks to extend financing to SMEs, and this size constraint is exacerbated by banks having limited information about the SMEs in their new location.

As they move into new markets, SMEs also need to deal with internationalising a small company and handling the regulatory risk, labour laws, customs, taxes and more in the new geographies. Dealing in various local currencies in these markets also creates the need for SMEs to manage currency risk and exposures in which they may have limited experience.

Along with hindering SMEs’ ability to support their long-standing MNC clients, the lack of financing and local market knowledge could be a key constraint for their broader integration into global supply chains. Credit-constrained SMEs could then find themselves stuck in the low-value-added stages of a supply chain.

Solutions for financing the shift in trade

Along with seeking transactional financing SMEs are also looking for pre-shipment financing to support processes, from the purchase order stage on through to work-in-progress and shipping. They will need to identify a bank that can offer medium-term loans to finance transactions as well as to support pre-shipment to post-shipment needs.

Despite the constraints, banks have become more innovative in providing trade finance solutions for SMEs as well as other clients. Some banks have increased their factoring of receivables due to SMEs from big-name anchor companies, for example, and they are also moving up the value chain through a suite of structured products. Improvements in technology are making it even easier for banks to provide financing, as trade flows become digitised and as information flows improve. Some major banks are increasingly able to offer pre-shipment facilities to support global supply chains.

MNCs running large global supply chains are also assisting by increasingly using innovations such as platform-based e-invoicing run by banks or other third parties. While large companies are under pressure to improve their ratios, they want their supply chains to be financed and are more willing to have banks transfer some risk to them so that their SME suppliers can obtain financing at reasonable rates. Multinationals with excess liquidity are also working with banks to use dynamic discounting-type solutions more often. This enables them to pay SMEs early and earn more than if they placed funds in a savings or current account.

Optimising SMEs in the global supply chain

While the rapidly-evolving supply chain offers opportunities for SMEs, then, it also means that arranging financing, managing local currency risk, and handling regulatory issues are likely to be key determinants of success for SMEs that set up manufacturing in markets such as Vietnam or Indonesia.

By selecting a knowledgeable banking partner able to leverage technology and market expertise to assist with comprehensive financing, hedging advice on managing currency exposure, banking services and market entry solutions, multinationals will be able to secure and enable their supply chains to be more cost-effective. SMEs too will be able to take better advantage of the rapidly-growing South-South trade opportunities in the years ahead.

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