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Why we have not yet cracked trade financing

Last week, I participated at a United Nations Conference on Trade and Development (UNCTAD) sideline meeting on trade finance organised by the Commonwealth. The breakfast meeting with the media focused on the challenges and way forward in trade financing.

The objective of the meeting was to attempt to solve the communication problem that characterises such high level conferences. The people who need to benefit from these conferences rarely get to know how to exploit opportunities such as trade finance.

It perhaps explains why unmet demand for financing trade in Africa stands at $120 billion, according to the African Development Bank’s 2015 report. This problem largely affects Micro, Small and Medium Enterprises (MSMEs) whose credit requests are often rejected by banks.

According to the World Trade Organisation’s (WTO) 2015 report, the main reasons for rejection of trade finance requests are the usual lack of credit worthiness or history, the insufficient limits granted by endorsing banks to local African issuing banks, the small size of the balance sheets (and capital) of African banks and insufficient US dollar liquidity.

Other factors include prohibitive cost of credit precipitated by lack of understanding between actual and perceived risk, dependence on external resources and limited financial inclusion.

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Not many analysts admit, but the 2008 financial crisis has had a huge impact on financing especially in developing countries. With critical information lacking in these countries, many financiers have become risk averse.

The problem is also compounded by the selectivity of financiers that often prefer large organisations, which they perceive to be less risky. There is also a perception that MSMEs are too risky even though research contradicts this view.

The WTO study shows that whilst trade credit pricing to Kenya averaged between 39 and 49 per cent, in Ghana it averaged between 74 and 78 per cent. This prohibitive pricing undermines credit availability.

Lack of credit therefore has far reaching ramifications. It means that preferential export opportunities like the Africa Growth Opportunities Act (Agoa), the recent WTO deal that was signed last December in Nairobi and other preferential trade agreements cannot be fully exploited.

However, several review studies (see for example the 2011 report, the effectiveness of Agoa in increasing trade from Least Developed Countries (LDCs) show that the impact has been dismal.

The report says although Agoa has had a positive impact on apparel exports from a small number of Sub-Saharan LDCs, outside of the apparel sector, there is little or no evidence of Agoa-induced gains in any other sectors for LDCs.

What does Africa need to do in order to play a greater role in international trade? There are supply and demand-side issues that require both the policy maker and the entrepreneur’s attention.

On the supply-side of credit, there is need to strengthen institutions such as payment collection agencies, credit information bureaus and provision of credit guarantees in order to share the risk.

On the policy front, there is need to create new rating agencies. India is overcoming credit problems through MSMEs rating agencies to ease the credit flow. On the demand-side of credit, there must be deliberate efforts to support MSMEs in accessing global value chains (GVCs).

Initially, MSMEs could, for example, specialise in a small area that fits into the GVCs, and then begin to grow into other areas after gaining the confidence to play at the global level.

Just like many newly industrialised countries have done, close collaboration with GVCs often leads to outsourcing some of the services to companies in developing countries. India is aggressively getting into this space through their brand ‘‘Make it India.’’

Trade finance is a key driver of export business but it is not the only challenge that African MSMEs face. There are other issues such as competitiveness and standards. Overcoming competitiveness skill gap is central to widespread exploitation of opportunities.

It requires deliberate effort to collaborate with the GVCs in order to satisfy their needs while building local capacities.

There is dire need for capacity building around MSMEs to understand customer needs and develop global networks.

Although the global financial crisis of 2008 has subsided with markets showing signs of normality, the structural problems facing developing countries in accessing trade finance still linger or in some cases have gotten worse.

Evidence from several research papers, including the WTO study, show that trade finance markets have shifted to large corporations even though in some cases there is a financial glut in this segment as poorer countries and their MSMEs struggle to find affordable finance.

In order to succeed MSMEs have to connect to GVCs and begin to expand from there.

The writer is an associate professor at the University of Nairobi’s School of Business

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