Welcome to the U.S.-Ukraine Business Council

Trade finance crucial for post-crisis, frontier economies.

Analysis & Commentary: By Daniel W. Riordan
President, Zurich Surety, Credit and Political Risk
Kyiv Post, Kyiv, Ukraine, Fri, Feb 5, 2010

With the worst of the global financial crisis apparently behind us, we are left to survey the damage the storm has left behind. The effects of the crisis will be seen for years to come. Perhaps the most significant long term damage is that being inflicted upon the global trading system, and the impact will be most severe in post crisis emerging market economies such as Ukraine.

But before we get into more detail about Ukraine and why it was hit so hard, let me provide a bit of background to put the global nature and impact of this into context.

This year, the global economy will experience the sharpest contraction in trade in the post World War II era, over 10 percent by volume according to recent International Monetary Fund projections. This historically sharp decline reflects several factors.

[1] First is the reduction in global demand. [2] This is amplified by higher elasticity of global trade, caused by increasingly complex supply chains in which goods are often imported, exported, and re-exported several times before the finished product is purchased by the end user. [3] A third and often overlooked factor is the increased scarcity of trade finance.

The World Bank estimates a trade finance “gap” of $250 billion. This gap is beginning to close through extraordinary measures undertaken by multilateral financial institutions and governments and as banks and other trade creditors rebuild their balance sheets and their risk appetites.

There is a real threat, however, that the decades old norm of preferential treatment of trade finance could be overturned by the actions taken by the governments of some crisis hit emerging markets. If continued, this may result in scarcer and more expensive trade credit, with the most severe consequences to be felt by post-crisis emerging market and frontier economies that stand to gain the most by integration into the global economy.

Trade finance often receives less attention than the more glamorous corners of finance due to the routine nature of its operations. But since 90 percent of trade transactions involve short term trade finance in the form of some version of credit, insurance or guarantee, it is vital to the functioning of the global economy. Trade finance is particularly important to frontier and post-crisis economies, such as Ukraine.

For these countries, it is often one of the few forms of international finance available. Because exporters are perceived to have preferential access to scarce foreign reserves, and because trade finance transactions can be structured so that goods provide security for loans, international trade finance often operates in markets that commercial lenders and investment bankers avoid.

Exporter credit agencies and private insurers, such as Zurich Surety, Credit and Political Risk, provide a critical facilitating role for trade finance. They allow trade finance creditors to manage their risk exposures through guarantees and insurance. Last year insurance for exports provided by members of the Berne Union, an international association of public and private export credit providers and investment insurance agencies, amounted to $1.4 trillion.

While trade finance may be one of the most basic and fundamental forms of global finance, because trade finance lines are short term and self liquidating, trade finance can quickly evaporate if it is not given priority treatment in times of crisis. As the IMF has noted in the past, "Sharp declines in trade credit have a number of adverse consequences, disrupting a country's trade and growth performance and possibly exacerbating the crisis."

Past crises have taught us that policy makers in crisis hit emerging economies must act decisively to restore trade finance before any vigorous recovery can get underway.

In 1998, Russia excluded some trade finance obligations from a 90-day moratorium on foreign exchange payments. In 2002, Argentina allocated a higher share of its scarce foreign reserves to debtors with foreign trade obligations, and recognized the central importance of maintaining trade flows and keeping financing lines in place by exempting debtors from obtaining Central Bank approval to convert and transfer payments to meet obligations insured by members of the Berne Union.

In 2001, when Turkey began to experience liquidity problems, the central bank quickly identified the maintenance of trade finance lines as a priority. After spending over $20 billion restructuring and recapitalizing the domestic banking sector, Turkey received commitments from trade creditors to maintain their lines.

In the current crisis, the most notable tests of the principle of preferential treatment of trade finance have occurred in Ukraine and Kazakhstan. Both of these countries suffered failures of systemically important banks with significant trade finance obligations. In each case, the commitment placed on the restoration of trade finance lines by government officials has been ambivalent at best. Likewise multilateral financial institutions have yet to provide clear support for the principle in their consultations with national authorities.

In Ukraine, where the bank failures have been widespread and the recession has been particularly severe, the Ministry of Finance has yet to demonstrate a serious commitment to the recapitalization of several systemically important banks or to offer appropriate restructuring terms to trade creditors.

Furthermore, a recently passed banking law aimed at improving the procedures for the financial rehabilitation of Ukrainian banks has undermined the rights of creditors, including trade creditors, by downgrading the ranking of trade creditors in case of a bank liquidation relative to obligations due to the Ministry of Finance and the National Bank of Ukraine.

In Kazakhstan, bank failures have been more limited, but the negotiations for the restructuring of the debts of BTA Bank, formerly Kazakhstan’s biggest lender, have been particularly concerning for trade creditors. BTA’s restructuring offer included a 82.25 percent haircut, with no exemption or referential terms offered to trade creditors.

As if those terms didn’t communicate the Kazakh government's stance clear enough, Grigory Marchenko, the chairman of the central bank of Kazakhstan, when asked if he was concerned that the harsh terms would raise concerns among investors, said:"Image is nothing."

The failure of the governments of Kazakhstan and Ukraine to place appropriate emphasis on the restoration of trade finance is undermining the recovery of their economies.

In Ukraine, by the second quarter of 2009, imports and exports were down by more than 50 percent year-on-year. While this is driven partly by demand, anecdotal evidence suggests the scarcity of trade finance is having a major impact on Ukrainian firms.

In recent months, Zurich has been contacted directly and through business forums by Ukrainian companies that are unable to import capital goods that are critical to maintaining or expanding their business.

Alexander Gordin, managing director of Broad Street Capital, a merchant bank with extensive experience structuring and arranging financing for trade in Ukraine, recently estimated to Zurich that some 30 percent of the drop in trade is due to lack of trade finance.

In assessing the fallout of the collapse in trade finance, Gordin said "We have seen numerous examples where… projects which are vitally important to the population are not getting done for lack of trade financing. Major manufacturers are forgoing the market and crossing it off their strategic plans since no financing is available."

It should not be surprising that the Ukrainian economy is believed to have contracted by 15 percent last year, the most severe recession of major emerging market economies.

Multilateral financial institutions must also recognize that the treatment of trade finance in this crisis will have implications far beyond Kazakhstan and Ukraine. A clear repudiation of the principle of preferential treatment of trade finance, with no response by the multilateral financial institutions, will increase pricing and reduce availability of trade finance for emerging market and frontier economies.

NOTE: Daniel W. Riordan is the President of Zurich Surety, Credit and Political Risk. Between 2005 and 2008, Zurich Financial Services underwrote trade credit and political risk insurance policies that facilitated $1.42 billion in trade and $465 million in foreign direct investment in Ukraine.

USUBC NOTE:  Zurich Surety, Credit and Political Risk, Washington, D.C., is a member of the U.S.-Ukraine Business Council (USUBC), Washington, D.C., www.usubc.org.

LINK: http://www.kyivpost.com:80/news/business/bus_general/ detail/58709