Magazine article EconSouth

Credit Storm Sinking Global Trade: Once a Mainstay of Worldwide Economic Growth, International Trade Is Foundering in the Rough Financial Seas Now Engulfing the World. as Credit Costs Soar and Private Credit Providers Are Less Willing or Able to Fund Trade Financing, Governments and Multilateral Organizations Are Having to Support Credit to Help Keep World Trade Afloat

Magazine article EconSouth

Credit Storm Sinking Global Trade: Once a Mainstay of Worldwide Economic Growth, International Trade Is Foundering in the Rough Financial Seas Now Engulfing the World. as Credit Costs Soar and Private Credit Providers Are Less Willing or Able to Fund Trade Financing, Governments and Multilateral Organizations Are Having to Support Credit to Help Keep World Trade Afloat

Article excerpt

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During the past several decades, the world economy grew rapidly, raising living standards and promoting development. This growth was driven in part by an even more dramatic increase in international trade. In the United States, the share of international trade (the sum of all imported and exported goods and services) rose to around 30 percent of gross domestic product (GDP) in recent years, up from a mere 10 percent four decades ago. International trade also accounted for about three-quarters of U.S. economic growth between the first quarter of 2007 and the third quarter of 2008.

International trade, especially in developing countries, depends to a large degree on the availability of credit to finance activities in the stream of trade. For instance, exporters often require financing to manufacture products before receiving payments from their buyers. Meanwhile, importers need credit to buy goods, such as materials and machinery, from other countries.

Globally, international trade of goods amounts to about $14 trillion annually, and, according to the World Trade Organization (WTO), 90 percent of these transactions involve trade financing. Trade-related credit is primarily issued by banks via letters of credit, whose purpose is to secure payment for the exporter. Letters of credit prove that a business is able to pay and allow exporters to load cargo for shipments with the assurance of being paid.

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A simple example demonstrates how trade-related credit typically works (see the flowchart on page 26). Company A, located in the Republic of A, wants to buy goods from Company B, located in B-land. The two companies draw up a sales contract for the sale price of $100,000. Company A then applies to its bank, A-Plus Bank, for a letter of credit for $100,000, with Company B as the beneficiary. (The letter of credit is either issued through a standard loan underwriting process or funded with a deposit and an associated fee). A-Plus Bank sends a copy of the letter of credit to B Bank, which notifies Company B that its payment is available when the terms and conditions of the letter of credit have been met--normally, upon receipt of shipping documents. Once these documents have been confirmed, A-Plus Bank transfers the $100,000 to Bank B to be credited to Company B.

Exporters and importers left high and dry by credit drought

Since the financial storm hit the world full force last year, the price of credit has risen significantly, especially for emerging economies. For example, the cost of a letter of credit tripled for importers in China, Brazil, and Turkey and doubled for Pakistan, Argentina, and Bangladesh, according to Bloomberg News. What's more, news stories from various regions of the world report that some banks have been refusing to honor letters of credit from other banks, leaving cargo ships stranded at ports.

Exporters and importers in emerging economies may be particularly vulnerable since they rely more heavily on trade finance. A WTO study on financial crises' effects on emerging economies in the 1990s shows that, in some countries, private markets' failure to meet the demand for short-term trade finance affected imports and exports, at times halting trade completely.

Since about 40 percent of U.S. exports are shipped to developing countries, the inability of the importers in those countries to finance their purchases of U.S.-made goods may have a negative impact on U.S. export industries, which are already suffering from falling foreign demand as the global economy slows. As testament to the current condition of global trade, the Baltic Dry Index--a daily average of prices to ship raw materials that serves as an indirect gauge of international trade flows--plummeted more than 90 percent since its peak in June 2008 (see the chart on page 26). This drop can be attributed not only to decreased global demand but also to the reduced availability of trade financing needed to meet the demand that remains. …

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