Tap into China's changing trade flows

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China will dominate world trade by 2030. But its relationships are changing. Anand Pande, global head of trade product management and head of transaction services product for Asia Pacific at RBS, examines the developing landscape and the implications for transaction banking and multinational companies.

Anand Pande, global head of trade product management
All the economic and trade flow forecasts say the same thing: the balance of power in the global economy is shifting from West to East. Asia is the key growth engine for world trade and China is its strongest performer. The region’s strength and influence is such that it is expected to form 15 out of the top 20 trade partnerships internationally by 2030. This is up from seven in 2009 and replacing the US as the world’s biggest trading partner according to figures from the PwC Future of World Trade Report 2011. World Trade Organisation (WTO) data reveals that exports from Asia in 2011 accounted for 31 per cent of global exports worth USD5.55 trillion, up from USD3.3 trillion in 2006. The region is closing in rapidly on Europe, which had 37 per cent, or USD6.6 trillion last year. These trends are likely to continue as the fallout from the financial crisis continues. With the US still trying to emerge from the doldrums and Europe struggling to resolve problems in the eurozone, the G3 economies (USA, Europe and Japan) have lost their dominance in world merchandise exports. China and other emerging market economies are stepping up to take over the leading role.

Emerging markets push past G3 economies

Strength in the East and malaise in the West mean that trade patterns are changing. Asian and other emerging economies have turned to their own domestic markets and each other to generate stable and continued growth. Intra-regional growth accounted for 55 per cent of trade flows within Asia in 2010. Although some of the trade represents items such as components that are used in a final product eventually exported out of Asia, intra-regional flows are still growing. The same is true for trade with other emerging markets. The Chimes corridor (China, India and the Middle East), the Silk Road to Asia with the Gulf Cooperation Council (GCC) countries and business with Latin America, Africa and Russia should see exceptional growth in trade flows. McKinsey & Co estimate the value of trade flows between China and GGC countries could reach USD350-500 billion by 2020. Russian and Chinese sources put volumes at USD200 billion by 2020 between China and Russia; and USD400 billion over the next five years between China and Latin America. China is the lead driver and is providing the direction for the future. Areas where the region is already playing several lead roles in global trade include major infrastructure development projects in the Middle East, sparking increased bilateral trade flows. In part, this is to support a huge Middle Eastern investment in extensive infrastructure projects. For example, the United Arab Emirates has recently invested USD11 billion to build a 930-mile railway line between its primary ports of Dubai and Abu Dhabi.

Commodities and infrastructure projects

There are also changes in what is being exported and imported as economies develop. China's massive investment in infrastructure has seen the country move from being a net exporter of commodities to being a net importer. This has had a knock-on impact across the world. Commodity-rich countries, such as Australia and Indonesia, are booming. Oil and gas dominate GCC exports to China. At one point during the crisis, China was a bigger buyer of crude oil from Saudi Arabia than the US. Its robust demand for commodities has also affected its neighbours. These include Japan and South Korea. They have been forced to look outside Asia to meet their own commodity needs which were originally serviced by China. Commodities and infrastructure development projects are likely to remain key drivers of global trade. Annual investment in infrastructure up to 2030 is expected to account for 3.5 per cent of the world’s GDP output. Adding this together, total cumulative investment in infrastructure up to 2030 is expected to be USD71 trillion. The Commodity Price Index over the last ten years has increased by over 200 per cent.

Chinese currency internationalisation

Another strong trend is the internationalisation of the renminbi (RMB). According to the Hong Kong Monetary Authority, RMB-denominated trade flows have been growing from 2 per cent to over 10 per cent of the USD3 trillion China trade flows in two years. The RMB has also started making an impact on traditional trade finance. According to SWIFT, the RMB is now the third biggest currency in global issuance of letters of credit by value (LCs), after the US dollar and the euro.

Faltering global trade growth

These trends are emerging against a backdrop of continued economic uncertainty that seems to be a permanent fixture for the foreseeable future. The upticks and downturns have impacted the growth of global trade. According to the WTO, global trade grew by only five per cent in 2011, a sharp fall from the 13.8 per cent growth rate achieved in 2010. Further projections are not rosy. Global trade growth is expected to drop another gear to 3.7 per cent in 2012. This will be well below the annual average of 5.4 per cent for the last 20 years. As a result, China and its trade within Asia and with other emerging markets represent one of the few pockets of growth that corporates can investigate. Against this shifting landscape, corporates need to review their strategies for their treasury function to stay ahead of the game. Key points they need to consider are:
  • Getting greater visibility across the supply chain;
  • Being circumspect in choosing and taking counterparty risks with commercial and banking partners;
  • Being proactive and nimble in terms of managing their businesses so as to be able to quickly adapt to the constantly changing regulatory environment;
  • Moving to business models which help in unlocking cash faster in their balance sheets;
  • Managing financial resources optimally across multiple geographies and localities.

Chinese corporates and working capital optimisation

Treasurers in China have been looking for incremental ways to optimise cash flow across their operations, squeeze liquidity out of their supply chains and reduce their dependence on external funding. The tight credit environment during the course of the financial crisis and its aftermath has heightened the focus on improving working capital and minimising credit and operational risk across the entire corporate supply chain. It has also prompted a large number of corporates to use internally generated cash as a source of funding. Bringing global economic and regulatory landscape changes into the mix mean companies regard trade finance as an alternative funding option to traditiona credit lines and crucial to working capital and supply chain management. This has sparked innovations such as supply chain finance solutions that help to enhance working capital management. The continued liberalisation of the RMB provides abundant opportunity for corporates to synchronise the currencies used in both procurement and sales process. Cross-border sourcing from China can now be invoiced in RMB. This provides a boost to the global trade community because foreign exchange risk can now be minimised with invoices issued in local currencies. RMB local currency invoicing will increase the dominance of China in world trade because it will enable local Chinese suppliers and exporters to expand their business overseas, and conversely for foreign companies to buy from China. RMU local currency invoicing will continue to be a main discussion point in the coming future. The evolving regulatory environment in China continues to pose challenges to the operating landscape. Companies need to stay vigilant and work closely with their banks to ensure all financial transactions are carried out within the remit of existing regulations.

Banking partners and technology

As cross-border trade has become increasingly more complex, many small local banks, while playing a very important role in providing on-the-ground intelligence to their corporate clients and to financial institution partners, cannot keep pace with technology changes. They often lack the capability to support the trade finance needs of increasingly international and sophisticated clients because of the sheer pace of innovation and the up front technology investment. Innovation has become the domain of the larger banks that have invested in the necessary platform and products, and have developed advisory skills to provide and structure the more complex solution. The future for trade finance in China for corporates is not just about selecting appropriate proprietary systems from their banking partners. Given the pace of change, corporates need to ensure that their banking partner (or partners) can offer an ‘open highway’ approach. This means that the bank can offer corporates the flexibility to choose from electronic, web-based proprietary trade and information reporting systems or bank-agnostic systems. This is a critical component of the open highway approach that will give corporates the flexibility for the future.

SWIFT services

In addition to flexibility for the long term, corporates should have access to industry relevant messaging and communications standards to securely exchange and manage information. For example, they should be able to leverage their existing investments in SWIFT treasury and cash management via the emerging MT798 Trade Envelope message. Corporates should also look for strong banking partners with the capability to leverage other industry platforms such as Bolero to extend the depth of their solutions for corporates. Another industry development is bank payment obligation (BPO) which means that corporates need to consider a bank’s technological leadership and willingness to invest in new ideas. The ideal banking partner can demonstrate early industry involvement in testing the commercial viability of new solutions that could shape the evolution of trading relationships. 

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