The Political Economy of Trade Finance

Export Credit Agencies, the Paris Club and the IMF

Pamela Blackmon

• Publisher: Routledge
• Year: 2017
• Topic: Business
• eBook ISBN:
  9781317672913
• Subtopic: Business General
• Index: Business

Export Credit Agencies provide insurance and guarantees to domestic firms in the event that payment is not received from an importer. Thus, ECAs reduce uncertainties domestic firms face in exporting their goods. Most countries have ECAs that operate as official or quasi-official branches of their governments and they therefore represent an important part of government strategies to facilitate trade, promote domestic industry and distribute foreign aid.

The Political Economy of Trade Finance provides a detailed analysis as to how firms use the medium and longer-term financing provided by ECAs to export goods to developing countries. It also explains how ECA arrears have contributed to the debt of developing countries and illustrates how the commercial interests of ECA activity are evident in decisions about IMF arrangements and related to Paris Club debt rescheduling agreements. Finally, the book documents how the medium and longer-term export credit insurance support provided by the G-7 ECAs was a central component in mitigating steep declines in international trade during the 2008 Global Financial Crisis. This book is of great interest to both academics and students in the field of political economy, finance and politics of international trade. It is also of importance to policy makers.

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1 Insuring and financing trade

ECAs promote and facilitate domestic exports. They do this by providing financing through direct lending, or more often through insurance, or guarantees of loans made through private sector finance designed to reduce the risk of nonpayment on exports incurred by domestic export industries. In fact, 80 to 90 percent of trade transactions involve some form of credit, short-term, insurance or guarantee achieved through trade financing (Auboin 2009: 4; WTO 2008). The risk of nonpayment due to the buyer’s government is under the category of political (or sovereign) risk that ECAs insure against; specifically these are actions by a government that include civil war, acts of war or preventing the transfer of payments. The second category of risk that ECAs ensure against is commercial (or non-sovereign) risk which is the risk of nonpayment by a private buyer, commercial bank, or public buyer; specifically insolvency, bankruptcy or non-payment (Stephens 1999: 76, 106). For example, the UK established the first governmental ECA in 1919 in order to provide exports to the USSR (lending on a sovereign basis) that would not have occurred under the newly installed communist government. The US Export-Import Bank (Ex-Im Bank) was established in 1934 via decree from US president FDR in order to not lose exports to the USSR especially around the time of the Great Depression (Hufbauer and Rodriguez 2001: 3–4).

Who benefits from ECAs?

Economic theories generally explain that openness to trade is beneficial in the aggregate for states, but that there are diffuse costs depending on the factor endowments and differences in the comparative advantages of states (Stolper and Samuelson 1941). This is often where politics influences the trade policies of a state, on the basis of which groups benefit from trade and which groups are disadvantaged by trade. Workers that do not benefit from trade openness want protectionist policies restricting trade, and workers benefitting from trade support open trade policies (Frieden 2006: 109–111). Workers in a steel mill are harmed by cheaper imports of steel, threatening their jobs. Conversely, Boeing employees understand that Boeing’s ability to export planes is crucial to the productivity of the firm, and thus their continued employment. Unsurprisingly, the citizens that are aware of the existence of ECAs are the ones that benefit from them; notably firms that are heavily export-intensive. Previous research has shown that citizens are likely to support trade and that exporters will mobilize in support of trade when those citizens and exporters benefit from increased trade (Kaltenthaler, Gelleny and Ceccoli 2004; Dur 2007). Therefore, there are strong political and economic motivations for governmental leaders and export firms to support exports and by extension export finance (Czinkota 1983; Reid 1983: 130–131). Powerful export industries benefit from this relationship because they have access to some markets that would otherwise have been too costly, and governmental leaders benefit because they are able to boast that financing through these agencies contributes to increasing domestic employment and exports.

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Thus, ECAs are somewhat unique in these debates concerning the benefits of trade openness because, since ECAs provide financing support for the export of domestically manufactured goods, their trade and export activities would be supported by domestic workers and firms.¹ Export credits are provided for short-term financing (up to two years) for consumer goods and raw materials; medium-term financing for capital goods; and longer-term financing for investment and infrastructure related projects (Kuhn, Horvath and Jarvis 1995: 5, 14). Most ECA credit activity has been for medium and longer-term business because commercial banks covering the risks for these types of projects would charge much higher interest rates than ECAs, so export industries prefer ECA insurance (Gianturco 2001: 2). Commercial banks often do not want to assume the risk period involved in insuring projects of a longer-term nature such as large infrastructure and capital goods projects, investments of sunk capital in which losses would be difficult to recover (Moran 1999; 2006). An additional reason that commercial banks are reluctant to cover medium and longer-term financing is that these longer-term debt obligations are subject to rescheduling in Paris Club debt rescheduling agreements (Cline 2005: 20). Thus, exporters turn to ECAs when private sector insurance is either too expensive or not available (Kuhn et al. 1995: 12, 14).² The following sections explain the differences between the two primary institutions involved in export credit activity: the Berne Union and the Organization for Economic Cooperation and Development (OECD).³

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Export credit under the Berne Union and the OECD

The Berne Union (also known as the International Union of Credit and Investment Insurers) established in 1934, was the first international institution designed to establish rules and principles for export insurance as well as to allow for the discussion and facilitation of information among its members. The Berne Union has grown from the initial four founding member states (the UK, Spain, France and Italy) in 1934 into an astonishing 48 members in 2010. As of 2008, its new business volumes were over US$1.5 trillion; 20 percent above the level recorded in 2007 (Berne Union Yearbook 2009: 11). However, the Berne Union is unique in that while it is comprised of government ECAs, it also has private companies among its membership; the institutions themselves are the members not the governments. In addition, in order to be a member of the Berne Union, the company (or ECA) must provide some type of export insurance or finance. In other words, if the company or bank only provides direct loans (operates as a bank) then it cannot be a member of the Berne Union (Author interview, US Ex-Im Bank economist, June 16, 2010).

The members of the Berne Union have ten official “guiding principles” including sharing information on activities and cooperating in setting up policies and procedures on export credit and investment insurance.⁴ However, there is little in the way of an enforcement mechanism for violators of the principles, and the principles themselves are rather loose guidelines.⁵ The main benefit of being a Berne Union member seems to be through the access of information about the business and finance activities of other members. For example, members share information about their activities during the two annual meetings and at various workshops and seminars.⁶ During interviews that I conducted in June 2010 with US Ex-Im Bank economists, they stated that subsequent topics to be discussed at the next annual meeting would have likely included whether firms had been having trouble with banks in Greece, in addition to discussing various programs that were initiated by ECAs as a result of the 2008 financial crisis (Author interview, US Ex-Im Bank economist, June 16, 2010). There is also a “Berne Union Intranet” which provides its members and their employees with data and other information about international finance. While many members of the Berne Union are also members of the OECD many are not, and the OECD has strict regulations for its members’ extension of export credit facilities.

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The OECD is an intergovernmental organization and thus its membership is only comprised of states. While the OECD is also primarily an organization in which higher-income states share and coordinate information on economic and social policies, the OECD also deals with setting guidelines for trade, and more specifically, guidelines for export credit through their Export Credits Division. The first OECD Arrangement designed to restrict or set limits on export credit facilities, formally known as the “Arrangement on Guidelines for Officially Supported Export Credits,” came into effect in April 1978 (OECD 1998).⁷ Specifically, the Arrangement (or the “Consensus”) “is to provide a framework for the orderly use of officially supported export credits” and applies to guidelines for trade-related aid and partially untied aid; including limitations (such as minimum premium benchmarks, minimum cash payments due at or before the starting point of credit, maximum repayment terms and minimum interest rates) on official export credits (OECD 2003: 3).

These restrictions were necessary in order to prevent an export credit subsidy war between the largest developed countries; a race to the bottom based on which country could offer the cheapest interest rates of credit for the export of their goods (Moravcsik 1989: 180–181; Letovsky 1990; Stephens 1999). Moravcsik (1989: 180) explains that these concerns about increased export competition were first discussed in 1973 because leaders believed that the oil and balance of payments crisis in developing countries would make the competition worse. Therefore the Arrangement set minimum rates of interest (7–8 percent) on export credit facilities, minimum payments of the cost of the contract to be borne by the firm (15 percent) and a maximum length of credit (5–10 years) depending on whether the buying country was an OECD country or developing country. This OECD Arrangement “has grown in importance, coverage and scope since its early days” (Stephens 1999: 98). For example, the OECD Arrangement is recognized under the WTO framework. Generally the WTO does not allow governments to subsidize their exports. However, the measures under the Arrangement do not violate WTO rules on subsidies because the WTO Agreement on Subsidies and Countervailing Measures exempts export credit guarantee schemes if at least 12 original General Agreement on Tariffs and Trade (GATT) members participate in “an international undertaking on official export credits” in order to regulate the use of those guarantees (Felbermayr, Heiland and Yalcin 2012: 4; WTO Agreement on Subsidies and Countervailing Measures, Annex 1, articles j and k). In fact, item (k) in Article 3 of the WTO Agreement on Subsidies and Countervailing Measures gives an exemption for export credits that conform to the specific interest rate provisions of the OECD Arrangement, irrespective of whether the credits are provided by a Participant or non-Participant to the Arrangement (Abel 1998: 15). This means that states that are not Participants in the Arrangement, but are members of the WTO, could legally provide export credits so long as they are within the interest rate provisions of the Arrangement. In 1999, the Arrangement set minimum rates for country credit risk or political risk; prior to this it had only established rates for commercial risk.

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One other area in which the Arrangement has evolved over time concerns how countries are assessed for the basis of risk premium categories. Recall that one of the purposes of the first Arrangement was to prevent a subsidy war between (at the time) the five largest economies in their goal to provide exports to developing countries. Even the first Arrangement in 1978 differentiated between terms of credit depending on whether the buying country was developed or developing. This type of classification was further modified to put countries in buyer risk classification categories in order to set minimum standards of lending based on the type of risk. Categories range from 0–7, with only OECD countries in the zero category (no risk) and category 7 indicating the highest risk of nonpayment. Category zero countries are also not supposed to compete with the private financial sector (and generally within each country they do not) but the problem is determining an appropriate level playing field in market conditions between countries (Author interview, US Ex-Im Bank economist, June 16, 2010). The most recent change to the Arrangement in 2010 lowered the minimum premium rates for country credit risk, and set a minimum fee for country and buyer risk for sovereign and non-sovereign lending for countries in the zero category (no risk) (OECD 2010a). Thus, the primary difference between the Exports Credit Division of the OECD and the Berne Union is that rules, requirements, and procedures for regulating the financing of international t...

Table of contents

• Cover Page
• The Political Economy of Trade Finance
• Routledge Frontiers of Political Economy
• Title
• Copyright
• Contents
• Detailed Contents
• List of Figures
• List of Tables
• Abbreviations
• Acknowledgments
• Introduction
• 1 Insuring and Financing Trade
• 2 Exporting Goods to Developing Countries
• 3 Paris Club Debt Rescheduling and the HIPC Initiative
• 4 The Cyclical Process: The IMF, Debt Rescheduling and Export Credits
• 5 Increasing Trade during the Crisis
• Conclusion
• References
• Index