By Charles Carlson, Global Head of Structured Export Finance, Standard Chartered Bank
Export credit agencies, more commonly known as ECAs, are public agencies that primarily exist to provide government-supported loans, guarantees, credits and insurance to support the exporting activities of private companies in their home country. The system of ECAs that is currently in place was established largely to support exports from a group of rich countries (historically identified as “developed economies”) to lesser developed countries known as “emerging markets”. An association known as the Organisation of Economic Cooperation and Development (OECD) was formed among the developed countries.
Historically trade patterns were such that emerging markets exported their raw materials to OECD countries and in turn, OECD countries used the raw materials to manufacture capital goods such as ships, airplanes, and construction equipment and then exported these finished goods back to the emerging markets and to other OECD countries. The traditional distinguishing feature between developed economies and emerging market economies was that the educated work force and advanced technology resident in developed economies allowed them to manufacture products while less developed countries were forced to export their indigenous raw materials such as ore, oil and gas without any value being added.
As capital goods are typically “large ticket” items with a relatively long useful life expectancy, few buyers pay cash for capital goods (whether in developed or in less developed economies). However, while developed economies have deep and diversified Capital Markets which enable buyers of large ticket items to raise financing domestically, buyers in less developed countries are usually forced to rely on the provision of capital by overseas financiers, typically from the OECD.
Hence the raison d” íÂªtre of the ECAs. For illustration purposes, under ECA programmes, a Sri Lankan buyer of a turbine generator could receive 12-year repayment terms from (ie) the US or German ECA, thus allowing it to finance the acquisition of this large capital good on economically viable terms and enabling the commercial contract to be concluded. By contrast it is probable that the Sri Lankan domestic capital market is not sufficiently large to enable funding to be raised on comparable terms.
In an attempt to level the export market playing field, the OECD countries developed an arrangement, effectively a gentlemen’s agreement, to set the terms and conditions of official ECA support to be provided from OECD countries. This arrangement is called the “OECD Arrangement on Guidelines for Officially Supported Export Credits” but is commonly referred to as the “OECD Consensus”.
An example of an OECD Consensus guideline is the agreement that the ECAs will not provide repayment terms beyond 10 years except for financings of large aircraft and power stations related to which 12-year terms are permitted. The intent is to create a level playing field with respect to financing terms provided under the official export programs of OECD countries in order that commercial contracts may be won or lost based on the underlying attributes of the goods and the commercial contract and not as a result of subsidised financing.
During the past decade, traditional export trading patterns have changed dramatically and many believe that the time has come to examine the official export financing schemes. Firstly, many emerging markets now manufacture capital goods and export them to other emerging markets and to OECD countries. Western Europe’s share of world merchandise exports has fallen from 43.3% in 1990 to 40% in 2000. Whereas Asia and Latin America’s share has increased from 26.1% to 32.2%. No more is Brazil only an exporter of raw materials. Today, Brazil manufactures commuter jet aircraft and very successfully competes with manufacturers in Canada and Western Europe on both technical strengths and price.
China manufactures ships and telecommunication equipment. India also manufactures aircraft. These and many other emerging market countries have aspirations for continued export growth. However as Embraer, the Brazilian aircraft manufacturer, will attest, providing export financing that is competitive with that provided by ECA’s from OECD countries is a stumbling block for growth.
For example, Canada can support exports by Canadian manufacturers to emerging markets such as the Philippines for terms up to 10 or 12 years in accordance with the OECD Consensus. Such financing can typically result in better tenor and pricing (to the tune of about 2.5 % per year) than a buyer in the Philippines could obtain had it sought to raise financing on its own without ECA support.
This can translate into a saving of US$1.2mn per year on a US$50mn transaction. EDC, the Canadian ECA, can fund itself for its own account at rates comparable to the US$ treasury bill rate.
By comparison, should the Indian government choose to support one of its own exporters by providing financing on similar terms to those provided by OECD countries such as Canada, it would have to dig more deeply into its treasury since India’s cost of capital exceeds Canada’s (for example) by about 1% per year on the basis of comparing the respective capital markets.
Trading patterns have changed and countries like India have rapidly industrialised and now have a skilled work force and a large middle class. Therefore, Indian companies can be very competitive in the export markets, but yet cannot compete on financing terms. One solution would be to emulate what the World Bank has done for investment insurance under the Multilateral Investment Guarantee Agency (Miga) and to establish a multilateral ECA. India and other countries could then seek guarantees and/or direct loans from such agency to support exports from their countries. In the above example, an Indian exporter to the Philippines could support its bid to supply aircraft to the Philippines by offering a triple-A rated guarantee provided by the World Bank or other multilateral agency. In so doing, the playing field would truly be levelled with respect to financing terms.
The advantages to India and other emerging markets would be enormous. Not only would a multilateral ECA encourage export led growth, but it would also foster foreign investment. Further, manufacturers in Europe and in the US could outsource sub-assembly work thereby reducing their manufacturing costs.
In such example, the World Bank would share out (through reinsurance programmes), the non-European and American content once the finished product is sold and exported. This would mean that when the European ECAs support the export of (for example) an Airbus aircraft to another country, the European ECA could provide a guarantee for 85% of the value of the aircraft and reinsure with the multi-lateral ECA those portions representing content from emerging markets.
The main beneficiaries in India would be the manufacturers of capital goods in such industries as Aerospace, Telecommunications, heavy equipment manufacture, utility and construction equipment sectors, and also in the now high tech industries supplying computers and related services including software, design and installation.
Clearly, any such initiative would be met with its detractors who would be expected to put all their political forces to work in order to prevent the establishment of a multilateral ECA. Labour groups in OECD countries would be concerned about jobs being exported to emerging markets who they would maintain already have a competitive advantage due to lower labour costs.
Both of these arguments can, however, be refuted. First, while the fear of exported jobs will undoubtedly result in short-term structural adjustments by accelerating growth in the emerging markets, it is now widely accepted that the growing middle class in emerging markets creates new opportunities for US and Western European products.
Second, the argument that low labour costs in emerging markets provides a sufficient competitive advantage to level the playing field with OECD countries, does not hold muster on closer examination. Large ticket contracts have to be financed over longer periods (even if they have been produced in an emerging market for a few million dollars less) and as such the support of ECAs is required for those exports. Whether the Philippines were to pay $20 million or $25 million for a new gas turbine, it would not seek to purchase such item unless it could obtain financing on economically feasible terms.
In summary, perhaps the time indeed has come when we must examine the entire export credit system and re-build it based on a new foundation that will enable the exporting emerging markets to more fully participate in a system which has so successfully supported OECD exporters for so many years.