A lack of trade finance availability for companies in the world’s poorest countries in Africa could potentially undermine the ‘trade not aid’ argument. Rebecca Spong reports.
The much-debated ‘trade not aid’ philosophy is beloved by economists and politicians of many different political leanings. Rather than pouring billions into aid programmes, they hope that the poorest countries could trade their way out of poverty.
Studies have suggested that if African countries increased their share in global trade by just 1%, this would result in an additional annual income of over US$200bn. This is around five times more than the continent receives every year in financial aid granted by governments and other agencies.
But the full integration of Africa into world trade has not yet happened, and despite the chatter around Africa’s ‘potential’ and the continent’s projected economic growth rate of 6% for 2012; trade, and particularly intra-Africa trade, remains low.
Africa’s share of global trade remains hovering around the 3% mark, while intra-Africa trade stands at just 11% of its total trade activity. Compare this to Europe where intra-regional trade is approximately 72% of total volumes, or Asia where 52% of trade is conducted within the region itself.
But it could get worse. A working paper from the Overseas Development Institute (ODI) released in June states that the developing world could face a cumulative output loss of US$238bn over 2012-13 due to the deepening crisis in the eurozone.
It is the poorest countries that are set to suffer the most; and particularly those where countries are more dependent on exporting to the developed world.
Côte d’Ivoire relies on exports to the European Union (EU) for over 17% of its GDP, while for Mozambique and Nigeria, exports to the EU account for 14% and 10% of their GDP respectively, according to the ODI report.
Reduced demand for goods in Europe and a lack of intra-Africa trade doesn’t suggest that Africa will trade its way to economic growth. In theory, ‘trade not aid’ is workable. In practice, today’s risk-averse environment could see it fall on its face.
No finance here
One problem facing exporters and importers, especially those small and medium-sized companies (SMEs) in poorer nations, is the lack of access to affordable trade finance from the commercial banking sector.
“While trade finance is supplied around the world by the private sector, this does not mean that access is universal or affordable for all,” explains Marc Auboin, counsellor at the World Trade Organisation (WTO).
“In practice, access varies significantly, both between countries and within countries. Low income countries in Africa and Asia typically fare the worst, although they are not alone. SMEs in both developed and developing countries also face serious challenges.
“In short, there are a series of ‘structural issues’ which affect the market for trade finance,” he adds. The WTO is working on solving these ‘structural issues’ through its Aid for Trade initiative.
“Aid for Trade is a catalyst initiative aimed at reducing supply side constraints to poor countries’ trade. Lack of access to trade finance is one of these constraints,” comments Auboin.
WTO director-general Pascal Lamy discussed the gaps in the provision of trade finance at an Aid for Trade workshop held in May. He told attendees that only a third of the poorest countries benefit regularly from services offered by trade finance facilitation programmes set up by multilaterals such as the World Bank’s International Finance Corporation (IFC), the European Bank for Reconstruction and Development (EBRD) and the Asian Development Bank (ADB).
“Even where trade finance is available, it does not mean that access is universal…. Least-developed countries in Africa and Asia typically fare the worst, although they are not alone,” he added.
With this in mind, the WTO has been lending its weight to initiatives that will increase the provision of trade finance in Africa. In a working group report submitted at the G-20 2011 meetings in Cannes, the WTO recommended that the African Development Bank (AfDB) set up its own trade finance facility (TFP).
“The WTO strongly supports the efforts of the AfDB to create its own, established, and permanent TFP,” notes Auboin.
“These programmes are very important to support small trade transactions in LICs [low-income countries], and keeping them affordable for traders. The G-20 supported the conclusions of our report, as did the shareholders and management of the AfDB,” he adds.
In June 2011, the Asian Development Bank announced that it was lending its support to the AfDB to set up a trade finance facility, providing the African organisation with the necessary legal document templates and operational know-how to run such a scheme.
The AfDB is now close to formally launching its trade finance programme by October this year, and there are already four financial institutions processing transactions through the programme.
The scheme is set to have an exposure limit of US$1bn and incorporate three products. One product is a risk participation programme that operates in a similar manner to other multilateral schemes where AfDB will offer guarantees to trade transactions between African and international banks.
There will also be a funded product which will allow AfDB to offer lines of credit to African banks to on-lend to African companies. The aim of this product is to encourage intra-Africa trade.
The final arm of the programme focuses on commodity finance, whereby AfDB will provide direct funding to agri-producers in Africa.
Initial transactions presently being worked on involve the risk participation scheme and the direct line of credit, while no commodity finance deals have been originated yet.
“The bank is keen to consolidate its role as a provider of trade finance in the future,” explains Yaw Adu Kuffour, head of trade finance at AfDB.
Other multilaterals are further ramping up their support for trade finance in developing markets.
In January, the IFC launched its critical commodity finance programme, which aims to support the financing of vital agricultural and energy commodities.
Although the programme has a global reach, a large proportion of the financing will be focused on Africa. Target markets are the 81 countries deemed by the World Bank as being the poorest in the world; the majority of which are found on the African continent.
The scheme runs on a risk participation basis, so the participating commercial banks and the IFC each put 50% of the financing into the scheme. All the deals signed so far have seen the bank and the IFC contribute US$250mn each. The financing is then on-lent at market rates.
The IFC should know exactly to which client and which country the money goes, and Michael Kurdyla, business development associate for trade and supply chain solutions, says that the IFC has to approve a list of clients submitted by the bank before the deal is even signed, to ensure the financing reaches those who need it most.
Société Générale, Rabobank and ING have all signed up to the programme since the beginning of 2012 and so far US$750mn-worth of private sector contributions has been disbursed.
The programme has a ceiling of US$1bn and the IFC has confirmed to GTR that the full amount will be disbursed by approximately the beginning of September as additional banks, particularly those in Europe, sign up to the scheme.
“The facility really keeps banks engaged in the market until there is sufficient economy recovery. Without this scheme there would be less commodity financing in these poorer markets,” Kurdyla adds.
The use of microfinance is another method of bringing much-needed trade finance to smaller exporters and importers in poorer countries.
Also speaking at the WTO’s Aid for Trade workshop in May, Roland Dominicé, CEO of the microfinance company Symbiotics Group, outlined how his firm is becoming more involved in trade finance.
Symbiotics provides short-term loans to microfinance institutions, many of which are active in trade finance. The company also lends directly to agricultural co-operatives active in trade finance. It has disbursed over US$1bn in micro and SME finance across low income economies, and Dominicé believes that trade finance will become a more important focus for the company.
“Trade finance is a very large market, which mostly targets large-scale operations. But on its micro and small segments, many microfinance and SME finance funds directly or indirectly invest in trade finance operations,” he tells GTR.
“I think this link will see an increasing influx of capital in the coming years. We’re actually seeing some new funds being set up, solely dedicated to this activity,” he adds.
Back in January, Symbiotics formed an investment fund with the charity Oxfam with the intention of targeting small and medium-sized businesses in developing countries, particularly those in Asia and Africa. Many of these companies will have some direct link to trade finance markets.
Oxfam will be the fund’s impact advisor, using its local knowledge to assess the impact of the investment activities. One of its main targets is to create 100,000 jobs in the first five years of the fund’s existence.
The target size of the Small Enterprise Impact Investment Fund (SEIIF) is US$100mn after three years, and will be invested in a portfolio of debt and equity instruments to target those with low risk, high impact profiles.
The ‘trade not aid’ argument will need the right environment to operate in, and will perhaps require new approaches to financing trade.
The use of microfinance or increased collaboration with charities could be a means to supporting trade in Africa. The WTO will also play a role in promoting the establishment of the right banking policies and legal and regulatory frameworks to encourage investment in Africa.
There will an even greater need for more public-private co-operation, with the creation of new multilateral-led trade finance programmes as well as the expansion of existing ones to ensure an adequate access to financing throughout the continent.