Facilitating trade finance essential for achieving India’s FTP goals

The Foreign Trade Policy (FTP) for 2009-2014 has set an ambitious target of doubling India’s share of global trade in goods and services by 2020 from 1.6% in 2008. The country’s total external trade was $670 billion in 2008, equivalent to 55% of its GDP. Clearly, for the target to be achieved, the total trade in dollar terms needs to increase considerably.

The current global economic crisis has had a particularly severe impact on global trade. IMF’s October 2009 World Economic Outlook projects that the world trade volume will decline by 11.9% in 2009 (for advanced economies, the decline is projected to be 13.6%); while the volume is projected to increase by only 2.5% in 2010.

For April-August 2009 period, India’s merchandise exports and imports in dollar terms declined by 31% and 33.4%, respectively over the corresponding period in 2008.

The global economic crisis has also had significantly negatively impact on accessibility, and cost of trade finance. Global trade finance is estimated to have shrunk 40% in the last quarter of 2008. Exporters, who were more willing to export on the basis of open account or cash against delivery earlier, are increasingly seeking letters of credit. On the other hand, the banks’ willingness to lend has declined, leading to increasing spreads on trade finance credit in 2008.

A combined effort by many multi-lateral institutions, export-credit agencies, and exhortations by G-20 has brought a degree of normality in external trade financing. For most, however, the traditional commercial banks are an important source of trade finance.
But there are strong indications that the health of the banking system continues to be fragile. A private bank consultancy in the United States, which ranked banks in terms of their soundness, recently estimated that banks with nearly $4,900 billion of deposits were in the ‘danger category’. If the new higher capital adequacy rules are applied, many of these banks may fail. The cost of such failure will need to be borne by other banks, reducing their ability to lend. If these cost are borne by the government, the public debt, already quite high, (for G-20 as a group it was estimated to average 100% of GDP in 2009, rising to 120% by 2014), may rise even further.

For India, the spread over the six-month Libor in accessing trade credit increased from 50 bps to 150 bps during 2008. While this was less than the rise in spread for some other countries such as Turkey and Brazil, the increase in cost of trade credit is a negative factor in India achieving merchandise export target of $200 billion by March 2011. It is estimated that 93% of India’s short-term debt of $49.4 billion in 2008-09 was trade-related.

The World Bank has estimated that the lack of trade finance credit globally could account for around 10-15% of the decline in trade. While this may appear small in aggregate global terms, with much of the decline explained by severely constrained economic activity and adjustments in US household balances towards greater savings and less consumption, measures to facilitate trade finance are still essential. They may reduce the extent of contraction in trade in the short run, while positioning a country to take better advantage of the medium-term opportunities.

In the case of India, there are additional reasons to be more aggressive in facilitating trade finance:

1.  First, the importance of services trade is much higher for India (around 38% as compared with the global average of about 20% in 2007). The traditional focus of trade financing agencies is on merchandise trade. While the Export-Import Bank of India (Exim Bank) has taken initiatives to finance information technology and software related services, given the relative the underdevelopment of travel, tourism, financial services, and transport and logistics, there is considerable room for more aggressive, yet commercially viable, measures to secure trade financing for services. Strategic measures to expand the exports of hitherto neglected areas of services could contribute significantly to realisation of FTP’s goals.

2.  Second, the small, medium and micro enterprises are an important generator of economic activity, employment and exports for India. Moreover, for their technological and managerial upgradation they also require access to imports at affordable costs. Constrained access and higher spreads on trade finance often have disproportionate impact on these enterprises. There is a case for Exim Bank and the Export Credit Guarantee Corporation of India to ensure that trade finance is both affordable and accessible to these enterprises.

3.  Third, India’s 2009-2014 FTP envisages expansion of trade, and trade generating projects and FDI with non-traditional economic partners, particularly in Southeast Asia, Latin America, Middle East, and Africa. In general, trade credit facilities are less robust in many of the newer economic partners, which FTP envisages, than with the industrial and advanced developing countries. Thus, more innovative but focused measures by both the Exim Bank and by the ECGC are needed to take advantage of economic opportunities in these countries. An exploration of strategic link between expansion of Indian Diaspora, trade, project exports, and FDI merits serious consideration.

4.  Fourth, the current situation provides an opportunity for India to constructively collaborate with other similar agencies through the Asian Exim Banks Forum set up in 1996, and which includes most of the major trading countries of Asia such as China, Japan, and Indonesia. Asian Development Bank (ADB) is also a member. A major advantage of such multilateral fora is that they provide an opportunity to engage in bilateral diplomacy. Thus, Exim bank should strengthen its trade finance cooperation with Japan Bank for International Development, and explore more effective use of SME trade financing facility offered by the ADB during such meetings.

India could also selectively consider cooperating bilaterally with those countries which have not formally established Exim banks, but which require more resilient trade financing facilities.

The government should view the trade financing issue not just from a short-term perspective, but as an integral element of its FTP. This will require focus on economic diplomacy designed to extend India’s economic space and leverage globally.

The writer is professor, Lee Kuan Yew School of Public Policy, National University of Singapore. Views are personal.