Leaders of the G20 countries gathered
at an Economic Summit in Washington, over the weekend, decided to launch
a process to implement reforms of the international financial system.
A similar effort is underway at the UN to convene a summit next year.
With so much attention focused on the response to the global financial
crisis, it would be easy to assume trade issues will take a backseat to
financial ones.
For developing countries, this approach would be a tragedy. As the financial
crisis continues to unfold, events are making it painfully clear that
trade is the main channel by which the financial crisis will make its
impacts felt on them, especially on their real economies. This does not
come as a surprise after years of reforms that have placed export-led
growth as the central paradigm in a context that did not give an equally
central place to mechanisms for ensuring the financial gains of exports
accrue to developing countries. The events are also a reminder that the
fate of developing countries in the trade system does not lie so much
in the achievement of enhanced market access as on meaningful reforms
to the international financial architecture in which context such trade
is pursued. Yet, this is an aspect typically ignored in trade negotiations,
which traditionally tend to focus exclusively on exchanges of market access
concessions. On the other hand, the trade dimensions and impacts of financial
reforms are neither appreciated nor factored in attempts at financial
reforms, either domestic or global.
The Scarcity of Trade Finance
One very obvious way the credit crunch will project onto the developing
economies is the impact it has on trade finance, this is, the different
mechanisms by which typically a bank or financial institution, for a fee,
guarantees payment of shipments by an importer. The deterioration of availability
and terms of trade credit was already being felt earlier this year, but
the situation significantly worsened since September, with the collapse
and defensive stances taken by major international banks. This was in
evidence in a statement made by Brazil last October in the WTO: “Exporters
from developing countries who seek trade finance find themselves in the
odd situation of being among the most creditworthy economic agents, but
unable to access credit in a scenario with heightened overall risk perceptions
that lead to more stringent requirements by the banks, or simply because
funds are not available any longer.”[1]
The negative impact that Basel II may have on trade flows, inter alia,
through increased procyclicality of trade finance, has also triggered
complaints[2].
Balance-sheet exposure to least-developing countries costs banks apparently
three times as much as exposure to developed countries, creating a large
asymmetry in access to this type of lending[3].
The urgency of the situation prompted the WTO Director General to take
the unusual step of hosting a meeting of main trade-finance providers,
which was held November 12 in Geneva.
In a recent paper, World Bank staff points out that trade credit was traditionally
thought to be only relevant from a microeconomic point of view, but he
argues this should no longer be the case[4].
The author explores the role of trade credit as a mechanism for the amplification
of shocks at the macro level and finds strong evidence for the hypothesis
that an increase in the use of trade-credit along the input-output chain
linking two industries results in an increase in their correlation[5].
This is certainly not good news to the many countries that have moved,
in the last two decades, to find their niche as providers in a number
of global production chains. The problems for both providers who need
cash but also buyers, who face the threat that their cash-strapped providers
may disappear because of the inability of holding up without such credit,
are becoming more evident.
The International Finance Corporation had recently announced an increase
of their Global Trade Finance Program (from US$ 1 billion to US$ 1.5 billion)
and it is now considering doubling the new amount. Still, this and other
pledges of trade-finance available would fall far short of what is needed.
According to an estimate presented at the November 12 WTO meeting, the
liquidity gap in trade finance amounts to US$ 25 billion. Analysts at
that meeting predicted that the situation will get still worse[6].
The concerted government efforts in a number of industrialized countries
to recapitalize their banking systems may, for this purpose, not be of
much help. A reporter said that, as the government takes a stake in banks,
their priorities may be to get taxpayers’ money back and, politically,
stimulate lending to domestic business rather than devote taxpayers’ equity
to far-off trade finance[7].
Moreover, the scarcity of trade credit is bringing the spotlight to another,
little heard of, sector that is vital to the continued operations of supply
chains: trade insurance. While large companies tend to take the risk that
trade credits will not be honored, small providers could be so largely
affected by the failure of a big buyer that they usually take insurance.
Recently, however, because of the drying up of credit, trade insurers
have seen a rise in their losses. Atradius, the UK's biggest credit insurer,
saw its losses increase to account for more than 70 per cent of revenues,
up from a norm of 50-60 per cent[8].
In what some reports say is a panic reaction, they are quickly blacklisting
as non-insurable many companies, some of them large buyers such as General
Motors, Woolworths and Ford. Moreover, trade credit insurers are likely
to base their assessment of the creditworthiness of a foreign company
partly on the economic stability of its home country. A commentator speaks
of the formation of a vicious circle: "insurers are cutting trade
credit insurance because they believe that the scarcity of bank loans
has increased the chances of businesses failing. Companies who use the
cover are then more exposed to collapse themselves, because some lenders
will not advance new funds unless credit insurance is in place[9]."
The seriousness of the problem is in evidence in the swift action taken
by countries like Brazil and India, where governments have rapidly made
available credit support for exporters. But it is unlikely that smaller
countries will be able to have that support forthcoming.
Overall, the full model on which world trade has thrived in the last several
decades, is in question. The model has fostered the power of companies
with transnational scope to locate pieces of the production chain at the
lowest cost locations. To the extent that what is in question is the capacity
of large conglomerates to increase profit margins at the expense of small
and medium producers, this might not be bad news. But the other side of
the story is the havoc in full economies which have been restructured
to participate in the global economy through global production chains,
and whose productive base will be wrecked by the credit failure.
The Role of Commodity Prices
Another significant impact that developing countries will bear is that
derived from commodity prices. Between 2002 and 2007 the prices of all
commodities, in dollar terms, increased 113 per cent[10].
This average masks large differences between the minerals group (around
260 per cent) and food and tropical beverages (a 60 per cent). But it
is clear that the increases were all significant, nonetheless, especially
after decades of declining prices. The fact that some factors behind the
increase (e.g., growing demand from high-growth economies such as India
and China) were out of the epicenter of the financial crisis led some
to hope that the fall in prices would not be that significant. However,
as growth projections for China and India were revised downwards such
hopes faded.
With a scenario of lower demand everywhere, commodity prices are on their
way down at, in some cases, shocking speed (e.g., oil which went to a
50 % of price in two months). There is a bright side to the slump in commodity
prices. Developing countries that until the middle of this year were trying
to cope with rising bills for their food and fuel imports will definitely
benefit.
But the prevailing side of the picture are the significant negative effects
that lower prices will have on export revenues. The fact that the exceptional
growth period experienced by developing country economies in the last
five years coincides with the surge of commodity prices is more than a
mere coincidence. For all but two Latin American countries, commodities
represent more than 50 % of their exports. More than three quarters of
the growth in export revenue in 2007 were due purely to price increases
of those commodities[11].
A similar trend is notable in Africa which is, in fact, more dependent
on commodities than Latin America. Primary commodities, including fuels,
account for near 70 percent of the average exports in the period 1995-2006[12].
What these numbers are saying is that what has been characterized as a
boom actually hides meager progress –or even retrogression -- in the export
structures of developing countries. Very few countries had been able to
use the increased revenue from the boom in commodities to get higher up
in the ladder of diversification and value-added. In some cases the hindrance
was that the rents of the boom were not captured at the country level,
while in other cases captured rents were not devoted to invest in infrastructure
and productive capacity but in either immediate consumption or long postponed
social needs. A few countries were merely able to take advantage of the
access to the natural resources to expand into natural resource-based
manufactures. As a result, trade profiles have not changed much, leaving
no room for cushioning the impacts of the decrease in prices. The effectively
utilization of increased commodity revenue would have required a capacity
that, after years of downsizing and withdrawal from economic planning,
states were barely starting to re-build.
To the extent that some countries were able to develop some manufacturing
capacity, there are signs that this may also fall prey to the scenario
of lower demand in client countries. Lower demand would force an adjustment
that, given the small margins available to adjust in price, will have
to be done via downsizing. The scarcity in trade credit mentioned in the
previous section is a compounding factor, as integration in global production
chains is the common expression of the export-led model in manufactures
by developing countries.
Not having made use of the surpluses of good times to diversify, developing
countries will be faced with the challenge of diversifying in bad times,
and with less income. But at least it is clear that the incipient capacity
for planning that, in a learning-by-doing fashion, they were starting
to develop, is at least as important an asset as any potential new access
to markets, and should be carefully nurtured.
The Role of Trade in Infrastructure and the Sustainability
of Debt
The impact of lower export revenues will be also felt in a number of indirect
ways. It is very common that, in times of boom, countries tend to be overoptimistic
about future trends. The risks of infrastructure projects going wrong
are generously evaluated against the backdrop of the growing income prospects.
Costs and terms of borrowing that are very high compared with the historical,
but not with the most recent, reality tend to be considered viable. This
boom has been no exception.
One particular trend in public funding for infrastructure projects has
been the increased role of private sector participation, through contracts
that provide public funding guarantees, often encouraged by multilateral
financial institutions. For example, it is common practice in public-private
partnership contracts to attach provisions that guarantee a certain level
of demand and, therefore, revenue to the provider. If the economic activity
then does not sustain such demand, the government becomes liable for the
difference. The exchange rate risk is sometimes built into demand guarantees.
That is, in spite of devaluations that may be necessary for monetary and
economic policy reasons, devaluations whose impacts domestic investors
and citizens bear in terms of decreased import purchasing capacity, would
not affect the private investor[13].
So, whereas ideally private sector participation should mean less of the
risks of a downturn will be borne by the countries, and more by the private
sector, the reality of public-private partnerships has been generally
the opposite. Compounding the generous concessions built into private
sector contracts, guarantees do not represent an immediate expense, so
they escape the degree of scrutiny that actual budget expenditures would
receive[14].
This opacity also fosters what the IMF has called “a guarantee culture”
on the part of the private sector, so guarantees, instead of a subsidiary
mechanism, are provided for risks that the private sector would be best
positioned to manage on its own. Since the guarantees are more likely
to be called at a time of generalized economic distress (e.g., a financial
crisis) their fiscal consequences are aggravated by their pro-cyclicality
and potentially multiplying effects[15].
As put by the World Bank, the financial crisis will cause some existing
projects to experience financial distress, and will cause significant
dislocations in countries’ agendas to address infrastructure deficits[16].
The links to trade are even clearer for many of the projects which were
ostensible undertaken to improve trade competitiveness, considered a complement
to increased liberalization of trade. There are usually no clauses safeguarding
the country’s position in the contract in case the expected returns from
exports do not materialize. Neither are there provisions to ensure the
country would capture a greater share of the revenue in case the projects
yield higher-than-expected returns.
The World Bank announced that it is going to be further increasing its
provision of funding for infrastructure. It has been announced that over
three years IFC is to invest a minimum of US$300 million and mobilize
between US$1.5 billion and US$10 billion from other sources. But the provision
of more lending may be a factor that improves or worsens the situation.
The final effect will depend on what is the appropriate sharing of risks
and returns between private and public actors and particularly between
IFC and its borrowers, and whether a realistic and sound methodology is
used for the evaluation of trade-related returns.
For low income countries, and in spite of the debt relief committed in
the Heavily Indebted Poor Countries Initiative and is most recent expansion,
the Multilateral Debt Relief Initiative—launched by the Group of 8 meeting
in Gleneagles 3 years ago - debt situations will deteriorate. Trade is
a key factor in that equation. The least risky group is, according to
the most recent reports, the 18 low income countries that received all
debt relief commitments already. Out of the countries in this group, less
than half of them have a low risk of falling back into debt distress[17].
Moreover, those with low and moderate risks are highly vulnerable to export
shocks[18].
Of the countries that were not eligible for HIPC/MDRI, one third are also
either in or at risk of debt distress.
But it is important to keep in mind that the assessment of risks and “sustainability”
is according to the rather tolerant parameters of the Debt Sustainability
Framework adopted in 2005. Such reform resulted in a ramping up of the
thresholds at which borrowers are considered to be in trouble. Some substantial
criticisms had been made of the methodology for measuring debt sustainability
in the past, which relied on overoptimistic projections of export and
GDP growth[19].
In spite of its attempt to address the problem with stress-testing methodologies,
the boom of the last years continued to boost the optimism of projections.
The IMF/ Bank staff assert, referring to the situation of countries not
in the HIPC/MDRI program, that the situation is not worse because these
countries were having an export growth rate of 11 percent average in a
10-year average. Export projections based on such trends will be rendered
useless by the impact of the crisis and so will the projections of debt
ratios for many countries. The very notion of “low” or “moderate” risk
will certainly come under challenge.
But increasing debt problems are not confined to the LICs group. Commodity
prices have been a major factor in the worsening export outlooks of several
middle-income countries, such as Argentina, Mexico, Brazil, South Africa
and Kazakhstan. As the current accounts of some countries show signs of
worsening, making more borrowing necessary, rating agencies such as Fitch
have proceeded to downgrade them[20].
The downgrades will only increase the costs for these countries to repay
their existing obligations or refinance them, feeding a well-known vicious
circle.
Reciprocally, the need to direct more income to paying debt service can
only contribute to accentuate the problems both low and middle income
countries have in making investment necessary to expand their production
capacity or place them in tighter competition with pressing immediate
social needs.
Trade as a Driver of Foreign Investment
There was another factor boosting the "boom" in developing countries
and it was record increases in foreign direct investment. Most of the
investment was tied, in more or less direct ways, to the high rates of
export growth. ECLAC reports that unprecedented volumes of FDI in Latin
America and the Caribbean were largely attributable to the persistent
worldwide demand for the natural resources in abundant supply in the region.
Natural resource-seeking investment was a high share[21].
But there was also so –called market-seeking investment, that actually
tries to profit from the greater purchasing capacity developed in some
countries[22].
This purchasing capacity that increased consumption markets was also largely
dependent on the boom of natural resource exports, and will be gone with
it. Commodity trends are associated even to some FDI flows in manufacturing,
as reported by UNCTAD in regards to resource-based manufacturing products
in Latin America[23].
FDI in natural resource-based sectors was also a significant factor in
FDI growing inflows into Africa and Central Asia.
This is no more than a confirmation of what civil society organizations
had repeatedly said about the need to carefully scrutinize foreign investment
for its contributions to development, and avoid "predatory"
investments. The attraction of foreign investment to export-oriented sectors
failed to ensure that part of the revenues from increased prices will
contribute to a domestic capital base. As for market-seeking investment,
they are fast to withdraw from countries no longer considered “good businesses”
after competing medium and small sized companies have been wiped out.
But the trend also shows the limitations of FDI as a stable source of
finance. Exactly when capital flows will be needed by countries running
into balance of payment problems, FDI will be headed towards the exit.
Trade and Exchange Rate Movements
The financial crisis has also underscored the difficulties faced by developing
countries trying to benefit from trade in the absence of a system to provide
some measure of stability to exchange rates. The projections of market
access and competitive advantages are made more difficult. Domestic investment
oriented to exports, especially in a long term, is hampered. Costs of
finance are rendered more volatile, too.
In already two studies[24],
the IMF has argued that fluctuations of exchange rates do not have such
a strong impact in trade performance and has advocated in favor of market-based
hedging instruments as the way forward for developing countries that are
affected. Critics contend that this is only available to large companies,
with the means and sophistication to pursue such hedging. But difficulties
being faced by companies in emerging markets should call into question
whether even for large companies in developing countries this practice
is a reliable safeguard or the most efficient use for the resources of
both the private sector and the government. In countries such as Brazil,
Mexico and South Korea, companies have reportedly lost huge amounts by
taking the wrong side on derivatives to hedge against dollar movements[25].
In Brazil, the government had to intervene to protect the companies affected
by lending to them at below-market interest rates, in another sign of
the costs that the problem may have for developing countries public treasuries[26].
In addition to these effects that the financial crisis will have on the
export chances of developing countries, the trade profile of the countries
exposed to the currency movements has important implications for the scope
of the impacts. The currencies of commodity-dependent economies are especially
affected, as their currencies tend to lose value in the face of declining
commodity price trends that make their growth and export prospects more
dubious and may prompt investors to withdraw capital. Some experts use
the term "commodity currencies" to refer to the strong correlation
between the prices of commodity exports and the currencies in countries
such as Chile (copper) or Australia and New Zealand (agricultural products)[27].
Even if the direction of causality might remain open to question, the
phenomenon means, by definition, that the export profile of the country
has a strong impact on how its currency will fare. Though the research
cited here focuses on commodity-producing countries, there are indicia
that it could more broadly relate to undiversified export structures[28].
Trade in Financial Services
The impact of the crisis will also be determined by the degree of openness
to trade in services, particularly financial services, of developing countries.
The flexibility of many of these countries to introduce the capital management
techniques required by the crisis has been compromised already by trade
and investment agreements.
In a recent speech, the WTO Director General Mr. Lamy’s stated belief
that financial services trade openings can also be useful, by “bringing
fresh capital inflows.” However, the experiences with foreign banks operating
in developing countries has oftentimes not meant they bring “fresh capital.”
Quite to the contrary, their business model is often based on use of existing
domestic capital that, given a larger pool of resources and access to
intra-company credit or international capital markets, can be better leveraged.
The latest IMF’s World Economic Outlook reports that it is the developing
countries that more opened themselves to foreign banks –economies in Eastern
Europe-- ¬that are faring worst comparing to the ones that had a relatively
more closed financial sector, such as those in Asia. Indeed, as the crisis
erupted, it became clear that, far from representing relief, foreign banks
operating in developing countries brought added woes. The crisis started
with a number of banks based in developed countries that had either invested
in subprime market securities or provided backup credit lines for special
purpose vehicles and had to recapitalize them[29].
For supervisory purposes, the originating banks were not even subject
to the jurisdiction of developing countries that are now bearing the impacts.
Yet, developing countries are now suffering lack of access to credit.
Even the remedial measures taken in developed countries to deal with distressed
banks represent a problem as they can hardly match such back-up government
support.
But liberalization of financial services do not only bring dangers to
the banking sector. In a powerful piece, Vander Stichele argues that the
government obligation not to stop a foreign service provider from entering
the country and offering financial services that have been committed may
mean in practice that it could be difficult for the authorities to prohibit
derivative trading, a measure many governments are finding necessary to
implement[30].
As Joy Kategekwa says, referring to similar rules in the Economic Partnership
Agreements, "The role of regulation has never been more vindicated
than at this time of financial turmoil,"[31]
so extreme caution in adopting any new rules, and even a roll-back of
existing ones, is in order.
Trade as a Development Finance Tool
As the financial crisis unfolds, it is increasingly clear that developing
countries stand to suffer the most, and that the impacts will be most
strongly felt through trade. Years of trade reforms in these countries
have emphasized an export-led, pro-liberalization model. Reforms, on the
other hand, sidelined the reality that no country can succeed in using
trade to develop and reduce poverty without supportive internal and external
financial structures. This is the time to pursue a rebalancing act. Trade
can be a development finance tool and one that helps countries weather,
rather than place them at the mercy of, financial cycles. But, in order
for that to happen, trade concerns should be at the center and guiding
the reform of international finance.