Thursday 22 January 2015

GLOBAL TRADE: AT (ANOTHER) TURNING POINT; by Giovanni Bartolotta, Group Head of Risk Management, FIMBank plc, Malta

What happened to global trade?  This is the question that is puzzling many analysts and commentators in the wake of the recent slowdown of global trade growth. Since the 1950s (see Chart 1), international trade grew faster than GDP –at a ratio of 1.4 -, with the 1990s representing a golden decade for trade, with growth rates more than double those of global income. This trend appears to have reversed in the last three years, with trade growing at 3% in 2012 and 2013 (and expected at a meagre 3.1% in 2014, according to WTO forecasts), a slower growth rate than the global economy. Suggestions of ‘peak’ trade abound in the financial press. The causes for such statistical anomaly could be both cyclical and structural and are usually broken down as follows:

1) the ongoing crisis of the Eurozone economies whose internal trade represents about 25% of global flows;

2) a secular transformation of the Chinese economy, where overseas parts for products assembled in China are gradually being replaced by parts made in the country (see Chart 2), especially in factories built inland over the years by foreign companies –it is becoming evident that the cost to move such parts to final assemblers is lower than shipping them from overseas, due to the improvements in the country’s transport infrastructure;

3) despite being a more recent trend, the end of the commodity boom is also held responsible, with rising volumes of energy and food exports not being able to compensate for the price weakness of commodities (caused, especially in the case of oil, by a supply glut and more efficient use of resources);

4) a lower supply of trade finance, sparked by the global financial crisis of 2008, which saw a significant increase in regulation and capital costs for providing trade finance to importers and exporters. This resulted in many leading European banks exiting from the sector altogether;

5) a slower pace of trade liberalization and some re-emergence of protectionism, also caused by the financial crisis.

While there is little evidence that trade finance developments and slower liberalization played a role in sluggish trade growth (will come back to this later), the reality might be that such slowdown is only a reversion to long-term trends, after an extraordinary period of growth in the 1990s when the emergence of global supply chains shaped a sea change in the world’s economic infrastructure. Trade growth started slowing down before the 2008 financial crisis, mainly as a consequence of reduced offshoring (or even reshoring, although this was quite limited) of industrial production. China can be seen as the main culprit for this, but only because, in the words of Aaditya Mattoo, head of trade research at the World Bank, “it globalized internally” a longer section of the global supply chain (i.e. trade flows took place within China and not across borders). Despite this, China has also emerged as the true “mega-trader”, a role last played by Victorian Britain at the end of the 19th century. China represents today 11.5% of global trade (which in turn constitutes almost half of its own GDP).  However, as China’s economy’s matures, its contribution to global trade growth and the pace of globalization will necessarily diminish and be replaced by other players.
 
An historical look at the different waves of globalization will explain why. The first wave occurred before World War I, when European countries imported commodities from the rest of the world in exchange for manufactured goods. Goods were produced in a region, but consumed in another. The second wave took place after World War II and was characterized by the break-up of production itself, with various stages performed in different locations. This was the traditional global supply chain.
The third wave of globalization is the one we are witnessing today, where growing specialization is further breaking down manufacturing of goods into specific tasks. Take the example of Apple products, which are designed in California, assembled in China, but with parts actually produced in other countries like Taiwan and Korea. Another fitting example is that of t-shirts manufactured in Mexico, with textiles imported from the US and the final product re-exported to the US. One might argue that the actual import is one of “tailoring services” from Mexico to the US.
 
 
 
Rapid advances in telecommunications, robotics, 3D printing and other edge technology are lowering the barriers to further specialization. As China matures (and its wages increase) further countries are joining the fray and are becoming specialized (and low cost) providers of either design, assembly or other manufacturing services to the global economy. Countries like Vietnam, Bangladesh, the Philippines and increasingly also Nigeria, Ghana, Uganda and Ethiopia are rapidly becoming integral part of this third wave of globalization. This phenomenon is known as the “flying geese” pattern of trade, where development of an economy and its subsequent wage increases trigger further offshoring to other economies. Whatever the reason, this will in turn provide a boost to global trade growth and allay fears that global economic growth is coming to a halt.
 
 
 
What were the repercussions of these global trends on trade finance?  Trade finance is certainly important for global trade, with the BIS estimating that around a third of all trade is supported by some form of bank financing. Did the global trade collapse (-38% from peak to trough) cause trade finance also to collapse or vice versa? It is true that, at first sight, traditional trade finance stagnated in 2009-2013, with many banks withdrawing from the market and causing a contraction in capacity in trade and export finance. However, the resulting gap has been filled in part by international banks and large emerging market banks. The emergence of such new competitors also contributed to tighter margins in traditional trade and export finance. This was particularly true in a number of markets, including Turkey, China and Brazil, where local banks sought to grab market share from the traditional players. The story is different for receivable and supply chain finance, where improvements in the legal environment allowed these less traditional trade finance products to flourish, increasing their share of overall trade finance transactions to around 25% of the total.
 
Changes in global banking regulation are also driving another significant phenomenon in trade finance. The introduction of stricter liquidity requirements under Basel III (for example the Net Stable Funding Ratio) has made certain asset classes less expensive to house on non-bank balance sheets. This is leading to the emergence of new non-bank players in trade finance: factoring and leasing companies, credit insurers, asset managers and hedge funds, with the latter looking at medium- and long-term trade finance assets as an alternative investment class, with relatively attractive yields (and lower capital requirements than for banks).
 
The globalization of trade has also been accompanied by digital and technological progress, which is affecting trade finance patterns. While in the past non-bank players were at disadvantage vis-à-vis banks because of the lack of distribution channels (i.e. bank branches), more and more trade finance transactions are now available and can be captured online, allowing non-bank players to access corporate customers more easily. This is shifting the traditional feature of trade finance from being ‘documentation-based’ to being processed entirely electronically. All these trends are rapidly increasing the availability of trade finance (see Chart 3) which, combined with the fading of protectionist measures, will act as an engine of growth for global trade in the next decade - albeit at lower rates than in the past 20 years. That is, until the next wave of globalization takes shape.
 
 

 
 

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