The decoupling dilemma
|Sultan: What is happening today is not just cyclical, it is fundamentally structural|
Much has been said about the decoupling of the Asian economies from its Western counterparts. Experts had predicted a total divergence between the developed and emerging economies in the wake of the global financial crisis of 2008.
According to a new quarterly report titled HSBC Trade Forecast, China is set to overtake the US as the largest trading nation in the world by 2025, accounting for 13% of global trade. Impressive as that may appear, it is unlikely that the developed world will concede its place in global trade anytime soon.
Rough estimates suggest that a hefty 40% of trade flows in Asia still continue to take place with Europe and the US. While there is no doubt that the growth of South-South trade corridors has been spectacular, there has been not so much a decoupling, as a growing interdependence among global trade partners.
Concerns surrounding the European debt crisis, political uncertainties in the Middle East and even one-off natural disasters trigger consequences for corporates worldwide. The financial crisis in the US set in motion a spate of credit and liquidity troubles and companies in Asia were quick to react, putting in place the requisite processes to counter the impending fallout.
Working capital management became prime focus as businesses faced shortages in credit and sought to better utilize their internal cash. Naveed Sultan, global head for treasury and trade solutions at Citi thinks that companies are reasonably well prepared, though worries about scarcity of dollar liquidity and the European debt crisis have resulted in uncertainty and volatility. “Most clients are worried about whether their supply chain will come under stress due to lack of financing”, he says. Undoubtedly, supply chain financing has become a defining trend for trade finance lately.
|Vashist: A programme-based solution is more preferable to a transaction-based solution|
Vijay Vashist, group product head of trade & supply chain finance and trade asset management at DBS Bank confirms that corporates have certainly shifted their focus towards the entire supply chain from procurement to sales. “Large corporates have begun to understand the need to ensure the financial health of their supply chain, both upstream and downstream, and the absence of that could eventually affect their operations,” comments Vashist.
Banks from their part have reacted with various solutions like supplier finance and distributor finance techniques to meet that need. The increased role of supply chain financing and working capital management is at odds with the theory of decoupling. In fact, their popularity hinges on the corporates’ ability to streamline liquidity across various entities and geographies.
Dealing with crisis scenarios seems to be the new normal and counter-party risk management continues to occupy centre-stage. “What is happening today is not just cyclical, it is fundamentally structural,” says Sultan. That is a powerful message for companies trying to find appropriate partners and to mitigate the short-term risks of doing business. In a recent press release, HSBC said that it is committed to facilitate US$750 billion of world trade by 2013 through working with international businesses in opening up new markets and trade opportunities. Large companies remain cash rich with no perceptible difficulties regarding access to credit.
For small and medium enterprises (SMEs) with little to offer in terms of collateral, the situation is starkly different. With governments tightening monetary measures to combat inflation, SMEs are feeling the heat. According to Aneish Kumar, head of treasury services for the Indian subcontinent at BNY Mellon, “there have been instances of firms where they reduce credit extended to suppliers or buyers because of the increased risk of non-repayment”. In light of such circumstances, he has observed that clients are focussing on risk mitigation, on liquidity management and unlocking working capital. “There is growing interest around innovative solutions, including supplier finance solutions,” says Kumar.
Businesses both upstream and downstream are, in fact, much more interconnected and it is becoming difficult to view them in isolation. Companies focussed on maintaining good cash flow forecasting are increasingly looking at solutions like bilateral receivables discounting to maintain the trade momentum. “End-to-end needs are coming into focus, with a programme-based solution much more preferable to a transaction-based solution,” says Vashist. Disengaging from the smaller players in the supply chain would be a mistake and large companies have recognized the need to stay connected with their strategic partners.
Risk management will undoubtedly remain a major challenge. “Banks need to look at developing capabilities for underwriting the risks of obligors who are often not the customers of the bank,” Vashist remarks. An interesting phenomenon noticeable in the last few years has been the move towards non-documentary trade despite the greater focus on risk management. “As the shift towards open account trade gains momentum, corporates grapple with new issues pertaining to liquidity and obligor risk management,” Vashist continues.
Though there are widely variant measures of the volume of trade conducted on open-account vis-à-vis documentary credit, there is a general consensus that a greater proportion of trade transactions will be done on non-documentary basis. Banks have realized this fact and have increased their thrust on how to intermediate and finance those transactions. “Supply chain financing is one option and it has become a most prominent example of open account services directly linked to the merger between cash and trade," says Kumar.
The choice between the US dollar and the renminbi as a means of trade settlement is seen by many as a zero-sum game. The emergence of new trade corridors between Asia, Africa and Latin America as well as those within the Asian region has opened opportunities for non-dollar denominated trade settlement. Emerging markets account for nearly 55%-60% of China’s total trade versus 47% ten years ago. That, coupled with the growth of China’s influence on the world stage, has resulted in a demand for the renminbi in trade settlement.
Cost savings on foreign exchange transactions and the appreciation of the currency have encouraged exporters and importers, both in and outside China, to switch to the renminbi at the expense of the US dollar. At present, this is largely a phenomenon that is restricted to the emerging country trade corridor. There are several aspects that need considering, such as the establishment of safe and liquid renminbi asset markets; liberalizing interest rates and the renminbi exchange rate; and removing foreign exchange and capital controls. Whether that would break the dominance of the greenback as the international reserve currency is yet to be determined.
Synergies in growth
Admittedly, there are businesses in Asia with tremendous stockpiles of cash. However, uncertainty in the capital markets has made them wary of risks and they are choosing to selectively invest in growth markets without losing existing market share. It would be amiss to dismiss the stagnation in the West and the growth in the emerging countries as proof of decoupling. Instead, there have been more linkages in the last decade than ever before with corporates having to embrace the changed paradigm in order to stay competitive.
To that extent, the universal banking model has merit in being able to recognize – and take advantage of – secular trends in the world. “The same model that was used for P&G can be implemented for Huawei or Tata but with a far shorter and compressed deployment cycle,” offers Sultan.
As companies adapt to the new realities, there is value in creating systems that can straddle geographic boundaries, improve access to liquidity and convert it to working capital savings. Banks recognize that the tightening of credit globally represents both a short-term challenge and a medium-term business opportunity. “Although the majority of cross-border open account trade is conducted corporate-to-corporate, surveys evidence that a significant percentage will migrate to a bank-assisted model over the coming years,” says Kumar.
Electronic invoicing has proven its value and represents a first step to link up the financial supply chain with the physical supply chain, as transaction data is automatically reconciled with inventories. When intermediated via banks, electronic invoices enable financing opportunities on both sides of the supply chain.
Strategies that embrace the symbiotic and interconnected global marketplace are likely to provide the best results.
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7 Dec 2011