As the star of international trade, China has attracted even more attention during the global crisis. With so many economies now dependent on China’s ravenous appetite for anything from raw materials to industrial equipment, even the smallest drop-off in demand could leave already struggling markets reeling, writes Helen Castell.
Optimistic decoupling theories fell flat on their face from mid 2008, as China’s massive economic machine started to splutter. But there are some signs that its decline could be shallower – and much shorter-lived – than anticipated.
“The effect of the global financial crisis on China trade has been far reaching,” says Peter Murray, senior partner at Ince & Co in Shanghai.
“It is a fact of everyday commercial life that there can be a sudden drop in demand for goods and commodities and that orders fail,” he says.
“However, the global financial crisis appears to have brought about a very different scenario – whereby there may still be strong demand for a product but the contract fails because the financing or the credit insurance normally underpinning the deal are no longer available.”
This impact can be felt across the board. Examples cited by Murray include shipowners cancelling orders for new vessels from Chinese shipyards or defaulting on payments due. Technological products are in less demand as factories stand still. And appetite for a full gamut of goods is falling, meaning virtually every kind of investment is postponed.
Turnover at ports in Hong Kong and Shenzhen has dropped significantly since the last quarter of 2008, and there appears to be no improvement in the first quarter of 2009, says Antonio Huang, head of export finance at Banco Santander in Hong Kong. “My gut feeling is that exports out of China have dropped by at least 20%, although the public figures could be less than that.”
Indeed they are. But it is worth remembering that China’s official data are notoriously opaque and can be vulnerable to state massaging.
Although for the whole of 2008, China’s imports and exports grew 17.8% to US$2.56tn. By November they had staged a dramatic contraction – shrinking 9% month-on-month and marking their first decline for more than seven years, according to Chinese customs figures. In December they were down by 11%.
Exports however have held up better, contracting just 2.2% and 2.8% respectively in November and December 2008, customs figures show. This compares with 18% and 21.3% dives for imports, caused largely by a big slump in the price of commodities such as crude oil, iron ore and base metals, and lower demand for machinery and equipment as investment into industry slowed.
The hardest hit industries on the export side have been labour-intensive manufacturing sectors such as textiles, garments, footwear, toys, travel goods and electronics, which have suffered as demand from developed countries drops, says Frank Wu, head of structured trade and export finance at Deutsche Bank China in Beijing.
The appreciation of the renminbi against European and Asian currencies – excluding the Japanese yen – has also hit exports.
Wu reports that some imports may however remain stable in 2009. Commodities like iron ore and copper may benefit from Beijing’s Rmb4tn infrastructure stimulus package, while the government may also take advantage of today’s low oil price to accelerate its stockpiling of petroleum.
There are also small signs that a recovery may be on the horizon. In mid February, the Baltic Dry Index, which tracks the cost of shipping commodities by sea and is therefore seen as a gauge of demand for raw materials, increased for 15 consecutive dates, notes Robert Martin, managing director, head of Asia at BMO Capital Markets in Hong Kong.
“It remains well below its record highs of last year but the advance in just the past three weeks is driven largely by rising iron ore shipments to China,” he says. “This may signal that the worst may already be over for the global economy.”
However quickly China recovers, it is worth noting that even a tiny decrease in Chinese imports – and to a lesser extent exports – will raise a sweat among its biggest trading partners, many of which have become dependent on the country’s massive demand for their own growth.
“China is an important trade partner for many countries,” says Wu at Deutsche. “Clearly everyone will be watching out for signs of economic recovery in China in terms of GDP and consumption growth.”
Australia relies on China as a market for its iron ore and base metals, Brazil needs China to buy its iron ore and soy beans, and Korea and Japan sell much of their electronic products there.
Germany is a particularly extreme case. After exporting €31bn-worth of goods to China in 2008 – with those of machines, cars and power plants/energy-related equipment jumping 17.2%, 18.3% and 24.5% respectively – these products are now in less demand and export growth rates are likely to slow.
However, BMO’s Murray argues that with China’s massive infrastructure and environmental investment plans, German exports won’t stay low for long.
“It is especially in these areas, like energy-efficient power plants and renewable energy, that main German companies like Siemens and Bosch are very strong,” he explains.
“Siemens has already constructed several very energy-efficient coal-fired power plants in China and is hoping to construct more. Likewise, they expect to profit from China’s expected investment into its railway system as they recently constructed the high-speed train from Tianjin to Beijing and earlier the Maglev in Shanghai.”
Impact on trade finance
The drop-off in China trade volumes – whether or not China’s official figures can be relied on – has clearly meant smaller trade finance flow for banks.
China-related trade finance deal flow will likely decrease in 2009 due to two factors. First, the fall in China’s overall trade volume, and secondly, the reduced risk appetite of banks – especially those foreign banks still deleveraging. And for commodity finance, overall demand will probably shrink along with price declines, adds Murray.
Commodity prices are, however, now at more reasonable levels than six months ago. This potentially lowers market risk and could attract banks to enter new financing deals.
The biggest shift in market trends lies in their pricing, with most reporting higher risk premiums and tighter liquidity, all of which makes credit more expensive.
“Pricing has increased significantly,” says Huang. “The average margin for an ECA loan has increased from 50 basis points to 150-200bp.”
Foreign exchange shifts have also effectively raised the cost of borrowing in many deals, notes Martin at BMO Capital Markets. On top of this, clients are becoming more prepared to pay commitment fees to access credit as it becomes harder to raise new capital, he says.
However, Charles Brough, director – head of forfaiting and trade finance (Asia Pacific) at UniCredit Markets & Investment in Singapore observes that: “The risk perception of China is actually abating. It’s one of the few countries whose margins have gone down.”
Demand for traditional trade finance such as letters of credit, guarantees and confirmations has also increased, while financing and payment terms have shortened, he adds.
Banks and corporates are naturally more cautious given the current market climate, with these institutions favouring simple and traditional structures – and trade finance is proving to be no exception.
“From a bank’s perspective, revenue and profit from traditional trade finance products is up,” adds BMO Capital’s Martin. “Because of the generally short-term nature of trade where China is involved, banks are generally able to reprice frequently to recognise market conditions.”
There is also a discernable shift away from open account to LCs, although “these conditions will not last forever”, he notes.
Blue chip corporations with “narrow” relationships are also becoming too expensive to maintain due to their large lending requirements, he adds.
Given the current environment, banks would be better off focusing on fewer deals with higher credit quality and higher margins, Huang advises.
Also, “affected by the financial crisis and the resultant bank mergers, the number of active players in the trade finance market will most likely decrease,” adds Wu.
Local bank input
Chinese banks have always been the major provider of financing for trade flow in and out of China and they are expected to remain heavy hitters here, potentially filling any void left by foreign banks.
Huge support from China’s state bank, which is flush with massive forex reserves, has helped keep local banks lending.
And they have been upping their game. “We have seen more and more overseas activities from Chinese banks, and I foresee that we will see more in the near future, after the current financial crisis,” says Huang.
As Chinese banks become more international in approach and more involved in cross-border financing, they are becoming “the real competitor or partner we need to consider for any China-related business”, he says.
While Chinese banks have traditionally preferred a bilateral structure, “we have seen signs of them becoming more open to working with foreign banks in syndicated/club deals”, Wu says.
Chinese banks, companies and insurers are moving to fill the void created by lower capacity among foreign players, and this trend will continue, predicts Murray.
Beijing has set itself massive urbanisation and environmental targets and needs high-tech imports to achieve them. In light of this, some banks are remaining optimistic that imports of high-tech equipment will resume once the finance and insurance aspects are retooled by Chinese companies.
One local player that no one can ignore is Sinosure, China’s unofficial ECA.
“The growth of Sinosure has been dramatic in the past year. It will be even more dramatic this year,” says Murray.
“We believe Sinosure will continue to play a key role in supporting Chinese export of capital goods, for example telecom equipment to emerging markets,” agrees Wu.
Sinosure plays a “critical” role for Chinese exporters, sponsors and investors, says Santander’s Huang, citing as an example its support of Chalco’s (the Aluminium Corporation of China) planned investment in Rio Tinto.
The development of an export credit insurance law to better define Sinosure’s role would enable some foreign banks to do more to support Chinese export business.
UniCredit for one does not currently accept Sinosure backing, notes Brough. “We’re not prepared to put Sinosure on the same level as Hermes or Coface, because it’s not really a direct government entity.”
China’s legal environment is steadily improving, and this has facilitated much innovation in trade finance structures in recent years. A new property law signed in 2007, for example, legalised the concept of floating charges.
“Of course, it will take time for any new legislation to be tested and perfected by market practices, but the overall trend is encouraging,” comments Deutsche’s Wu.
China’s foreign exchange administration is also said to be improving, which is in turn helping to improve the authenticity and conformity of foreign exchange collection and settlement in trade.
Yet, “corruption remains a problem within some local governments, especially in more remote centres”, says Rick Mackenzie at BMO Capital Markets.
“Other concerns with the Chinese judiciary include no reporting of decided cases and no predictability of outcomes. Also, the Chinese courts rely on the local governments for their budgets, leaving them exposed to local influences.”
“China’s bankruptcy legislation was only introduced in 2006 and it was only in 2007 that China recognised some property rights by passing the PRC property law,” Mackenzie adds.
“The impact of these changes is still being felt and has not been fully understood. Overall however, in 30 years, China has built an impressive legal system that technically complies with WTO standards.”
Reluctance to pay
The biggest problem foreign banks face in China is documentary risk, says UniCredit’s Brough. Although Chinese banks typically have the cash to cover their commitments, if prices fall, some still “try and find something wrong with the documents to avoid paying you”.
Although Beijing is working to counter this – forcing non-paying banks to go to court and pay up when found to have rejected documents ‘frivolously’ – this route is expensive and time-consuming, Brough notes.
“You have to be very careful, especially with the provincial branches of the big banks,” he says. “You have to have a very good bills department. You have to check documents.
“You must look at the applicant, make sure there’s no fraud involved. And then you must look at the prices of the commodities.”
According to Murray at Ince & Co, there are no statistics to measure the risks associated with using trade finance products such as guarantees, LCs or documentary collections in China. There are also no relative laws or regulations governing this at present.
“As things stand, financial institutions should continue to inspect documentation more carefully and strengthen their management of all risks,” he advises.
For all its faults, China has rapidly become a market that few trading partners can afford to see falter.
In the heady bull years up to 2007, it was the world’s most-watched market as its seemingly insatiable demand for imports sparked the resurgence of whole industries abroad, while its manufacturing machine created controversy among struggling competitors.
As China trade now starts to slow, even more eyes will be upon it. And those now hoping for its engine to get back into gear will far outnumber those who formerly feared it.