Developments in the African market have taken centre stage in the trade finance industry lately, but this has not done much to dispel the hurdles that the market faces.
With a global energy and food crisis peaking, alongside hiking inflationary rates and geopolitical tensions, it may seem that the road ahead for the African continent is not as straightforward as one would hope.
Speaking to George Wilson, head of institutional trade finance at Investec, Trade Finance Global (TFG) was able to find out more about the African eco-system.
FX and access to trade finance
Dollars have always been scarce and expensive for banks and businesses on the continent to obtain.
Now, as global central banks hike rates to rein in inflation, and businesses battle with sourcing goods through strained supply chains––exacerbated by the Russia-Ukraine conflict and China’s lockdowns––Africa finds itself with a growing problem: accessing US dollar liquidity.
Historically, emerging markets have had little in the way of a natural source of US dollars, relying on their exports to sustain central bank reserves and their much-scrutinised foreign exchange (FX) import cover.
Developing economies simply do not export enough in dollars to provide sufficient FX, and the impact is very real for SMEs that provide the bulk of the employment in Africa.
Wilson said, “African countries don’t export enough in dollars to generate the dollars that they need to pay for their imports.
“There is also a thriving market for structured letters of credit [LCs], which is essentially a method that African countries and African banks can use to import short-term trade-tenor dollars into their countries.”
Despite the improved liquidity gained from the structured LC and trade refinance markets, the dollar timing and availability to African banks’ treasuries still fall short of what is required to support critical trade finance.
Moreover, steep inflation rates have significantly hiked prices of essential imported food and energy commodities, exacerbating issues surrounding dollar shortage.
African SMEs: closing the trade gap
The primary cause of the trade finance gap in Africa is the inability of SMEs to obtain trade credit and FX from their financial institutions.
Furthermore, global banking regulation is the root cause of the unavailability of trade facilities from African banks to their SME clients.
To function at all, these SMEs need access to trade credit and FX from their banks. Still, these local banks have limited access to dollars and high capital costs––largely due to the extraneous Basel regulatory capital and US dollar liquidity. Overall, these facets make it unprofitable for banks to provide trade facilities to their SME clients.
African banks have limited interest in investing their finite dollar liquidity and capital in ‘risky’ SMEs, with the return of equity (ROEs) way below their cost of equity. Instead, it is a much more attractive option to buy government bonds––completely risk-free––and earn a 15% return.
These are commercial banks which must be mindful of shareholder interests, and, thus, the only responsible policy is to avoid trade finance altogether––hence the trade finance gap.
Wilson said, “The trade finance gap…pre-COVID was estimated to be around $120 billion. It’s almost certainly north of that now [due to] the Russia-Ukraine conflict and the dollar liquidity situation.”
Despite this persistently large trade finance gap, trade remains a key driver of Africa’s social and economic development.
There is a danger that well-meaning international sustainable development goals (SDGs) and environment, social, governance (ESG) requirements may actually heighten the trade finance gap and limit funding even further to African SMEs.
There is an emerging risk that the environmental element of ESG completely precludes and overrides the social and governance aspects, not to mention the United Nations’ (UN’s) 17 SDGs.
The harsh reality is that much of the continent depends on extractive industries for survival, with Africa currently running on diesel and coal––albeit contributing only 3% of emissions globally. Shut these off, and fragile economies won’t just falter and fail, but people will suffer.
Trade is estimated to contribute up to a third of gross domestic product (GDP) growth in developing African economies, SMEs employ as much as 85% of the population, and trade is the ultimate supply mechanism for food security, health, industrialisation, and infrastructure in African economies.
Wilson added, “There are billions, perhaps trillions, of dollars in the impact and alternative investment market looking for an ESG, or sustainable, home for their investment dollars. It could very elegantly solve the trade gap and provide them with safe, really sustainable, financing opportunities and investments.”
Industry policymakers and traders worldwide can look toward the 2021 ICC Standards for Sustainable Trade and Sustainable Trade Finance positioning paper as a marker of sustainable trade’s parameters.
The ICC’s roadmap to sustainability in the trade sector is a step in the right direction for the developed market, but there needs to be more input from emerging markets and, specifically, African trade finance.
As such, under the auspices of the African Regional Committee, ITFA will soon be releasing a positioning paper on ‘Sustainable Trade Finance and African Trade’, which intends to amplify the African voice in the proposed standards for sustainable trade finance.
This will hopefully help improve delivery on all of the UN’s SDGs through African trade, reduce the trade gap, and leverage the full benefit of the burgeoning African Continental Free Trade Area (AfCFTA) developments.