Sunday, November 16, 2008

'Credit crisis tsunami' threatens world trade

Bloomberg

Published: October 29, 2008, 23:43

Washington/Los Angeles: Richard Burnett's lumber company had started loading wood onto ships heading for China. More was en route to the docks. It was all part of an order that would fill 100 40-foot containers.

Then Burnett got a call from his buyer at Shanghai VIVA Wood Products Co. The deal was dead. He told Burnett, president of Cross Creek Sales LLC in Augusta, Georgia, he couldn't get a letter of credit (LC) to guarantee payment for at least six months.

"It was like a spigot got cut off," Burnett said, recounting the transaction that fell apart in July. The inability of buyers in China and Vietnam to get letters of credit has cost his company as much as $4 million (Dh14.68 million) this year, a third of projected revenue, forcing him to lay off 15 of 35 employees, he said. 

Suppliers of oil, coal, grains and consumer products from Chicago to Mumbai are losing sales as the credit crisis spreads beyond financial institutions, and banks refuse financing or increase the fees for buyers. Coupled with declining demand, the credit squeeze is threatening international trade, one of the lone bright spots in the global economy.

"It's like standing on a beach watching a tsunami, knowing that it's coming," said Scott Stevenson, manager of the International Finance Corp.'s Global Trade Finance Programme. IFC is the World Bank's private lending arm.

Emerging markets such as Brazil, Vietnam and South Africa are particularly vulnerable because buyers have more trouble proving their financial strength. The slowdown is also damaging the US, the world's largest economy, where exports accounted for almost two-thirds of the 2.1 per cent growth in gross domestic product in the 12 months through June, according to the US Trade Representative's office.

Shipping rates fall

Another sign of trouble: The Baltic Dry Index, a measure of commodity shipping costs that banks watch as an economic indicator, fell below 1,000 yesterday for the first time in six years, dropping it 89 per cent for the year.

Global trade volumes may sink next year, their first decrease since 1982, according to Andrew Burns, a lead economist at the World Bank. While there is still uncertainty over future prospects, trade may contract by as much as 2 per cent, after annual increases of 5 per cent to 10 per cent over the past decade.

"We only see this kind of shock when we have outbreaks of war, or maybe the oil shocks of the 1970s," said Kjetil Sjuve, a commodities shipbroker at Lorentzen & Stemoco in Oslo. "This lack of credit was a shock to the entire economy. We were hit second after the banks." 

Of the $13.6 trillion of goods traded worldwide, 90 per cent rely on letters of credit or related forms of financing and guarantees such as trade credit insurance, according to the Geneva-based World Trade Organisation.

Commentary: An important detail I have sought for a few weeks now.

Letters of credit are centuries-old instruments that allow far-flung partners to complete large transactions. An importing company gets its bank to issue the letter, guaranteeing payment for a delivery. That bank provides the letter to the exporter's bank, which then guarantees payment to the exporting company. The system breaks down when banks don't trust one another and are unwilling to accept a letter of credit as proof that payment is coming.

Cost triples


From 2000 through last year, the use of letters of credit declined to about 10 per cent of global trade transactions, the IFC's Stevenson said. Over the past six months, they began "roaring back into fashion" as sellers sought to guarantee payments from buyers they no longer trusted, he said. At the same time, liquidity problems caused banks to increase charges. 

Commentary: It would appear the maxim of "building trade relationships" means little when your bank looks ready to falter.

The cost of a letter of credit has tripled for buyers in China and Turkey and doubled for Pakistan, Argentina and Bangladesh, said Uwe Noll, director of country risk sales at Deutsche Bank AG. Banks are now charging 1.5 per cent of the value of the transaction for credit guarantees for some Chinese transactions, bankers say.

"The whole global trade production line relies on letters of credit," Matt Robinson, an analyst at Moody's Economy.com wrote in an October 23 report. "No letters of credit, no transactions - and no transactions mean no international trade."

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