Globally and in India, trade finance activity has remained sluggish following the global financial crisis. But, there has been little evidence on what affects cross-border credit in India. Thankfully, RBI researchers have found some answers and now appear certain that both demand and supply-side dynamics influence flow of cross-border credit.
In fact, the fall in trade finance intensity in recent years was clearly an indication of supply-side constraints, while the financial health and size of overseas network of banks operating in India matter for trade credit. “Empirical evidence suggests positive impact of imports volume on trade credit flows and makes short-term external debt as one of the critical variables to be monitored for external sector vulnerability.
This is especially pertinent when import payments are driven by higher international commodity prices,” concluded Rajeev Jain, Dhirendra Gajbhiye and Soumasree Tewari in their RBI working paper: ‘Cross-border Trade Credit: A Post-Crisis Empirical Analysis for India.’
The paper profiles trade credit extended by domestic and foreign banks to Indian importers by focusing on size, composition and cost pattern. Using panel data of 55 banks over nearly eight years between Q1FY08 and Q4FY17, the paper found that both demand and supply-side factors influence the flow of trade credit. It suggested that higher imports — whether due to high prices or volumes — lead to an increase in trade credit.
Similarly, from the supply-side perspective, financial health of banks, cost of trade credit and size of their overseas network seem to influence trade credit operations. The authors also suggested that banks need to expand their global banking relationship and shift towards the use of globally accepted trade finance instruments instead of indigenous instruments (such as LoUs /LoCs) which may push up the cost. Incidentally, the drying up of trade credit disbursed through domestic banks in the aftermath of prohibition of LoUs/LoCs by the RBI in March 2018 confirms that their narrow overseas network base is a binding constraint for their trade credit business.
As tight global financial conditions are found to impede trade credit flows, policy efforts towards strengthening of banks’ overseas business network may make these flows more resilient. Domestic banks largely depend on their own branches or subsidiaries of other domestic banks which have been accepting non-standardised trade instruments like LoUs and LoCs for arranging the trade credit so far. “The over dependence of domestic banks on their overseas branches through less standardised trade credit instruments limits the scope of their trade credit operations,” the report noted.
Globally, up to 80 per cent trade is supported by some form of credit, guarantee or insurance, while bank-intermediated cross-border trade credit accounts for about one-third of the global merchandise trade as on 2014, according to the Bank of International Settlement. Various surveys suggest a significant tightening in bank-intermediated trade finance markets during the 2008-09 financial crisis. A few even pointed out that disruptions in trade finance exacerbated the trade slowdown. Post-crisis trade finance activity has remained sluggish, and a study by the Asian Development Bank estimated a global trade finance gap of $1.5 trillion in 2017. 40 per cent of this was in Asia and the Pacific region.
“While there is no consensus as to what caused low trade finance activity at the global level in the post-crisis period, few studies based on cross-country surveys attribute it to both demand and supply-side factors. The importance of drawing clear linkages between trade finance and its determinants is critical, especially when trade protectionist sentiment has accentuated and banks continue to face capacity constraints since the peak of the global crisis,” the authors noted.