16, Sir William Newton Street
Port Louis, Mauritius
When Covid-19 hit Africa, a sharp decrease in global trade was ensued by a rapid contraction of economic output. The International Monetary Fund (IMF), stated in their report that the global economy shrank by approximately 3.5%, worse than the 2007-2008 global financial crisis. Although, even prior to the pandemic, Africa had been suffering “because of a drop in Chinese demand for African commodities”, the survey revealed, with oil exporting countries being particularly affected, and the added impact of the Russia-Saudi Arabia oil price war.
Sub-Saharan Africa (SSA) is on the path of recovery from the impact of the Covid-19 pandemic that came about in late 2019 / beginning of 2020. However, the recovery has been disrupted by the recent Russia-Ukraine conflict, causing disruptions in the global trade and supply chain primarily in agriculture, fertilizer and energy sectors. The disruption has been largely attributed to trade sanctions imposed on Russia and impacting their supply of commodities to the rest of the world. Sub-Saharan African countries being net importers of oil and food commodities have largely been impacted by these sanctions. It is well known that Russia is the third largest producer of oil in the world and a leading global wheat exporter. The sanctions have caused persistent increase in prices of major commodities such as oil and food all over the world creating inflationary pressure and threatening economic growth in SSA. However, oil and other commodity-exporting countries could also benefit from the higher prices of exported commodities in the present environment.
The Trade Finance Gap for SSA
Africa’s trade finance gap constrains the growth of African international trade and finance. The gap has been largely attributed to the withdrawal of large international banks from Africa’s financial services sector, which began to materialize well before the Covid-19 pandemic came into light. “The supply of trade finance services, which supports more than 80% of global trade flows annually, has been one of the key constraints to the growth of African trade” stated the IMF report.
Africa is trading USD 1.1 trillion per annum and banks only intermediate 40% of these flows, whereas they should be intermediating almost 80%. After the pandemic, many African banks recorded falls in net foreign assets and many large international banks and financiers cancelled or reduced lines of credit limits for African banks. Although banks responded by increasing digital transactions and their trade finance capacity, global “systemic issues” have emerged, including tighter regulatory controls and difficulty accessing sufficient foreign currency, according to the report. Quoted in the report, the IMF said “the dominance of the US dollar (USD) in trade and finance is likely to amplify the impact of the Covid-19 crisis.” The report also highlighted increased demand for trade finance following Covid-19, met with a simultaneous slump in letter of credit business and banking operations. Southern Africa and Western Africa, in particular, reported the largest increase in trade finance demand, although, unfortunately, domestic, foreign and privately owned banks have become reluctant.
Trade finance solutions typically provided by banks such as Bank One are crucial to address the rising working capital requirements by importers in SSA caused by oil and food inflation fuelled by the challenges already highlighted above. Financial instruments such as Letters of Credit (LCs), Standby Letters of Credit (SBLCs), Trade Advances, allow businesses such as importers and exporters buy and sell goods more easily. These instruments have proven to be useful throughout the pandemic. They were and still are effective tools for importers and exporters to access capital, ensure business continuity and guarantee payment to trade counterparties amidst the uncertainties of the pandemic.
Trade and supply chain finance solutions have played a key role during the crisis, not only in supporting the development initiatives throughout SSA but also in providing liquidity to the local economies and facilitating international trade. Trade finance is becoming more inclusive for commercial businesses and small and medium sized businesses across SSA. The latter are vital to the global supply chains and trade finance solutions such as supply chain finance backed with sophisticated technology are helping more businesses in the supply chain gain access to trade finance liquidity by accelerating cash flow and bridging the working capital gap.
SSA banks have found themselves in a position of raising interest rates due to the Federal Reserve Bank’s decision to pursue higher interest rates as a way to curb inflation and the supply chain challenges associated with the Russian-Ukraine conflict and the Chinese lockdowns. Most African businesses are facing a growing problem in accessing US Dollar liquidity to facilitate their import payments obligations. Emerging economies, including those in SSA, are faced with huge debt service costs, hence the increased pressure on dollar liquidity as these countries do not export enough in US dollars to cover for their imports requirements.
Consequently, businesses struggle to access trade finance credit and foreign exchange and banks find themselves in a situation of limited access to dollars and excessive cost of funds due to regulatory capital requirements and liquidity overheads. Banks such Bank One being strategically positioned in the Mauritius International Financial Centre have access to substantial dollar liquidity that can be deployed competitively in SSA to address the dollar liquidity challenges and offer trade finance access to their clients.
Inflationary pressures imposed on commodities such as oil, fertilizer, wheat and food have created more working capital requirements for importers based in SSA, as they need more trade finance lines with their banks to support their imports for these critical commodities. At Bank One, we are well positioned to offer trade finance credit lines to support the trade requirements for these economies.
The way forward for SSA trade finance supply:
The central banks and capital market regulators have to take a proactive approach to work together with the banking industry and create new trade finance liquidity solutions by involving other players such as private asset companies and equity funds.
There is a need for increased correspondent banking relationships to take advantage of growth opportunities and expanding demand. There is also a need for more engagement between central banks and multilateral agencies to explore new trade finance capacities and for improved relationships between governments and Development Finance Institutions (DFIs).
Digital trade finance adoption by banks in SSA can also help in addressing the trade finance gap issue. They can provide enhanced access to trade credit by expanding the traditional trade finance offerings to deep tier businesses that do not have access due to insufficient collateral availability.
Lastly, another way of bridging the gap would be to boost the African cross trade flows and the only way that this can be facilitated is through the recently launched initiative on African Continental Free Trade Area (AfCFTA). It is estimated by Afreximbank that the initiative can bring together a USD 3 trillion market and help unite more that USD 84 billion in untapped African exports. The implementation of AfCFTA will help improve intra-Africa trade by over 50% and, therefore, support the trade finance supply chain among the domestic banks and as well lure back more correspondent banks to support the Africa trade flows in the international and domestic trade arena.
However, a collective AfCFTA implementation is crucial to achieve the success mentioned above, as it needs a collective effort to kick-start and coordinate the implementation process by the member states who have ratified the initiative. It is also important to note that capital flows have started to come back gradually in some SSA countries where the regulators have been proactive to intervene and support sectors that are crucial to the economies such as oil and food imports.
By Gerald Ndosi, Head of Trade Coverage
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