Lower for longer oil prices, China rebalancing, Brexit and Trump: what will drive regional trade ﬂows in 2017? How are importers and exporters covering their risks and managing related costs?
Global trade growth remains sombre. The slowdown and rebalancing of the Chinese economy, Brexit, lower commodity prices, the ramiﬁcations of US President Donald Trump’s multifaceted policies, as well as the prospects of higher US interest rates continue to weigh on global and regional trade growth prospects in the medium term.
Brexit continues to unfold with the long-term arrangements in relations between the United Kingdom and the European Union remaining uncertain. Brexit is not only a symptom of fraying consensus on the beneﬁts of cross-border economic and trade integration amid weak growth, but could catalyse pressures for inward-looking policies elsewhere as well. This has been augmented by US President Donald Trump’s trade policy calls for an increase in US-led protectionism and de-globalisation which is likely to be a key risk for global trade in the medium term.
“The impact in the context of GCC regional trade will be broadly immaterial. First, the trade impact of Brexit is insigniﬁcant between the GCC and the UK – just 1.4% of total GCC exports go the UK, and only 5.1% of total UK exports go the GCC. Secondly, an increase in US-led protectionism and de-globalisation would not affect the Mena region materially, as the US only accounts for 7% of the Mena region’s total exports,” says Takayuki Akita, Global Head of Transaction Banking at MUFG.
Beyond this, the GCC region is facing a new chapter of ﬁscal realities driven by low oil prices and high spending needs. Indeed, lower for longer oil prices are testing GCC government ﬁnances, leading to spending cutbacks, which is taking its toll on economic activity.
In this regard, GCC government budgets play a central role in driving activity, trade and overall growth. They are by far the most dominant force in their respective economies, and budgets have been the key proxy through which wealth is transferred through public sector wages, expenditure on infrastructure, healthcare, education and diversiﬁcation projects. The growth model worked well during the years when oil prices were high, which enabled GCC governments to adequately accumulate sizable ﬁscal buffers. However, as the medium-term horizon looks more challenging for oil markets, governments need to assess new revenue sources to fund long-term development targets in line with their National Vision strategies.
2016 turned out to be a pivotal year for the GCC, as countries prepared for a sustained period of low oil prices and reassessed their medium-term spending plans to address ﬁscal vulnerabilities.
To limit the drag on economic growth, ﬁscal consolidation plans have focused on reining in current expenditures, including limiting growth of public sector wages and reducing costly energy subsidies. GCC countries have also focused on the areas and efﬁciency of spending. Moreover, non-oil revenue generation efforts (higher corporate taxes and municipal fees, privatisation, and the eventual implementation of VAT), have all accompanied efforts to contain spending.
“We see three fundamental approaches for GCC governments to address their ﬁscal challenges, namely, (i) a restructuring of revenues away from oil and to develop a more comprehensive and sustainable income stream; (ii) prioritisation of capital expenditures to focus on the quality and efﬁciency of project spending, as well as the rationalisation of current expenditures, notably the removal of costly energy subsidies; and (iii) the promotion of privatisation and PPP initiatives to foster private sector participation and help reduce ﬁscal burdens on their budgets,” says Shichito Tobari, MUFG’s Regional Head for the Middle East.
Going into 2017, GCC budgets all suggest a credible path of targeting a signiﬁcantly narrower ﬁscal deﬁcit, primarily owing to the expectation of higher oil revenues in light of the boost given to oil prices from the OPEC and non-OPEC agreement production cuts
in December 2016.
The ability of each GCC country to fully implement announced budgetary measures, and avoid reversals in the future, will be critical for their policy credibility and assessment of their ﬁscal and external sustainability by markets. Three concerns are worth noting. First, certain announcements have been made in an ad hoc manner, which means they are not anchored to a comprehensive medium-term ﬁscal framework at a country level that takes into consideration the possibility of oil prices remaining low over the medium-term. Second, compared to the size of the ﬁnancing needs and required ﬁscal adjustments to prevent any further deterioration in creditworthiness, the impact of the reduction in energy subsidy measures in terms of ﬁscal savings is likely to be limited and therefore insufﬁcient in the short term. Accordingly, ﬁscal gains are likely to be limited in 2017, and therefore much of the adjustment in the short to medium-term is likely to come from the capital spending side as current expenditures are more difﬁcult to rein in. Third, reform implementation is unlikely to be without risks. Several of these measures will have an inﬂationary impact while others could dampen growth, further complicating the implementation momentum and heightening the risk of policy reversals or delays, notably if oil prices show some signs of recovery in the months ahead.
Attending to growing ﬁnancing needs in a lower oil price environment is driving the GCC states increasingly to diversify their sources of ﬁnancing. “GCC countries have the capacity to ﬁnance their budget deﬁcits and investment programmes for two key reasons: (i) they have accumulated signiﬁcant savings in the last 10 years, which could be tapped to ﬁnance budget deﬁcits and investments; and (ii) public debt to GDP ratios are low, which along with the strong credit rating proﬁles, makes it easy to raise debt on international markets at favourable interest rates,” says Elyas Algaseer, Co-Head of MUFG’s Dubai Branch.
Given the backdrop of aforementioned risks and volatility facing global and regional growth, the demand for trade ﬁnance products to mitigate potential risks associated to cross-border trade is likely to increase. Going forward, advantages associated with trade ﬁnance (such as risk mitigation, swift payment processes and short maturities), offset not only challenges, but also provide comfort to both corporates and ﬁnancial institutions across the GCC region.
While the region’s importers and exporters are still using traditional trade ﬁnance solutions to support a large part of their trade ﬂows, MUFG has seen signiﬁcant signs of change in the last few years. Key exports from the region are driven by national oil companies.
As some look to improve sales into Asia, they are slowly moving away from letters of credit and are covering the risk of export receivables using different solutions from their banking partners. Silent payment guarantees and silent receivables discounting are two key solutions we have seen being used by some of the large exporters in the region.
Similarly on the import side, even with large, well-established importers, we are still seeing substantial use of traditional trade ﬁnance solutions, such as documentary credits and collections to support the transactions, both in terms of providing risk cover to the exporters and for generating post-import ﬁnancing for the importers. MUFG has also seen an uptick in use of TSU BPO by some of the large importers in the region. To some extent, this is driven by the fact that TSU BPO has been approved for use by one of the largest Japanese exporters to the region, and we expect that along with usage of documentary credits there may also be an exponential growth in the usage of TSU BPO to support some of the larger value imports from Japanese manufacturers/exporters. To an extent, large importers in the region are looking to compensate for higher funding costs by optimising all other costs across their supply chains, therefore appreciating the value generated by using the same bank at both ends of their supply chain in securing lower processing costs and reducing transaction completion times. MUFG’s TSU BPO solution is ticking the box from this angle too.
“On the back of the drop in oil prices, we have seen a substantial reduction in liquidity, especially US dollar or foreign currency liquidity. This development has led to an increase in pricing for US dollar funding, which – though better aligned with the underlying risk than before – is still more attractive than funding in local currencies across the region. Larger importers/exporters across the region are therefore increasingly demanding US dollar funding from their local relationship FIs and this demand has opened up a vast new area of collaboration between the local and global FIs, especially those global FIs with a long-term commitment to the region. Changes in business scenarios over the past two years have allowed MUFG to play to its strengths and grow its trade ﬁnance market share in the Middle East signiﬁcantly in the corporate and FI space,” says Kersi Patel, Head of Trade Finance for Middle East at MUFG.