Changes in the liquidity environment are driving public and private-sector corporates and governments to seek alternative sources of liquidity such as trade finance, supply chain finance and export credit agency-supported finance, writes Yusuf Ali Khan, Treasury and Trade Solutions Trade Head, Middle East, North Africa, Pakistan and Turkey at Citi.


The Middle East and North Africa (Mena) region has experienced a material change in liquidity in the past few months. Previously, local and international banks allocated capital cheaply and freely, as trade finance competed with other modes of financing, or to attract borrowers that were relatively liquid. Credit is still available for major corporates in both the private and public sectors. However, lenders are more selective and seeking higher pricing for capital while small and medium-sized enterprises (SMEs) are finding it increasingly difficult to access financing, creating significant stress in the sector.

A number of macro-economic and geopolitical drivers are forcing corporates and sovereigns to focus on creating greater efficiencies in their working capital cycles, optimising balance sheets and gaining access to long-term funds for infrastructure development.


Alternative sources of liquidity

The tightening of liquidity and more turbulent conditions in the bond market have had major implications for sovereigns and corporates seeking to borrow. However, it is important to recognise that the problems they face are not on the same scale as those encountered during the financial crisis of 2008/2009.

Nevertheless, the changed liquidity conditions have resulted in a much deeper engagement by corporates, the public sector and governments with banks about alternative sources of liquidity to meet their short-term needs and working capital efficiency goals, as well as their longer-term needs for infrastructure and capex investment.

Specifically, interest has increased in supply chain finance (SCF) and receivables discounting to meet short-term financing needs, while there has also been increased interest in measures to improve working capital efficiency. At the same time, there has been an increase in inquiries for export credit agency (ECA)-led finance for large projects where long-term funding and stability are required.


SCF and working capital efficiency

The motivations and objectives of the entities seeking alternatives to bank lending differ depending on the product involved. Many corporates simply want to improve the efficiency of their working capital to reduce the challenges they face in accessing working capital from banks.

Companies implementing SCF programmes may have similar motivations. The success of SCF programmes has spurred interest from other public-sector entities in Mena. Indeed, a number of ministries of finance across the region are currently considering SCF. Their objectives are primarily to support smaller suppliers, ensuring they get paid more quickly and have access to funding, which is often expensive or in limited supply from the commercial banking market.


ECA activity

ECA-supported finance has long been important for large projects in Mena but strong conditions in the commercial bank and bond market in recent years led to some projects being financed in these markets where execution is quicker and less complex. This trend has now reversed as sovereigns have come under fiscal and ratings pressure. Consequently, there is increased interest in long-term financing which may be more structured in nature, but will provide sovereigns with a better way to manage their national budget cashflow, and also lower borrowing costs.

In February 2016, Citi acted as an arranger for a US$250mn Overseas Private Investment Corporation-supported term financing for a Pakistani utility company. The innovative structure allowed the utility to access seven-year financing at more competitive rates for foreign currency borrowing than would be possible from the local bank market. Crucially, it offered the company certainty of both pricing and execution.

Similarly, in 2015, Citi acted as arranger and lender on a US Exim-guaranteed financing for a Moroccan public sector entity and for a Multilateral Investment Guarantee Agency-supported financing for a large development bank in Turkey. These financings offered a number of advantages to the borrowers, including longer tenor, competitive pricing compared to the
bank market and certainty of execution.

ECA activity is also increasing in markets where political and economic risks remain high and commercial bank financing remains challenging. ECA support has been invaluable for the financing of infrastructure projects in the transport, power and oil and gas sectors. Similarly, in Pakistan, ECA-supported financing is a key source of long-term funds (although the public sector has been a more active user than private-sector corporates).


Long-term outlook remains attractive

It is important to remember that while there are significant short-term challenges to trade in Mena, the long-term outlook for the region remains strong. China continues to make significant investments across Mena, such as the US$46bn-worth of investments in Pakistan it announced in April 2015 covering the energy, infrastructure and oil and gas sectors.

China intends to create a road and rail corridor across Pakistan to transport goods to southern China. This will significantly reduce China’s logistics costs, as goods, including oil, currently face a long journey by sea. For Pakistan, China’s investment will have a multiplier effect on its economy, creating jobs and spurring the creation of new SMEs to service Chinese companies. China’s eventual goal of creating a link via Afghanistan to Europe would further integrate Pakistan into the regional and global economy and drive additional economic growth.

The China Export and Credit Insurance Corporation (Sinosure), China Development Bank and China Eximbank are already increasing their activity in Pakistan as a result of China’s investment commitment to Pakistan. In the coming years, alliances or joint ventures could be formed between Chinese and Pakistani banks to facilitate trade-related flows: Pakistan banks would contribute local knowledge about markets, risks and regulations while China’s ECAs would supply capital and experience of international projects.


Greater co-operation is required

The slowdown in economic growth in many Mena markets will make 2016 a challenging year for many borrowers: pain is already being felt in the SME sector as companies struggle to access financing. However, the region offers strong opportunities given the demands for infrastructure financing by sovereigns and the need by corporates to right-size their balance sheets.

Alternative sources of finance will go a long way in bridging these gaps by creating greater efficiencies as borrowers look to manage their balance sheets and raise term debt to finance critical infrastructure development projects. However, banks will need to adopt a new mindset given the changes in the trade environment. Competition between banks has been fierce in recent years, driving down borrowing costs to levels that did not reflect risk. The changed liquidity scenario will allow lenders to correct asset pricing and close the gap between risk and returns. It will also require lenders to co-operate more if they are to address the needs of their clients over the short to medium term, especially as the credit environment undergoes a change.