2 December, 2008

Counterparty risk fears and scarce inter-bank liquidity have hit trade finance, forcing a slowdown in global trade. A report released today by Dun & Bradstreet reveals that industrial production and trade volumes are declining, with flow on effects causing freight rates and commodity prices to fall.

The report - The global liquidity crisis and trade finance - reveals that few market participants are willing to admit their exposure for fear of impacting their own creditworthiness. This is creating increased uncertainty in a manner similar to that which eroded trust in the financial sector regarding sub-prime assets.

The uncertainty has restricted the availability of letters of credit (LCs), the primary source of financing for the USD 14 trillion of trade moved by ship each year. The immediate impact has been a decline in trade volumes and industrial production, which has resulted in falling freight rates and commodity prices.

For Australia, the tightening of trade credit combined with external demand shock from falling world trade in commodities could cause commodity prices to fall further. This would have flow on implications for Australia's already declining GDP growth. Mining-dependent Western Australia will be hardest hit however the effects will reach the whole economy over the next few quarters.

According to Christine Christian, D&B's CEO, the tightening of trade finance has significant implications for Australian traders.

"Demand from China is critical to Australia's economic prosperity," said Ms Christian.

"However with this demand now steeped in uncertainty, exporter finance will become significantly more difficult to arrange. Smaller exporters in particular, will find themselves more exposed to credit rationing.

"This means exporters will be hit by the double whammy of lower prices for their exports and higher costs for trade finance.

"A weakening Australian dollar is also cause for concern. Banks are likely to be wary of Chinese letters of credit, meaning exports will be impeded and cash flows negatively affected."

According to the D&B report, countries with falling currency such as Australia and South Korea will suffer the greatest impacts from the tightening of trade credit. A variety of importers around the world were refused LCs in the second half of October. Those importers who obtain finance through smaller financial institutions were hardest hit as the institutions found it difficult to access sufficient foreign exchange (FX).

However even those with a stable currency are being hit with increasingly difficult trade conditions, including cash in advance (CiA) requirements or far higher interest rates on LCs.

Evidence suggests a wide range of trades have been impacted already, sometimes severely. The international steel trade is said to be gripped by inactivity as a result of counterparty related uncertainty. Meanwhile the pulp and grain sectors are feeling the pressure. Cargoes are piling up as foreign buyers disappear from the market unable to raise LCs or FX.

"There is potential for the whole chain of trade credit to suffer," said Ms Christian.

"As counterparty risk fears continue to spread, an increasing number of traders will find themselves unable to obtain finance.

"As a consequence prices and global trade will likely contract further. This will contribute to a sharp slowdown in economic growth worldwide."