Week in Review

What We're Reading:

August 24, 2020

Hong Kong to take action against US ‘Made in China’ label demand. Territory’s government says new restrictions on exports breach World Trade Organization rules. (Financial Times)

EU, Britain trade blame after scant progress towards post-Brexit deal. Britain and the European Union made scant progress towards a deal on future ties in talks this week, and their chief negotiators blamed each other for the stalemate as time ticks down to an end-of-year deadline. (Reuters)

Corporate America Is choking on debt and imperiling the recovery. After tapping the bond market at a record-shattering pace in recent months, Corporate America is more indebted today than ever before. (Bloomberg)

Japan suffers worst economic plunge in 40 years. Japan’s economy saw the steepest decline on record in its second quarter—as the global health crisis took a big bite out of consumption and exports. (HSN)

Lack of human capital is holding back Latin America’s growth. In 1990, Latin America’s average GDP per capita was a little over a quarter of the United States’ income level, while emerging and developing Asian countries’ GDP per capita was only 5 percent. In 2019, Asian countries had grown fourfold, but Latin America was still at the same level. (IMF)

Coronavirus will double the default rate for Europe’s junk debt. The default rate among junk-rated European companies will more than double by June 2021 as the COVID-19 pandemic brings about “arguably the most pronounced deterioration in credit quality ever,” credit ratings firm S&P Global said. (HSN)

Unprecedented GDP declines push major economies into recession. Simultaneous, unprecedented GDP declines across major economies in 2020 revealed the extent of the damage caused by the coronavirus-induced economic crisis. (Fitch)

As Pakistan and Saudi Arabia drift apart, China moves in. A growing schism between Saudi Arabia and Pakistan points to new alliances in the Muslim world. (Interpreter)

Brazil, India and South Africa face toughest recovery among G-20 nations. Brazil, India and South Africa face the harshest road to recovery of all the G-20 (Group of 20) major economies, according to a new study. (HSN)

USMCA aims to help workers with new labor provision; importers should ensure their vendors comply. If your company is importing goods duty free from Mexico thanks to the United States-Mexico-Canada Agreement (USMCA), you need to ensure your vendors are following Mexican labor laws or you could find yourself staring at a big bill for overdue duties. (Shipping Solutions)

Dollar squeeze chokes Nigeria’s economy as recession looms. Nigeria’s foreign-currency shortage is squeezing the life out of Africa’s biggest economy. (Bloomberg)

Central banks scale back dollar repos as market tensions ease. The Bank of England said on Aug. 20 that it and other major central banks would reduce the frequency of 7-day dollar liquidity operations to once a week from Sept. 1 due to low demand and reduced financial market tension. (HSN)

US trade controls against China reach supply chain and end-use targets and activities. Supply chain, end use, and human rights–related sanctions, export controls, and Entity List designations target public and private entities in China. (Lexology) 

What is Forex risk and how can your business manage it?Businesses & economies can struggle due to FX fluctuations, but as a business dealing internationally, there are a few FX market hedging tools & options that can help you mitigate these risks to some extent. (Finsmes)

The regime of Ibrahim Boubacar Keita has been in control in Mali for seven years. In that time, his government has earned a reputation for rampant corruption and ineptitude. 

Keita still had the support of the U.S. and many European states because he was virulently antagonistic toward the Islamic insurgents in the region. It was that support that propped him up. 

This has proven to be inadequate. His army recently started to mutiny and has now staged a coup that has removed him from office. The assertion is that there will be elections to follow, but few believe these will take place. It is thought the military is also anti-insurgent, but that remains to be seen. The U.S. has lost one of its allies in the area.

A Look at Mexico

The regime of Andres Manuel Lopez Obrador (AMLO) has been struggling almost from the moment it took power. He has had to deal with the pandemic and a full-scale recession as well as unequaled hostility from Donald Trump.

AMLO has done little to address these three issues. He continues to deny the seriousness of the infection, continues to spend money he doesn’t have on programs that do not advance the economy and continues to pick fights with Trump. 

Now he has tried to shore up his faltering popularity by accusing his political opponents of corruption, while ignoring those closest to him. His latest targets have been his predecessors in the office he holds: Felipe Calderon and Enrique Pena Nieto. This has served to distract to some degree, but he remains far less popular than was the case when he was elected. 

News reports based on the International Monetary Fund’s 2020 External Sector Report: Global Imbalances and the COVID-19 Crisis point to strong underlying depreciation pressures on the Turkish lira. The Wall Street Journal (WSJ) reported last week that the lira has lost about 20% of its value against the dollar this year.

Sudden and sharp currency depreciation “can lead to runaway inflation levels by driving up the cost of both imports and payments on foreign debt, while eroding the value of savings and financial assets, leaving domestic consumers with little purchasing power,” WSJ states. “Concerns that a central bank is unable to stem a currency’s decline could prompt a further exodus of foreign investors and creditors, exacerbating a nation’s financial woes.”

As Turkey burns through its FX reserves to support the lira, Turkish central banks will have “little room to maneuver if the currency slide continues,” the WSJ says.

The IMF recommends that Turkey rebuild its foreign currency reserves and rein in rapid credit growth, reports Turkish publication, Ahval. The IMF further warned “that global financial stress could increase the risk of debt defaults and the need for more financial support for economies with pre-existing vulnerabilities.”

The IMF report states:

Large external financing needs and relatively low reserves leave Turkey vulnerable to shocks. … The size and composition of external liabilities, coupled with relatively low reserves, continue exposing Turkey to liquidity shocks, sudden shifts in investor sentiment, and increases in global interest rates. The FX exposure of nonfinancial companies is high, with the potential to undermine bank asset quality.

At the end of 2019, gross reserves for Turkey has increased to 85% of the IMF’s assessing reserve adequacy (ARA) metric—up from 74% at the end of 2018. By mid-May, the IMF notes, the reserves dipped to 67%. “Similarly, reserve coverage of external financing requirements rose to 64% in 2019, from 46% the year prior, and then dropped to 49% in mid-May. Significant accumulation of reserves over the medium term is needed given sizable external liabilities and dependence on short-term and portfolio funding.” In other news on Turkey, the Trading Economics website shows that bankruptcies in the country increased to 1,130 in June, nearly double from May. The site expects bankruptcies to reach 2,980 by the end of the current quarter. “Looking forward, we estimate bankruptcies in Turkey to stand at 1,560 in 12 months’ time. In the long-term, Turkey bankruptcies are projected to trend around 2,520 companies in 2021 and 1,200 companies in 2022, according to our econometric models.”

As part of FCIB’s series on country-specific insolvency laws, Istanbul-based Cengiz Söylemezoglu, of UnitedKS Law Firm will provide insight into Turkey’s. The webinar will include general information about enforcement methods for the collection of debt, legal procedures for bankruptcy and consequences of a bankruptcy decision.

The impact of lockdown on trade has been monumental with the repercussions of Covid-19 stretching long into the future. One aspect that will undergo a significant change will be how organizations treat paper-based processes. Sectors that utilize letters of credit (LCs) will need to review the implications these documents will have and adapt accordingly. Aside from the longstanding legacy issues around the manual and time-consuming process LCs hold, in a post-lockdown world, there will also be significant health and security concerns to consider. As countries exit lockdown, businesses will begin to consider how they can innovate these processes, making them fit for purpose in the modern world.

Recognizing the Barriers

Covid-19 has underlined some of the major challenges that affect how an LC operates. The overreliance on manual processes and lack of accessibility with the document—often due to it being a paper document that needs to be physically transported through the process—have made LCs slow, expensive and cumbersome for decades. Working remotely has disrupted ingrained processes and forced companies to change their working practices very quickly and sometimes imperfectly. This has put additional strain on the LC process when teams cannot even get to the office to receive their mailed documents.

Governments, financial institutions and corporations are now conscious of the transmission challenges that exist in using physical documentation—as well as the vast delivery networks they require that have been interrupted by flight disruptions. Combined with the increased risk of security that exists when individuals work remotely serves to highlight the need for finding a new way to manage LCs. As lockdown eases across the world, these challenges will not go away. The entire trade ecosystem needs to collaborate to build a workable alternative for the future.

Interoperability—The Key to Digital Communication

Digitization will be a priority for companies over the coming years, but it is impossible to expect every organization to make the same decision at the same time. The danger is that this leads to a market filled with companies utilizing different providers and software that may struggle to communicate with one another. This would create a new, but no less damaging, barrier to an effective LC market.

Competing organizations are naturally suspicious of sharing systems. However, as businesses exit lockdown, and consider investing heavily in technology to digitize LC documents, they must also welcome interoperable systems into their new set-up to avoid creating a new, digital version of the current siloed and ineffectual setup.

Banks and corporates should look at the technology they use as enhancing their processes, but also seek out methods to allow clear and effective communication with the systems run by other businesses. Rather than hinder a healthy competition between different organizations, this approach will do the

exact opposite. Organizations can still have the advantages of the latest technology, without limiting the way it engages with partners and other companies in the trade. Better communication will allow companies to forge new connections, open better avenues of trade and strengthen existing relationships. In short, the entire industry can digitize together, or it can risk failing separately.

Start with a Standard

To build acceptance of a new product or set new standards is an educational challenge that takes time and money. In an area like international trade, where banks and regulators involved, the barriers to change are even higher. So, starting small is a more prudent path to take. Well-known brands like Amazon are a prime example—it started building the acceptance of purchasing online by choosing a simple product that had the least risk – books. People then became accustomed to buying online and now it’s a ubiquitous service covering a wide range of items.

For trade finance, LCs are the standard product that everyone understands and therefore improving the LC process should be the first product to digitize. Perhaps the oldest financial tool in trade finance, it provides a common standard and process that is globally understood and governed by the International Chamber of Commerce (ICC). If all institutions can establish best working practices by digitalizing the LC process, the industry can then go on to tackle more complex forms of documentation which lack common standards altogether.

To do this, LCs need a neutral, decentralized backdrop that allows the various technology solutions, corporates and banks to work together. It is here that technology such as blockchain can be hugely effective—providing the infrastructure needed for different organizations to integrate existing software into the network, communicating with counterparties and improving the process of utilizing an LC. Blockchain also allows maintenance of individual databases rather than centralized ownership of data, which is also a requirement for acceptance in this more geopolitically polarized world.

This change to the industry is not about decisions by individual organizations, but a collaborative effort. It is about connecting banks and corporates as well as the various shipping and customs organizations together. Establishing a series of networks that connect at the intersection of common clients in the LC process can achieve this and change the sector for the better.

While lockdown restrictions begin to ease over the coming months, there will be an increasing drive to improve the technological capabilities of traditional industries. However, this cannot come at the sacrifice of clear communication and efficiency. As more organizations begin to embrace technology to mitigate the risk of a post-Covid world, there still needs to be an effective solution that allows for the various nuances that exist in the sector to work together and for the benefit of the industry. As an accepted standard that has been established for over a century, LCs are the ideal trade finance product to upgrade to set the baseline for the new online interconnected world.

Reprinted with permission from CTMfile.

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 Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations