By Michael F. Quinn, Managing Director, JP Morgan Global Trade and Chair of USCIB’s Banking Committee
As 2009 ended, we viewed the global economy – and its lifeblood, trade – through the prism of cautious optimism. The limited trade finance available from strong providers had been supplemented by central banks and international finance organizations. To keep the wheels of commerce turning, central banks had also injected liquidity into local economies and assisted in deleveraging bloated balance sheets. In markets where local action was weak or nonexistent, massive trade finance initiatives by various regional and global development banks had delivered much-needed liquidity. For all these reasons, we saw 2010 as the year in which the global economy would receive a strong push along its road to recovery.
Trade rebounds
Throughout 2010,this proved to be the case. Economies in Asia and Latin America stayed strong as intra-Asia and South-South trade continued to show growth and vitality, although the rebound in Western Europe and the United States was slower, and some regions — Africa, Central Asia and Central America — continued to lag behind. Throughout 2010, demand for manufactured and finished goods increased. The voracious appetite of China and India for raw materials to support their internal infrastructure and increased production capacity continued unabated, keeping commodity flows strong as well . In the US, consumers who saw low inflation and a marked improvement in returns on investment came back from the sidelines, showing their famous American optimism even as housing values continued to erode and the job market failed to improve. Europe’s economic engine, Germany, resumed its traditionally strong performance, providing stability and funding to the Eurozone economies. Global supply chains were restored — and in some cases, streamlined. The shipping industry, which had over-invested in capacity in boom times, adjusted capacity to meet demand while taking less efficient equipment out of inventory. Countries not previously engaged in global trade entered the market as the new low cost providers. The evidence of these global improvements was faster growth in Trade than the WTO had originally envisioned. Its original growth forecast for 2010 was 9%; the actual figure is a considerably higher 14.5%.
In 2010, Letters of Credit usage continued to remain flat to the ’09 exit rate, with volume concentrated in support of Small and Medium sized Enterprises (SMEs) and smaller economies. Dollar values tended to increase, tracking the rising costs of commodities as well as consumer goods and electronics orders that were the largest seen since early 2008. J.P. Morgan’s correspondent bank customers increased their demand for dollar-based financing to support the needs of their local customers, but from all appearances the transactions financed were open account. Supply chain finance demand continued its growth trajectory as major buyers continued to strengthen their supply chains while negotiating more favorable terms. As sellers showed more appetite for their counterparty’s paper, previously constrained liquidity sources began freeing up capacity. Highly structured trade finance transactions re-emerged, but with greater transparency and fortified documentation. The credit insurance market also saw improvement as overall trade flows grew and underwriting became more viable.
In 2011, with mostly good news on a macroeconomic front, Trade Finance pricing continues to fall. In many markets, prices are now at or near pre-crisis levels. Secondary markets have been restored, with investor appetite continuing to increase and ramping to near pre-crisis capacity through a combination of direct participation in deals and continued utilization of development bank support programs. Market participation has also expanded to pre-crisis levels as banks that withdrew during the crisis returned. Unfortunately, some are now demonstrating the bad behavior that was in evidence before the crisis and taking risk without reasonable and rational return.
Trade trend: Up, with some possible turbulence
A repercussion of the economic crisis for the banking community has been intensified scrutiny by the local and global regulators working to prevent a reoccurrence of the ’08 debacle. Basel III emerged in 2010, sending shock waves through the banking industry. The proposed requirements for trade transactions — increased capital, higher risk premiums –are causing banks to seriously reconsider their involvement in the trade finance arena. Especially troubling are proposals to dramatically increase the capital required to support off-balance sheet documentary credits. The Asset Value Correlation factor, which impacts credit exposure to other financial institutions, and the Liquidity Ratio, which implies that Export Credit Agency lending will be considered illiquid, promise to raise the cost of trade loans significantly. Uncertainty about Basel III is also challenging trade bankers, since much of the implementation timing and actual capital impact of Basel III will be determined by local regulators. On another regulatory front, global sanctions imposed on Iran by the United Nations have also had a major impact on most banks, requiring greater scrutiny of transportation information associated with trade transactions. As local “know your customer” requirements diverge, global banking could become increasingly fragmented, impeding the flow of information and documentation among buyers, sellers and bankers.
Despite these challenges and complexities, our global trade outlook for 2011 and beyond is bullish. Major trading partners are expected to continue their rebound or growth trajectories. Trade finance will remain in demand, but capacity in most markets will continue to improve, reducing prices even further. Initial forecasts indicate that by early 2012, global trade will have recouped its losses and will resume its traditional growth rates. Other than in credit constrained markets, the expectation is that the multilateral financing vehicles will diminish in importance in the primary and secondary markets, but will remain as a safety net in the event of a double dip recession. Letter of Credit utilization will continue to be concentrated in SME markets and the smaller economies, since their growth prospects are not as favorable as the major markets. Priming the pump in these markets continues to be challenging. For any financial institution other than donor organizations, the ability to do effective KYC is both problematic and not cost effective, given the relative size of the parties. This lack of access to traditional bank funding will further impede economic development efforts in this sector.
Though increasingly less likely, the threat of a double dip in 2011 remains as deleveraging and the purging of “bad” assets continue unabated. The dreaded risk of inflation will also lurk as the cheap liquidity used to stoke economies after the crisis is reduced or eliminated. China’s strong internal inflation is now threatening low cost exporters. Brazil’s commodity boom is showing signs of contributing to inflationary pressure; Argentina seems to be suffering from the same complaint. In the Eurozone, any future disruptions threatening the fundamentals of its currency will force the European Union’s strong countries to take collective action. Increased volatility in sovereign risk and foreign exchange rates may create another dimension of risk in this year’s trade environment. A “wild card” to the trajectory of global trade growth is the seismic shift in governments in North Africa and the Middle East. Immediate and obvious impact will be on the price of oil which has implications for the almost every country but could be particularly harmful to economies which are still struggling to regain momentum. Austerity measures taken in the United Kingdom and contemplated in other markets could adversely impact global economic growth and have a knock-on effect among trading partners. But whatever bumps we encounter on the road to recovery, we remain optimistic about this year’s prospects for global trade and trade finance.
