Dr. Rebecca Harding
- Quantitive easing and low interest rates are no longer “extraordinary”
- Almost impossible for rade finance to be profitable without focusing on bigger deals with fewer S&P 500 or FTSE 100 companies.
- The World Trade Organisation had always assumed that trade growth would always outstrip GDP growth by a factor of between 1.5 and 2. The Coriolis modelling has for some time been suggesting that this ratio was unlikely to be restored; there is no likelihood of it returning to those levels now.
Where will the next economic crisis come from? This might seem like a crazy question in the middle of an uncertain recovery from the Covid 19 pandemic, as cases in Europe rise and as economists everywhere ponder whether or not the “strategic competition” between China and the United States or Covid 19 will have a bigger impact on future economic growth. Yet it is a critical one if we are to learn any lessons at all from the last global finance crisis and to avoid turning a recession into a credit squeeze on a similar scale.
To understand why this is the case you have to look at the relationship between monetary policy and trade finance over the past 12 years. During that time the word “extraordinary” has been put in front of the words “monetary” and “policy” to explain why hundreds of billions of dollars have been tipped into buying assets through quantitative easing programmes against a backdrop of unprecedentedly low interest rates. After 12 years and two crises, each with different origins, we may now want to drop the “extra” from the “ordinary” as it seems like this is the new normal around the world. Economic growth had not started to justify any significant tightening even before the Covid pandemic. Now, any talk of tighter policy from the Central Banks seems to be off the table completely, at least until 2023.
Now let’s look at what has happened to trade during that same time. Immediately after the 2008-9 crisis, many banks moved their operations to Asia since Asian economies were less entangled in the aftermath of the crisis, and this created a substantial amount of growth between Asian and other emerging economies. In the case of China, by way of example, the value of exports fell by just over 15% between 2008 and 2009. This was far lower than the world average of 22%. By 2010, its exports had recovered to grow by 29% on their 2009 values and at over $1.9 tn were nearly 9% higher than they were in 2008. This was fuelled by an expansion of trade finance in the region.
That growth did not last and the slow down after 2012 was marked. It could be argued that slowing trade was because Europe lost its dynamism during the Eurozone crisis; equally the collapse in oil prices between 2014 and 2016 had major consequences for the export revenues of oil exporting nations. The World Trade Organisation had always assumed that trade growth would always outstrip GDP growth by a factor of between 1.5 and 2. The Coriolis modelling has for some time been suggesting that this ratio was unlikely to be restored; there is no likelihood of it returning to those levels now.
Yet this was the ratio that many trade finance banks worked with to model how much trade they could facilitate after the last downturn. It failed to materialise, and Central Banks kept interest rates at historically low levels while continuing to keep asset purchase schemes largely in tact after the “taper tantrum” in 2013 when it looked like the Federal Reserve was slowly reversing its quantitative easing. The result has been liquid equity markets as investors have sought high returns anywhere other than more traditional forms of investment. Against this backdrop it has been almost impossible for trade finance to be profitable without focusing on bigger deals with fewer S&P 500 or FTSE 100 companies.
Things could well get worse from here for several reasons. First, companies that were once amongst the biggest global businesses in sectors such as retail, air travel and commodities, are now higher risk and falling out of the stock market indices. These are the companies which are often most associated with the traditional forms of trade finance where goods transfer between countries as part of global supply chains. Many businesses have shrunk over the past few months and some will struggle to recover, particularly if oil prices remain low. The result is an ever-declining pool of larger business for whom this type of finance is suitable meaning that any trade finance deals are highly prized, and fought over as a result.
Second, the sectors that are doing well, technology and pharmaceuticals for example, are also the ones that are caught in the cross-fire of the US-China “strategic competition.” For example, although technology stocks have done well through the pandemic, these are businesses that are disproportionately threatened by any disruption to supply chains from Covid itself, but also from the restrictions imposed by either China or the US on trade in technology hardware or software. The US Department of Commerce has imposed restrictions on US companies using Chinese technology and on Chinese businesses using US technology, and it has escalated the use of sanctions against businesses and individuals in the wake of China’s tighter approach to security and dissent in Hong Kong. Compliance functions in banks are operating in a more restrictive and uncertain environment as a result and this will undoubtedly limit the number of deals around.
Finally, the businesses who are most likely to see their size affected by the Covid 19 downturn are the exporting SMEs around the world. The fabled $1.5tn trade finance gap for SMEs is likely to be substantially higher in 2020 because smaller businesses will have disruptions that mean they cannot supply on time while their clients or buyers will have similar disruptions which mean they cannot honour contracts. Estimates vary, but a survey by the United Nation’s International Trade Centre (ITC) of SMEs globally suggests that many are expecting their export revenues to drop by as much as 50%. This is a group of businesses that is already seen as unaffordable for the banking sector because the onboarding process costs anything between $30,000 and $60,000 in working hours depending on the complexity of the deal. The result? Companies that were larger and able to fit within some framework for trade finance will now have fallen below the threshold and be unable to get the short term support they need in order to stay afloat.
So the next crisis could well be one of trade finance. This will affect trade, and therefore economic recovery and sustainable growth over the longer term. The evident risks mean that Trade Credit Insurance has fallen out of any project ranked 3-5 (where 5 is the highest) on the risk spectrum; with no insurance, there is a trade finance squeeze. At present, there is little evidence that governments around the world are systematically “doing the right thing” to address this market. UK Export Finance is taking a lead along with Germany’s KfW, but it is a small, and relatively weak, chasing pack.
In the end, governments have stepped in to rescue and support many parts of our economic and social life but have taken trade for granted. If we are to avoid the next credit crisis, then a focus on trade and trade finance is imperative.