By Shehzad Sharjeel
Trade, the commercial manifestation of countless cross-border flows of goods and services between people, organizations and countries, is the lynchpin of the global economy. These flows impact not only exporters and importers, but also play a crucial role improving national economies, ultimately lifting people’s standard of living and giving them a chance to grow and prosper.
But this all came precariously close to a grinding halt when the global financial crisis revealed itself towards the end of 2008. Although trade was not the cause of crisis, it became one of its main casualties, as evidenced by a global trade contraction of 12.2 percent in 2009 — the sharpest decline in 70 years and the steepest drop since the Great Depression.
Some experts called this huge contraction, which occurred between the third quarter of 2008 and the second quarter of 2009, “The Great Trade Collapse.” The drop was sudden, severe and synchronized, making it particularly interesting to dissect. And while several explanations for the strangled trading environment have been proposed, the most plausible view is that it happened because a serious credit crunch, originating in the financial crisis and exacerbated by the global supply chain system, cut off financing for those engaged in cross-border commercial activity.
A rapid response by world governments to support national economies allowed us to avoid a full blown depression. Multilateral agencies did their best to ameliorate the situation. IFC, for example, doubled its Global Trade Finance Program limit to $3 billion to support global trade and later initiated the Global Trade Liquidity Program, a unique public-private partnership to revitalize global trade.
Having said this, the recession triggered by the global financial crisis has damaged economies in many parts of the world, in particular developed economies where recovery is fragile, unemployment is still high, business credit is squeezed, and financial markets remain cautious because of high government deficits.
Although the economic recovery has begun, the “Global Economic Prospect” report issued by World Bank this month states, “The global economy is transitioning from a rapid, bounce-back phase of recovery, toward a slower, more sustainable paced phase.”
And for trade, the report notes, “Global trade began recovering in the second quarter of 2009, and continued growing rapidly for four consecutive quarters, expanding at a 11.9 percent annualized pace during the first ten months of 2010.” This recovery is being driven predominantly by developing countries. But, challenges remain.
Further market turmoil is possible, contagion in Euro area sovereign debt markets remains on the radar; and rising commodity prices could threaten the recovery in developing countries, since in most cases they are net importers of commodities, particularly food products.
Middle East and North Africa as a region was less affected by the global recession than other developing regions, in part because of the region’s limited financial integration, and but also due to its export mix. However, each of the challenges listed above could exert a direct impact on the overall economy and trade.
Results through coming quarters will demonstrate in which direction the wind is blowing. While prevailing macro factors will impact economic results into the future, some important milestones were crossed within in the world of trade in 2010. Two of the most important were the launch of Uniform Rules for Demand Guarantees URDG758 as a replacement of URDG458 rules in Jul 2010 and revisions to Incoterms, reducing the number of rules that define buyers’ and sellers’ respective obligations and risks when entering a contract of sale.
While the new sets of rules mentioned above will facilitate trade, a further development in the making is Basel III’s impact on trade, which may not be very favorable. Among the changes, the one impacting most would be leverage ratio, which is aimed at limiting bank’s debt levels and is determined by dividing total assets by Tier 1 Capital. The ratio rule intends to introduce a 100 percent credit conversion factor to certain off-balance sheet items, which include several key trade finance instruments.
The intention is to safeguard risks, but a consequence of such a change will be to treat certain trade instruments which are contingent in nature, such as Letters of Credit (LCs), the same as certain riskier instruments such as derivatives. Thus, if Basel III is approved in the form currently contemplated, it will have an adverse impact on banks in terms of capital requirements, which would ultimately limit trade financing availed by SMEs.
The silver lining to this, however, is that banks, including a number of industry bodies like the ICC, WTO and World Bank, are not only conscious of the concerns but are also seeking active dialogue and advocating amendments to these proposed changes. Time will tell how successful those efforts will be and what shape the global trade landscape will take into the coming years.
Shehzad Sharjeel is a Senior Trade Finance Officer and Regional Head – Trade, Middle East and North Africa at the International Finance Corporation. He is based in Cairo and covers the Middle East and North Africa. He has over 13 years of management experience with strong focus on Customer Services, Trade Services, Trade Finance, Trade Risk Distribution and Training and Capacity Development. This article was written exclusively for Daily News Egypt.
The findings, interpretations and conclusions expressed in this article are the author’s own and do not necessarily reflect the views of IFC, a member of the World Bank Group.
