by Helen Sanders, Editor
The combination of China’s slowdown and commodity price volatility has resulted in significant damage to commodity-reliant economies, but does this spell the end – or at least a pause - in the expansion of ‘south-south’ trade?
‘South-south’ trade, i.e., exports/imports between counterparties in regions that fall largely in the southern hemisphere: Latin America; Asia and Africa, has increased dramatically in recent years, driven by the growth in demand from China. As China’s growth trajectory has shallowed, the resilience of national economies in these regions has been tested. As we discussed in the last edition of TMI (edition 243), for example, Africa’s oil- and investment-dependent economies such as Nigeria have suffered a great deal from China’s cooling demand. However, Sumanta Panigrahi, Citi urges caution in over-generalising about how each region, and ultimately each country is affected by changing global trade patterns,
“When considering south-south trade corridors, it is important to recognise that they can differ significantly. China-LatAm, for example, is predominantly commodities-driven; China-Africa is more investment-led, and intra-Asia trade is focused on equipment exports. As a result, the drivers and influencers are often quite different.”
So how are other economies, particularly those in Asia, dealing with the inevitable impact of China’s rebalancing, and what does this mean for treasurers operating in, or trading with counterparties in these countries?
A quarter of global trade
South-south trade is no longer an economic sideshow, with nearly a quarter of world trade already taking place between counterparties in emerging or newly emerged countries. As Michael Vrontamitis, Standard Chartered Bank emphasises,
“We have seen rapid growth in south-south trade: it now accounts for around 24% of global trade, and we expect it to reach 43% by 2035.”
Although medium- and long-term forecasts are positive, these trade flows have been under stress recently, as Michael continues,
“We have seen a significant slowdown in trade over the past 24 months for a variety of well-publicised reasons, not least the collapse in the price of many commodities and China’s slowdown. These two factors impact on many emerging, commodity-dependent markets bearing in mind China’s importance as a buyer of commodities. China’s economy has not collapsed or stagnated, however, it is simply experiencing slower growth, from more than 10% to 6 -7%. A key element in this is the underlying transformation of the Chinese economy from a predominantly manufacturing economy to a consumption based economy, which inevitably leads to a reduction in cross-border trade, particularly exports.”
One outcome of a slowdown is the problem of over-capacity, as Sumanta Panigrahi, Citi explains,
“Over the past few years, during a period of strong growth, excess capacity has developed across most industrial sectors. Today, therefore, there is less investment in new capacity and less demand for commodities, which in many respects can be seen as a rebalancing.” [[[PAGE]]]
Warmer trade winds
This has a significant impact on countries and companies that had invested in satisfying China’s voracious appetite. However, there are additional trends impacting on south-south trade in addition to commodity price volatility and China’s slowdown (which as we have established, continues to grow at a rate that western economies can only dream of), and some of these are more benign. Firstly, Michael Vrontamitis, SCB underlines the fact that recent poor performance in some aspects of global trade does not point to a permanent downward trajectory,
“The relatively poor performance in the United States and much of Europe has not helped the underlying global trade picture, including the fortunes of manufacturers in the east. However, with the US coming back, favourable medium- to long-term prospects in China, and improvements in commodity prices, we expect to see greater stability ahead.”
Secondly, Sumanta Panigrahi, Citi explains that governments have been quick to take steps to increase competitiveness and boost economic resilience,
“While south-south trade routes have been impacted to some extent by China’s slowdown, they remain robust, and while any slowdown inevitably creates short-term problems, this is compensated by the renewed government focus and initiatives to promote greater long-term stability. These include infrastructure and a variety of theme- or region-based funds to support funding across the capital spectrum.”
There is also ongoing investment coming from China itself. The One Belt, One Road (OBOR) initiative, a foreign policy initiative that includes $40bn from the New Silk Road Fund to fund private investment and potentially upwards of $100bn from the Asia Infrastructure Investment Bank (AIIB) aims to develop infrastructure and facilitate trade between China and the west. As yet, there remains some uncertainty about what this will mean for China’s trading partners in Asia and beyond. Firstly, the geographic extent of OBOR is not clearly defined – some identify 65 countries, others believe the number is greater. Secondly, there are currently only a few examples of OBOR projects outside China, and the way in which projects are identified and financed is not clear-cut. Third, the value of OBOR is greatest when a comparable degree of development takes place across its full length – at least from the perspective of China’s trade.
Even so, this initiative has significant potential as a source of financing for key projects as Michael Vrontamitis, SCB comments,
“There is a great deal of excess capacity as China transforms its economy. The One Belt, One Road (Silk Road Economic Belt) leverages this capacity to support the development of economies along the belt and road route. We estimate that official financing for OBOR could potentially top US$1tr in the next decade.”
Looking beyond China
It is not only investment from China that is creating positive opportunities, but also the shift in its economy, particularly for lower-cost markets in Asia. Michael Vrontamitis, SCB continues,
“South-south trade corridors are inevitably impacted by trends in global trade, but there are a number of regional developments taking place that are having a positive impact. For example, the movement of manufacturing capacity out of the Pearl River Delta area towards the east of China and markets such as Bangladesh, Vietnam and Indonesia, China’s role as a centre of low-cost manufacturing is declining, which creates opportunities elsewhere.”
There are inevitably obstacles and complications with this move southwards, however. In particular, it is primarily foreign companies, especially those headquartered in China, that are investing in lower-cost manufacturing in these countries. As a result, these countries need to balance the need to encourage investment on one hand whilst ensuring that there is a positive impact on the national economy. Furthermore, China’s slowdown has emphasised the need for Asian economies to reduce their reliance on a single trading partner and establish stronger global trade links. A key initiative to promote co-operation and diversify trade is the ASEAN Economic Community. Michael Vrontamitis, SCB comments,
“ASEAN is a key region from a global trade perspective, although it represents a collaboration between countries with some common views rather than an integrated unit. Around 11% of global trade passes through ASEAN, but this is sporadic and unevenly distributed across countries. However, free trade agreements that are being signed by the ASEAN bloc, and ongoing negotiations that are taking place, will have an important economic impact on the region, although the benefits will not be uniformly spread.”
Similarly, Sumanta Panigrahi, Citi notes,
“ASEAN is a relatively diverse group of countries, so it can be difficult to gain agreement and implement policies consistently. However, trade and supply chain participation is a valuable driver of positive co-operation, and some of the smaller countries in particular are seeing considerable growth and an increase in foreign investment.”
This co-operation is essential as well as timely to take opportunities that emerge from China’s economic restructuring, as Sumanta Panigrahi, Citi continues,
“Supply chains in many industries are becoming more diverse and extended, with more links in the chain, and each step in the supply chain typically performed in the most efficient location. As costs and wage levels in countries such as China and Korea increase, we are seeing a definite trend in offshoring from these traditional manufacturing nations to ASEAN countries.”
He continues,
“In this environment, co-operation across ASEAN countries is very important to create a more powerful trade and supply chain zone, not least due to the fundamental issue of infrastructure deficiencies. There is still a great deal that can be achieved to attract investment and manufacturing in the region.”
Despite the diversity that exists across ASEAN, there are some key initiatives and innovations taking place, particularly in Singapore, that have the potential to increase trade competitiveness and efficiency across the region as a whole. Michael Vrontamitis, SCB illustrates,
“As a key player in ASEAN and a flagship for trade in the region, Singapore is leading the way in digitising trade processes and developing a national trade platform which will become a model for ASEAN, particularly given that a large proportion of trade flows through Singapore’s ports. These initiatives will reduce the cost and increase the speed of international trade and the effectiveness of ASEAN as a trading location.”[[[PAGE]]]
The treasurer’s response
Treasurers that are active in facilitating south-south trade, or operate in Asian economies that have been impacted the most by China’s slowdown and the hit to commodity prices need to focus on two key, closely related areas to strengthen their business during an extended period of volatility and potential vulnerability: supply chain resilience and FX exposures. Looking first at FX risk, Sumanta Panigrahi, Citi emphasises,
“The impact of currency volatility cannot be ignored when considering trade in emerging markets. Emerging currencies have experienced significant recent volatility and depreciation, and this trend is likely to continue. This is an advantage when seeking to attract corporations to extend their supply chains into these markets, despite the negative impact on imports.”
However, these currencies are often subject to significant restrictions, so as Sumanta Panigrahi, Citi continues,
“Corporate treasurers need to manage their currency exposures carefully, particularly as the number of currencies increases as their organisations extend their supply chains. Related to this, they need to find ways of optimising their supply chains in working capital terms.”
However, supply chain risk extends beyond credit, liquidity and FX risk. Sumanta stresses,
“It is also important to manage cross-border risk as supply chains extend across a growing number of emerging markets, such as trade, supplier and political risks. For example, in 2015 there were demonstrations in some industrial zones against foreign corporations’ working practices which resulted in some instability. There are also positive political initiatives that treasurers should seek to find out about. The Japanese government, for example, is investing in infrastructure in Vietnam to support Japanese corporations’ manufacturing and promote social and economic stability.”
Treasurers need to play a strategic role in anticipating and managing the various elements of supply chain risk rather than reacting to changing business demands. Michael Vrontamitis, SCB explains,
“From a treasurer’s perspective, the key issue to consider is how to maintain the adaptability of supply chains as these become increasingly complex. Manufacturing and assembly of a product no longer takes place in one location, but trade finance has evolved to allow task-based production, where components may be produced in a variety of locations, and assembled in other locations, which are often closer to the end customer. It is also essential to recognise and anticipate the gradual – but rapid and significant – shift in manufacturing. For example, it is not just the TPP (Trans-Pacific Partnership) that is enabling Vietnam to grow as a manufacturing location, but labour costs, access to ports and friendly tax and customs practices are also encouraging investment.”
This leads to (at least!) four key action points for treasurers:
- Work with their supply chain partners across procurement, production and sales to discuss and anticipate the evolving shape and direction of the business;
- Work with their banks to understand the regulatory conditions and financial infrastructure in countries in which the company may introduce or increase direct manufacturing, or build new supply chain partnerships. This includes looking at ways to maintain liquidity and access to funding in these countries;
- Analyse the best means of supporting local currency payments and collections to reduce foreign currency risk and cash ‘trapped’ in-country, such as banks’ international payment solutions;
- Assess the potential impact on supply chain risk, and investigate potential trade finance opportunities to address this.
Michael Vrontamitis, SCB notes that many treasurers are already engaging closely with the business to build a robust supply chain,
“To achieve this, treasurers are becoming better connected internally with sales and procurement, contributing to shared objectives and fulfilling a vital technical and financial role. For example, managing FX and cash flow risk is key to enabling more fluid and complex supply chains, as well as ensuring sufficient funding and liquidity support is in place across the supply chain to support high-quality, low-cost production.” [[[PAGE]]]
Stabilising and strengthening south-south trade
China’s economic restructuring and rebalancing have inevitable short-term effects, some of which have proved crippling for more fragile, commodity-reliant economies; however, the medium- and longer-term prospects, not only of China’s internationalisation process but also the improving resilience of its trading partners, are more positive. Michael Vrontamitis, SCB observes,
“China’s economic influence will continue despite the slow-down, and despite short-term volatility resulting from the structural reforms that are taking place, these are vital to longer-term stability. No economy has been through the same internationalisation process that China has undertaken, and there will undoubtedly be bumps in the road. It should still be considered a mega-trader in the world economy and a champion of global trade, with 12% of the world’s trade passing through China.”
He continues,
“The importance of south-south trade will continue to grow but also evolve, not least the shift in production south-westwards from China into Indonesia, India, Vietnam, Bangladesh and Africa as China becomes a more service-oriented and consumer-led economy.”
This shift will impact on some industries directly in terms of sourcing and manufacturing, and on others indirectly as consumer wealth in these countries and regions increases. However, in all cases, supply chains to facilitate this evolution are extending and becoming more complex, leading to greater demands on treasury, and the ability to play a more strategic role in facilitating growth and mitigating risk. Given restrictions on liquidity and FX, trade finance and supply chain solutions are likely to play a key role in enabling this, so treasurers need to stay informed about the options that exist today, and how these are continuing to change.
