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LONDON: Trade financing, a basic lubricant for the global economy, is becoming much more expensive and tougher to get, accelerating an already harrowing downturn.

Banks are reluctant to allocate scarce capital to trade financing, which finances cross-border buying and selling, and are very wary about being caught short by defaults by other banks that write letters of credit or by the importers and exporters themselves.

While not the prime cause of the slowdown in global trade, tough conditions for the obscure but crucial corner of finance that fuels the dispatch and delivery of goods and commodities are sand in the wheels.

The stunningly bad trade figures from China underline the problem. China had been expected to show double-digit growth in trade last month compared with November 2007, but the data showed exports falling 2.2 percent from a year earlier and imports sliding 17.9 percent.

"Global demand for Chinese products is vanishing," said Gene Ma, an economist at China Economic Monitor in Beijing. "Secondly, the credit freeze in importing countries has made it hard for Chinese exporters to sell abroad. I heard some Chinese exporters had to cancel shipments as they were worried about getting paid by their buyers."

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Morgan Stanley posts $2.4 billion lossOPEC agrees to a major cut in production European banks tally losses linked to MadoffChinese banks have been very nervous about accepting letters of credit from abroad, making it tougher for imports to China to get the needed financing. China and the United States pledged $20 billion to promote trade with developing countries last week, but that is a tiny balm for a huge market.

The rule of thumb is that 90 percent of global trade requires financing. Karl Alomar, chief executive of China Export Finance, estimates that letters of credit, which had accounted for about 70 percent of Chinese trade financing in 2007, might now only have 30 percent to 40 percent of the market, in part because of concerns about international banks.

Many deals that would otherwise go through will inevitably be scrapped, while many more will be less profitable. The World Trade Organization's director general, Pascal Lamy, said in November that some transactions that had charged 80 basis points over bank benchmark rates a few months ago were now charging 500 basis points.

It may well take concerted international action by central banks and governments to bring trade financing back to life. But there are many other calls on governments for capital and guarantees and it could prove politically easier to prioritize "purely domestic" issues, like the U.S. bailout proposal for automakers, over trade.

For the weakest importers, like the British retailer Woolworths, denial of trade financing could hasten a death spiral.

"Woolworths is one of the better examples of that," said Sandy Chen, a banking analyst at Panmure Gordon. "Because they couldn't get the credit insurance to effectively fund their pre-Christmas inventory stocking, they couldn't put orders in to shippers in the Far East. Because shippers couldn't get the assurances on whether or not Woollies could pay, they wouldn't ship."

Woolworths had to put its retailing and distribution business under creditor protection.

Even putting such buyer-shipper risks aside, trade financing is vulnerable in the current situation. Banks and, crucially, many nonbank finance companies are having difficulties raising funds and are being required to pay more for them. They are also under considerable pressure to channel their resources into areas that either have a big payoff or, like mortgage lending, win points with their government regulators and shareholders.

Trade financing, though vital, doesn't check off many of those boxes. It is also fairly easy to pull back from without enormous immediate repercussions for the banks, as it involves short-term transactions.

Difficulties with trade financing have also contributed to a 94 percent decline in the price of storage space for dry commodities on large ships.

The Baltic Exchange's chief sea freight index, which tracks fees for shipping resources like coal and iron, is close to a 21-year low.

The chilling thing about the trade financing situation is not its impact in isolation but the way it illustrates how easy it is to send a very highly integrated global economy into reverse.

"If there are significant increases in perceived counterparty default risks leading to a shutdown of one part of the supply chain, it rapidly moves on to the rest of the chain," Chen said. "It's a cycle that feeds on itself."

http://www.americaneconomicalert.org/news_item.asp?NID=3538131
 
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