Trading With Emerging Markets

Q: How do you assess the stability of the current economic recovery in both developed and emerging markets?

A: (Johannes Meyer-Bretschneider, sales strategist, Commerzbank) Let’s highlight the good news first: Most institutions with a view to global economic development are currently predicting a recovery from world recession.

According to the World Trade Organisation (WTO), world trade is set to rebound in 2010 by growing at 9.5%. Exports from developed economies are expected to increase by 7.5% in volume terms over the course of the year, while shipments from the rest of the world (including developing economies and the Commonwealth of Independent States (CIS)) should rise by around 11%.

The World Bank projects an increase of global gross domestic product (GDP) of more than 3% per year in the coming three years. Gross domestic product (GDP) in developing countries is expected to grow by about 6% during this period. This is more than twice as quickly as in high-income countries, where growth is projected to strengthen from 2.3% this year to 2.7% in 2012. Of course, these predictions assume that measures in place will prevent today’s market timidity from slowing the normalisation of bank-lending, and that a default or restructuring of European sovereign debt is avoided.

Everyone recognises that there is still uncertainty following the sharpest decline in world trade in more than 70 years. Although these figures now paint a positive picture, this picture is very different from nine months ago, and we have to acknowledge some incidents in the recent past.

In November last year, just as markets began to believe that the financial crisis was over, Dubai World’s announcement that it might need to stall payments on US$26bn of debt sent another shockwave through the system. Although the development in Dubai was mainly a result of an exaggerated real estate speculation, in combination with a sharp decline in buyers’ interest (which, however, was also caused by the financial crisis), the fear of a domino effect was very much alive.

Another example that suggests predictions of a return to normal might be premature have been the developments in Greece that led to several downgrades of its sovereign credit rating in the first half of this year. Its membership of the EU could not prevent this from happening. This is also true of a similar situation in Ireland.

At the same time, a more critical attitude towards other European countries (for example Portugal and Spain) by the international capital markets caused further tumult for the euro and forced the European Monetary Union (EMU), together with the International Monetary Fund (IMF), to unfold a previously unimaginable €750bn safety net to its member states. These incidents show that the positive trend – which is also dependent to a large extent on psychological factors – is still sensitive to negative (economic) news from individual countries, especially from the US, where the battered housing market has not yet regained its footing.

But even the news of a remarkable recovery of trade flows in most countries does not necessarily mean that the worldwide economy has already re-established a more sustainable medium-term growth path. Central banks in key currency areas have pumped in huge amounts of money to support their economies. The resulting liquidity contributes to an unsustainable rise in asset prices, creating bubbles that are bound to burst later. Monetary policies will have to become more restrictive once more. In addition, the impact of the fiscal programmes will lose ground, probably earlier than a more self-supporting upswing of the private economies will occur. So, we should still be cautious – at least for the economic recovery of developed countries.

Q: Does this careful approach, with regard to economic recovery, also apply to emerging markets?

A: (Meyer-Bretschneider) Fortunately, we see a much more dynamic trend in economic growth in emerging countries. Unlike economies in the western world, many of these countries have been affected much less by a recession of their domestic economies, but more by the sharp decline of exports. However, as exports pick up again, their economies have started to recover accordingly. In addition, most emerging markets followed a prudential economic policy in the recent past. Raw material prices are high, from which many countries in Africa, Latin America and the Middle East are profiting.

Q: Despite this promising development in emerging markets, do you still see a conservative approach to risk from corporates?

A:(Meyer-Bretschneider) In recent years we have seen a quite substantial move from documentary credit to open account payments. This means that, instead of using guaranteed payment of banks via letters of credit (LCs) or guarantees, importers are directly paying suppliers before or after receipt of goods. This way of claim settlement is obviously less expensive and time consuming for both parties.

In light of recent developments, however, we see a greater awareness of risk on the side of the exporter. Counterparty risk – which is directly influencing the supplier’s capital balances and reserves – has again become a major ongoing concern for treasurers. Companies have become more sensitive when it comes to checking their risk positions in trade with emerging countries. We are experiencing an increased focus on risk management in the emerging markets, with companies asking for support on risk hedging. Banks can contribute to decreasing these risk positions for the company.

Q: Are banks now prepared again to take more risk on to their books?

A: (Meyer-Bretschneider) Many banks have already changed their very conservative approach to risk, especially with regard to developing countries. The demand for risk hedging is increasing. This is a result of their move away from trade on an open account basis towards a higher usage of LCs. This demand is now, to a large extent, offset by the banks. By taking more risk, the banks facilitate business with companies located in emerging markets.

The International Finance Corporation (IFC) introduced a Global Trade Liquidity Programme (GTLP) in 2009 to counter the crisis-related fall in trade flows and support trade with developing countries. This unique initiative, which is focussed on short-term trade financing, brings together governments, development finance institutions and commercial banks. This is vital to strengthen the flow of credit and especially, liquidity, for the trade between importers and exporters in emerging markets. Participating banks share the risk with the investors in this programme and are therefore in a position to offer more business volume by taking higher risk positions (counterparty and country risks) of their correspondent bank partners in the participating emerging countries.

Commerzbank is one of six banks worldwide participating in this programme. It will receive up to US$500m from the programme and commit an additional US$750m from its own account to provide up to US$1.25bn for trade finance activities in developing countries. These funds are expected to support up to US$7.5bn in trade finance in emerging markets over a three-year period.

The programme provides the opportunity for exporters to offer deferred payment financing to their importers also in regions, where normally only payment on sight was possible, and allows under certain circumstances to purchase this business before maturity. It is designed for all companies that are securing their exports into emerging markets using deferred payment LCs, and would like to generate liquidity before maturity.

Q: Which instruments do banks offer to reduce risk for trading partners in emerging markets?

A: (Meyer-Bretschneider) The liquidity generated with the help of the GTLP but also from the banks themselves is mainly used for the LC business. This instrument is still the first choice for reducing the trading risk for suppliers (exporters). LCs are used to cover the risk that a supplier takes by sending their products to the buyer. Via the exporter’s confirming bank, the exporter ensures that the buyer will pay them as agreed, provided that they deliver documents as stipulated in the LC. This instrument normally covers short-term risks of up to 360 days.

But the LC not only provides some guarantee of payment for the exporter and protection of goods for the buyer. It is also an important financing tool, especially for smaller suppliers. A confirmed LC with deferred payment terms makes it relatively easy for the exporter to obtain a discount on the value of the LC. LCs can also be used as collateral securing a loan to buy the raw materials, to allow pre-shipment financing or to cover ongoing overheads needed to produce goods. In any case, it can improve the quality of the supplier’s balance sheet.

It is also important for the exporter to know that an LC which has been confirmed by their bank is not only taking on the payment risk but also the risk of the country where the importer is located.

Q: Which instruments can be used to mitigate the risk in medium- and long-term denominated trade?

A:(Meyer-Bretschneider) One possibility for manufacturers, exporters and traders in OECD countries is to insure their political and economic risk when exporting to emerging market countries with the support of export credit agencies (ECAs). Although ECA cover has in the meantime become very popular for short-term financing (such as LCs), its major purpose is still to provide cover for medium- and long-term financing. In contrast with private insurers, ECAs have maintained their support for exports and export finance despite the crisis. For example, credit insurer EulerHermes Kreditversicherungs has approved a new record volume of cover amounting to €22.4bn in 2009.

ECAs act on behalf of their governments to promote exports, even if they are private entities. To avoid unfair competition among exporters by using more favourable financing terms based on government-oriented cover, ECAs have similar products and common rules derived from the OECD consensus. In general, having a high proportion of goods and equipment sourced locally is a precondition for ECAs but they are also flexible enough to support manufacturers with an international production set-up, i.e. subsidiaries or sub-suppliers worldwide.

With the support of ECAs, exporters are secured towards all forms of political risk, economic risk and protracted default – if the borrower simply does not pay without any known reason. Banks in emerging markets are qualified as potential borrowers but also corporates with a solid creditworthiness to be evidenced by financials and audits based on international standards. During the past few years, ECAs have seen a flood of applications and new momentum in their acceptance by exporters, lenders and borrowers.

An efficient and popular way for exporters to generate liquidity is the purchase (forfaiting) of debt claims under LCs, which banks are offering for tenors of up to five years. This tool is helping to improve the asset quality of the seller (e.g. exclusion of currency risks and higher liquidity). Despite the worldwide signs of economic recovery, we see further increasing demand for the mitigation of political and economic risk in international trade.


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