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SynopsisName : Rinku Nyati

MIB IV Sem.Mewar Girls College

Session : 2009-2010

Topic Name of the Project A Study on


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Trade Finance Institutions for Trade and Small and Medium Size Enterprises Developmentin South Caucasus and Central AsiabyYann Duval and Urmi Sengupta1Table of ContentIntroduction ....................................................................................................................................................... 2A simple model of national trade finance institutional structure (TFIS) ............................................................ 5The Proposed National TFIS Model............................................................................................................... 5Level I institutions......................................................................................................................................... 5Central Banks and Monetary Authorities ................................................................................................... 5Other Level I institutions........................................................................................................................... 8Level II institutions ....................................................................................................................................... 9Export Credit Insurance and Guarantee Institutions................................................................................... 9

Export-Imports Banks (EXIM Banks)...................................................................................................... 10Level III institutions .................................................................................................................................... 12Commercial Banks .................................................................................................................................. 12

Non-Banking Financial Institutions (NBFI)............................................................................................. 13Is the model adapted to Central Asian and South Caucasus countries?............................................................ 14Selected experiences from UNECE Member countries in transition............................................................ 14Financial sector dynamics in NIS countries since independence ................................................................. 16A favourable macroeconomic environment as a pre-requisite to TFIS implementation .............................. 18Toward a Step-by-step Implementation of the TFIS Model......................................................................... 20Conclusions and Recommendations................................................................................................................ 21References ....................................................................................................................................................... 24

Abstract

A generic model of a national trade finance institutional structure is presented for possible

adoption and implementation in the newly independent states of Central Asia and theCaucasus. The importance of specialized state-supported trade finance institutions for thedevelopment of trade and SMEs is highlighted. However, these institutions may not beeffective unless a stable macroeconomic environment is established, characterized byincreasing domestic and foreign trust in the public sector and the banks. Given the limitedresources of governments in the region, a staged implementation of the model is suggested.-------1 Yann Duval [email: [email protected]] and Urmi Sengupta are Economic Affairs Officer and former Intern,respectively, both in the Trade Efficiency and Facilitation Section, Trade and Investment Division,UNESCAP. The author acknowledges valuable inputs and research assistance from Mr. Lee Yow Jinn, SeniorAssociate, International Trade Institute of Singapore, and Ms. Neravan Rojchaichaninthorn, former Intern,UNESCAP. The opinions, figures and estimates set forth in this publication are the responsibility of theauthors and should not necessarily be considered as reflecting the views or carrying the endorsement of the

United Nations. This publication has been issued without formal editing.2

Trade Finance Institutions for Trade and Small and Medium Size EnterprisesDevelopment in South Caucasus and Central AsiaIntroductionCross-border exchanges of goods and services are widely acknowledged as animportant engine of growth for most developing and transition economies. The recent WTOministerial meeting in Cancun has further demonstrated the importance of international


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trade and investment flows, with many developing economies joining hands to vigorouslydefend their interests in this area. While countries need to actively engage in negotiationswith others to create a favourable foreign environment, each must first insure that itsdomestic environment is favourable to trade development.Whether the domestic environment is favourable can ultimately be measured by theeconomic cost of importing or exporting specific goods and services into or from thedomestic market. In most economies, major transaction cost factors would includetransportation costs and financing costs (including insurance), as well as costs associatedwith red tape. Unpredictable and/or uncompetitive transportation, financing, or proceduralsand documentation costs can all be formidable barriers to trade for small and medium sizeenterprises.Financing of trade and investment has long been identified as one of the mostchallenging issues faced by new and small and medium enterprises (SMEs) in developingor transition economies (Dhungana, 2003; Das 2003; USDC, 2002; Suhir and Kovach,2003; UNCTAD, 2002; among others). The issue of financing is particularly important, asfinancing is needed not only during the export process itself, but also for the production ofthe goods and services to be exported, which may include imports of raw material or

intermediate goods. Lack of financing at any time during the production and/or the exportprocess will result in a failed transaction.South Caucasus and Central Asian (SCCA) economies in transition, all members ofboth UNESCAP and the Commonwealth of Independent States (CIS), include thefollowing countries: Armenia, Azerbaijan, and Georgia (South Caucasus); Kazakhstan,Kyrgyztan, Tajikistan, Turkmenistan, and Uzbekistan (Central Asia). These countries areare all newly independent states (NIS) in transition from the central planning system of theformer Soviet Union to a market-based system. The transition process started for most ofthese countries in the early 1990s and involved large scale reforms, including a completerevamping of their financial sector infrastructure. As part of the transition process, manySCCA countries have privatised their entire financial sector.The new capital requirements imposed on existing banks and the inexistence ofdeposit insurance mechanisms resulted in many bank failures and a loss of confidence ofthe population in banks, such that the deposit base of many of the countries, as a % of GDP,is often extremely low (less than 10%). The financial sectors remain extremely weak inmany of the SCCA countries, and generally provide, if at all, very limited support to SMEs.While some of the development banks and other international institutions or foreign aidagencies, especially EBRD, are now providing lines of credits to SMEs through domesticbanks, much remain to be done to develop a trade finance infrastructure able to effectivelysupport the export potential of these young enterprises.3

Exports of goods and services from CIS countries have increased by an average of6% a year from 1994 to 20012. Taking into account the impact of the 1998 Russian

financial crisis on the CIS countries, the moderate growth rate of trade shown in Figure 1remain encouraging, although significant differences exist across countries. This positivegrowth in trade has been accompanied in the 1990s by a shift from intra-CIS trade to non-CIS trade. Newly independent states as well as Russia preferred to sell to non-CIS countriesfor political reasons but also because these countries could offer hard currencies, higherprices and less risks than their neighbouring economies in transition.Figure 1 - Trade of CIS except Russian Federation,1994-2001 (in Million $US)0


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5000100001500020000250003000035000

40000450001994 1995 1996 1997 1998 1999 2000 2001CIS-11exportsCIS-11imports

Source: UNECE (a), 2003

The sluggish growth in intra-CIS trade can be partly attributed to an underdevelopedtrade finance infrastructure within the CIS region, including inadequate exchange rate andpayment systems and an unreliable and inefficient financial system, resulting in limitedpayment options and ability to mitigate the risks associated with cross-border transactions(UNECE (a), 2003)3. While much progress has been made since the early 1990s, most CIS

countries need to further develop their financial systems to adequately encourage andsupport the growth of trade, both within and outside of the CIS. This is particularlyimportant given the very high correlation between trade volume and government revenue inmany transition economies with weak tax collection systems.Most of CIS exports consist of oil (Turkmenistan, Russian Federation, Azerbaijan,Kazakhstan) and primary commodities. Trade in oil and, to a lesser extent, primarycommodities, has long been facilitated by governments and/or large international tradingcompanies. However, the growing number of entrepreneurs and SMEs in SCCA countries2 In addition to the already mentioned SCCA countries, CIS countries also include Belarus, the Republic ofMoldova, the Russian Federation, and Ukraine (often referred to as European CIS countries).3Note that it is not argued here that these are the only, or most important, factors explaining the sluggish tradegrowth. Some other factors affecting the official trade data reported in some of those countries includeinternal conflicts (e.g. Georgia), red tape and corruption, lack of transparency, inadequate transportation and

other basic infrastructures, and national standards not compatible with international ones. Many of theseissues need to be addressed in a holistic manner, based on a comprehensive trade development strategy.4

face significant obstacles to financing trade and related investments. Because of the lack oftrack record (many companies are new since the private sector began to develop only afterindependence) and the lack of (enforced) auditing and accounting standards, among others,collateral requirements often reach 150% of the amount of the loan.High collateral requirements are indeed considered by businesses in transitioneconomies to be the most important obstacle to trade and investment financing, followed bythe cost of a loan (i.e., cost of borrowing) and weak or unreliable financial statements (seetable 1). Other obstacles include the fact that many banks do not loan below a certainamount, which makes it difficult for small companies to get financing when they need it

(e.g., Kartu Bank, one of the 4 biggest banks in Georgia does not make any loan below$20,000). Poor management skills and poor business proposals, comes fourth and fifth,respectively, as the most important obstacles to trade and investment financing. In countrieswhere foreign banks are allowed to operate, many businesses are unable to benefit fromtheir credit lines, as these banks remain very weary of the risks (commercial and political).Other barriers to trade-related financing not listed in table 1 include lack of effectivebankruptcy laws and the fact that most lending rarely exceeds 12 months.Table 1 - Obstacles to Trade Financing or Investment Financing (most important: 1; least


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important: 11)Avg.

Ranking

Arm

enia

Azerb

aijanGeo

rgia

Kazakhstan

Kyrgy

zstan

Lack of collateral 1 1 1 1 1 1Cost of a loan 2 2 2 8 2 2Balance sheet weakness (e.g., lack ofcapital; unreliable accounting)2 3 3 2 4 4Minimum amount needed 4 6 9 3 5Management weakness 4 4 3 5 6Poor business proposal 5 5 5 4 8 3Lack of credit lines from foreign banks 6 4 9 6 6 7Unacceptable terms of foreign vendors 7 10 7 7 8Source: Modified from BISNIS Finance Survey 2003, WWW.BISNIS.DOC.GOV

With real interest rates on short-term loans of over 30% per year in someSCCA countries4, it is easily understood that the financial environment does not provideSMEs with trade and investment financing options that would allow them to be competitivein servicing foreign markets. Most entrepreneurs in these countries are likely to be deniedthe benefits of international trade unless a favourable trade finance infrastructure, includingspecialized trade finance institutions, are developed to assist them in overcoming theabove-mentioned obstacles.

Based on a review of trade finance related institutions in Asian countries, a genericmodel of a national trade finance institutional structure (TFIS) is developed for possibleadoption and implementation in SCCA countries.4 The real interest rate in Armenia reported in the World Bank Development Indicators Database (data for theyear 2000), was 33%. The real interest rate for the same year in Czech Republic was only 6%.5

A simple model of national trade finance institutional structure(TFIS)The national trade finance institutional structure of a country is part of its overallfinancial sector structure. Developing countries with fairly well-developed financial sectorsappear to have adopted a two-tier banking system, where one Central Bank or Monetary

Authority conducts monetary policy and regulates the banking system. Most of thesecountries also feature financial market institutions at difference stages of development, suchas stock markets, foreign exchange and derivative markets, as well as non-banking financialinstitutions and domestic credit rating agencies. More importantly, at least from a tradefinance perspective, these countries also feature a number of specialized institutions, amongwhich trade finance institutions (see figure 2). The TFIS model proposed below is mainlybased on this last observation.The Proposed National TFIS ModelWhile many developing countries have increasingly left commercial banking to the


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private sector, they have retained ownership in special-purpose banks, such as developmentand industrial banking institutions, and including trade-related financial institutions such asexport credit insurance and guarantee companies, or Export-Import Banks (EXIMs). This isalso true in most developed countries, including the United-States of America (USA), withits government-owned US EXIM Bank. While recent trends have shown a willingness tomake these organizations more independent (self-financed), most countries have beenreluctant to privatize them as they provide governments with some tools to addressperceived market failures in the financial and trading sectors5.The suggested TFIS model is presented in Figure 3. In this model, the institutionsare grouped in three categories based on the level of government ownership and control.While the level of government control over trade finance related organizations varysignificantly across countries, the model presented here is arguably representative of thebasic TFIS of many middle and high income countries. Note that the financial marketsinstitutions, (e.g., bond markets, stock markets, securities markets, among others) and otherinstitutions indirectly linked to trade finance, are not included in the model, given thelimited scope of this paper. The role of each of the institutions in the model, as well as therelationship between these institutions, is discussed in more details below.

Level I institutionsCentral Banks and Monetary Authorities

Most countries now have a Central Bank or a Monetary Authority. Theseinstitutions are typically responsible for managing the money supply, as well as theregulation and oversight of the financial system, particularly the banking system. They alsooften act as the banker to and the financial agent of the Government.5 See Stiglitz, 1994 for a discussion of the role for the government in financial markets.6

Figure 2 . Institutional Structure of Financial Sectors in Selected Asian CountriesSource: Peralta, ADFIAP, 2003 (www.adfiap.org)7

Figure 3 The Proposed National Trade Finance Institutional Structure ModelLevel I Institutions

DirectGovernmental RoleLevel II Institutions

Full or partial Governmentownership but limiteddirect management roleLevel III Institutions

Market Driven - No orvery limited Governmentownership -Ministry of FinanceNational Export-Import Bank(EXIM)Other financial and insurance sectorregulatory bodiesMinistry in charge of tradeCentral Bank / Monetary AuthorityExport Credit Insurance and

Guarantee AgencyOther trade-related specializedfinancial institutions/agencies (SME

banks, Industrial or developmentbanks)Commercial banksOther privately owned non-bankingfinancial institutions (leasingcompanies, factoring houses)Specialized support to new and small and medium enterprises, and other organizations withlimited access to the product and services ofConsultancy and training services to SMEs


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of Finance. In some countries, Ministries of Finance also play a role in providing taxincentives or tax holidays so as to encourage trade development. Depending on the needsand strategies of the governments, these tax incentives may be limited to specific groups oftraders (e.g., SMEs) or/and products (e.g., handicrafts). Finally, Customs Departments,9

often under the finance ministries, can greatly affect the cost of trade transactions and the

time it will take for goods to reach their final destination. This will in turn affect thefinancing needs of traders.Ministries in charge of trade are typically in charge of regulating trade as well asof developing and implementing an overall trade development strategy. Most ministries incharge of trade oversee trade promotion organizations (TPOs), such as trade and investmentpromotion agencies. These agencies provide export support services which may includetrade facilitation and trade finance services6. One important role of the agencies in chargeof trade development is to correctly assess the needs of the private sector and to coordinatewith other ministries, including the finance ministry, to develop policies, regulations, andprogrammes that will facilitate trade. From that perspective, the Ministry of trade, based onregular interactions with traders and other stakeholders in trading activities, should be

proactive in the development and implementation of laws and regulations that affect trade,even if these laws and regulations are not under the direct responsibility of the ministry (asis typically the case for trade finance regulations and many other trade facilitation-relatedmeasures).Other government institutions may also play an important role in making tradefinance tools and instruments available. Indeed, in some countries, the Central Bank doesnot oversee all the financial institutions. For example, in Malaysia, securities markets aresupervised by the Securities Commission, while the insurance companies in the Philippinesare under the supervision of the Insurance Commission. In order to facilitate trade financeinfrastructure development, all the regulations and provisions of the financial sectorregulatory bodies should be scrutinized to insure that they do not unnecessarily impedetrade.

Level II institutionsExport Credit Insurance and Guarantee Institutions

Credit insurance is an insurance against non-payment of an export contract. Suchinsurance typically covers the exporter and its bank against the risk of buyers fraud orbankruptcy, and sometimes the political risk. An export credit insurance makes it easier forexporters to safely extend credit to buyers (often a key factor in getting an export contract)and obtain needed working capital from their bank, because some of the risk associatedwith the export transaction is shifted to the insurer.Institutions providing export credit insurance and guarantees can take differentforms. Some of the first such institutions established were government-backedorganizations (part of the trade or finance ministries) for which export growth was the only

priority. Increasingly, however, export credit insurers are government-owned corporationstasked with encouraging exports as well as making a profit.Export credit insurers may also take the form of private partnership of banks,insurance companies and other related organizations. In these organizations, governmentstake on political risk either through a department or through an appointed agent 7. Given theprevailing conditions in CIS economies, a private credit insurer in which the Government6 For more information on the role and structure of TPOs, see UNESCAP, 2001.7 For more details, see ITC, 1998.10


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only takes on the role of official reinsurer of all political risk on exports, as in Zimbabwe,may be particularly appropriate.Box 2 Facts about COFACE, EFIC, and ECGC

COFACE, the French Export Credit Insurance and Guarantee Company, is one of theleading export credit insurance company in the world, and active in over 91 countriesaround the world. It started as a state-owned company in 1946, with the goal of supportingexports of French products to a wide range of destinations. COFACE was privatized in1994, and listed in the stock market in 2000. In 2002, Natexis Banque Populaire, a Frenchbank, took majority ownership of COFACE. While most of COFACEs business is toprovide its own credit insurance and risk management products, it remains in charge ofproviding public insurance and guarantees to exporters on behalf of the FrenchGovernment.EFIC, Australias Export Finance and Insurance Corporation, is setup as an integratedgovernment-owned corporation. At the end of 1996, it had a paid-in capital of $A 6 million,supported by $A 200 million of callable capital and a comprehensive governmentguarantee, and acuumulated reserves and profits of $A 177 million. On the basis of thiscapital structure, EFIC was able to support $A 5 billion of credit insurance annually, as

well as $A 1 billion of medium-term lending and guarantees to banks. This representedabout 10% of Australias exports at the time.ECGC, the Export Credit Guarantee Corporation of India, originated from the Exports RiskInsurance Corporation (ERIC) that had been created by the government of India in 1957. In 1964,ERIC was transformed into the ECGC, a company wholly owned by the Government of India.ECGC functions under the administrative control of the Ministry of Commerce, Government ofIndia. A Board of Directors comprising representatives of the Government, Reserve Bank of India,

banking, insurance and exporting community manages the organization. ECGC is the fifth largestcredit insurer in the world in terms of coverage of national exports. However, in the context of theliberalization of the Indian economy and in view of the opening of the insurance sector within the

purview of (Insurance Regulatory and Development Authority) IRDA, the role and position ofECGC in the Indian insurance market is going to be challenged and ECGC is repositioning itself asa multi-product organization servicing the export sector of the small-scale industry segment.ECGCs recent initiatives include insurance cover on losses from discrepancies in documents underLetter of Credits.Sources: www.coface.fr/ ITC / ECGC annual report 2001-2 / various other sources

While, the cost of establishing an export credit insurance agency needs to beweighted against the export potential of a country, it is important to recognize that domestictraders will likely be at a disadvantage compared to foreign traders whose transactions canreadily be insured.Export-Imports Banks (EXIM Banks)

EXIM banks are typically government-owned banks established to facilitate and encouragethe development of trade. They are often conceived as a one-stop shop for export-importfinancing, taking over some of the responsibilities of what may have been distinct units or11

departments of ministries of trade, finance, or even the Central Bank, as was the case forthe Thai EXIM bank (see box 3 for more details). Sometime, the activities of a previouslyestablished Export Credit Insurance Agency may be merged into the newly created EXIMbank.Box 3 - The EXIM Bank of Thailand

The success of Thailands economic development efforts during the second half of the1980s had prompted many economists to believe that Thailand could further this success byadopting an export-led growth strategy that would provide SMEs with an opportunity to


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international banking services. An EXIM Bank, while not expected to finance a large share of exports and foreign

investment under normal circumstances, can be an effective backup financing sourceduring a major financial crises (EXIMTs activities doubled during the Asian crisis). An EXIM Bank should be managed as a self-sustainable organization, with no subsidiesof interest rate, but a modern and creative risk assessment and management program tosupport small and new enterprises with export potential.Many of the larger EXIM banks are members of the Berne Union(www.berneunion.org.uk) , whose goal is to promote sound practices in export andinvestment financing, and to facilitate the exchange of information and expertise amongmembers. While new export credit agencies (EXIMs as well as export credit insuranceinstitutions) do not qualify for membership, the Berne Union, in cooperation with theEBRD, has setup the Prague Club to support ECAs in developing their export credit andinvestment schemes. Many ECAs of transition and emerging economies, including EXIMT,meet regularly during the Clubs meetings.Level III institutionsCommercial Banks

In most countries, commercial banks are, from far, the largest providers of tradefinance services. The main role of banks is to act as facilitators and/or intermediariesbetween savers and borrowers. Banks provide short-term financing of trade transactions byvarious means, including advances against (or discounting of) export bills. They also helpreduce the risk inherent in trade transactions by providing documentary credit (e.g., lettersof credit) services or other alternative methods of payments, and by facilitating access toforeign exchange markets to hedge against a possible currency risk.While private commercial banks make up the largest share of trade financingactivities in most countries, they generally favour lending to well-established and largerfirms to reduce their risk exposure, or to the government. As a result, small and mediumenterprises may find it difficult to secure trade financing through traditional commercial13

banks. In the case of transition economies, where the private sector mostly consist of smallfirms with a short corporate history, trade financing through commercial banks typicallyinvolve very high collateral requirements (e.g., 150% of the value of the loan in Mongolia),which severely limits these firms ability to export and grow.Non-Banking Financial Institutions (NBFI)

The non-banking financial institutions are an important part of the trade financeinfrastructure. While they are typically not authorized to take deposits (as opposed tobanks), they can play an important role in trade finance. A non-exhaustive list of NBFIincludes export houses, factors, as well as agencies specialized in leasing or counter tradearrangements.Export houses are non-bank institutions that traditionally provide confirmationservices only, typically acting on behalf of overseas buyers. However, over time, they haveoften extended their services to trade financing. Many export houses may provide financeto cover the gap between the goods leaving the factory and being purchase by the end user.Credit is provided for periods of 30 to 180 days and is available for all types of goods(export of capital goods can often be covered for periods of up to 5 years). Export housescommissions are based on the period of credit, average invoice value, volume of businessand the amount of other services provided.Factors are organizations that buy from traders their outstanding book debts. Inpractice, the exporter will send all invoices at specified intervals and will receive a cheque


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for an agreed initial percentage of the total invoice value usually in the range of 80-85%.As payments are made, the balances of sum due are credited to the exporter.Leasing may be described as an agreement whereby the lessor (e.g., a leasingcompany) conveys to the lessee (e.g., a wine producer and exporter), in return for apayment or series of payments, the right to use an asset (e.g., a harvesting machine) for anagreed period of time. Some estimate that leasing companies provide about one-eighth ofthe worlds annual equipment financing requirement. Leasing can allow small firms tofinance their growth and/or survival in difficult environment, and should therefore beencouraged in SCCA countries (Lasfer and Levis, 1998).8Counter Trade can be considered to be a viable alternative in countries wherecapital or funding is limited. Some financial institutions specialize in arranging countertrade deals, by assisting exporters to negotiate and dispose of the goods they will receive aspayment for their exports.Note that, in most countries, the services offered by NBFIs may also be offered bycommercial banks and some of the level II institutions. For example, ECGC Limited(India), offers factoring services to exporters.8 see www.leaseurope.org, for more information on leasing.

14Is the model adapted to Central Asian and South Caucasuscountries?To answer this question, we start with a review of selected experiences of some ofthe countries most advanced in their transition process, followed by a stylized analysis ofthe financial sector dynamics in NIS over time.Selected experiences from UNECE Member countries in transition9The selected experiences from Ukraine, Czech Republic, and Estonia presentedbelow highlight some of the challenges and issues related to the development ofstatesupportedtrade finance institutions (level II institutions), which are often lacking orunderdeveloped in SCCA countries.Ukraine

State support to enterprises in transition economies has not always been successful.Some time ago there was an Innovation Fund in the Ukraine, which was financed throughdeductions from company revenues (one per cent of the total revenue). This fund wasactually governed by State officials; they were in charge of loan allocation. The history ofthis Fund testifies that as much as 70 per cent of loans were provided to enterprises thatwere operational for less than one year. Consequently, the Funds loan portfolio mainlyconsisted of bad loans. Currently [October 2001], the Innovation Fund is under liquidationand there are several proposals on how to use its financial resources and there arediscussions in the Government regarding the establishment of a State Bank forReconstruction and Development.

One more example of an unsuccessful State-supported project in which our bankparticipated relates to servicing intergovernmental credit lines. In the early 1990s, throughthese intergovernmental credit lines, Ukrainian enterprises obtained loans worth more thanUSD three billion. The loans were approved by the Foreign Exchange and CreditsCommission of the Ukrainian Government. As in the case of the Innovation Fund,borrowing through intergovernmental credit lines resulted in a large amount of bad debts,which the Government had to service imposing considerable burden on the State budget.The State Export-Import Bank of the Ukraine was established in January 1992 on


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the basis of the former USSR Vneshekonombank representative office in Ukraine. Thebank inherited from Vneshekonombank its staff, and, as you know, personnel are the mostprecious asset. The Export-Import Bank has become one of the leading banks in servicingthe foreign trade of Ukrainian enterprises. During its first years of operation, it serviced upto 40 per cent of Ukrainian foreign trade. At present, the respective figure is about 20 percent and the export-Import Bank is considered by enterprises to be one of the mostprofessional in foreign trade financing.Initially, the founders of the Export-Import Bank thought that its functions would besimilar to those of western banks specializing in foreign trade financing. However, inpractice, the functions of the bank have become very broad, characteristic rather of auniversal bank. Until last year, the Export-Import Bank, which was established as a State-9 The material in this section is borrowed from UNECE (b) 2003.15

owned entity, was outside of the Ukrainian legal framework according to the Law onBanks and Banking Activities of Ukraine, the banking structure comprises only two levels,namely the Central Bank and commercial banks, which the then already existing StateSberbank and Export-Import Bank not mentioned. To remedy this, it was decided in 2000

to transform our bank into a joint stock company and that is how the open Joint StockCompany State export-Import bank of Ukraine was established. (Source: Mr. MikhayloButsko, Deputy Head, Export Development Department, Eximbank, Ukraine, October2001.)Czech Republic

There are a number of State entities providing enterprises with information onexisting insurance and financial opportunities. Czech Trade, for example, is a small agencythat provides information to SMEs about foreign markets and support schemes offered byinternational organizations (e.g., the World Bank). Czech Trade also conducts marketresearch, helps companies to participate in international fairs, and offers them advice onexport finance and insurance. This agency has branches abroad, which assist in promotingCzech goods abroad.

The most important link in the export support system is the Export InsuranceAgency (EGAP a.s.). Established in 1992, it has achieved considerable results in exportcredit financing and insurance. In 1995, the Czech Export Bank (CEB, a.s.) was establishedwith the aim of financing medium and long-term export projects. The Czech Governmentparticipated in the statutory capital of EGAP and CEB, having allocated funds from theState budget. It also provides government guarantees for EGAP and CEB. At the sametime, both institutions have created their own reserves and are financially self-sufficient.CEB provides refinancing credits to commercial banks: it borrows on internationalmarkets with government guarantees and then on-lends these resources to Czechcommercial banks. Further on, direct export credits channelled from western banks toCzech commercial banks via CEB have become more common. Pre-shipment (pre-export)financing appears to be the most demanded financial instrument in export financing. At thesame time the Bank guarantees the exporters obligations (notably, guarantees onpreshipmentfinance, performance bonds, etc.).CEB supplies medium and long-term export financing, whereas domesticcommercial banks are unable to provide such a service. It also creates the possibility forCzech exporters to provide credit to their buyers at internationally competitive conditions.The system of minimal fixed interest rates adopted by the OECD allows Czech exporters tobe competitive as compared with their German, French and other OECD competitors. It


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should be noted that CEB does not subsidize interest rates on loans to exporters and it doesnot anticipate using this instrument of export finance.CEB finances only two per cent of Czech exports. However, this portion of exportsis important because it includes products with high value-added, the production of whichinvolves many local suppliers and sub-contractors. Therefore, its operations also have anindirect, positive effect on export growth in machine building, in particular. In 2000, CEBsshare in the outstanding credits in foreign currency was over 8 per cent. (Source: Ms.Miroslava Hrnirova, Deputy General Director and Member of Board, Czech Export Bank,October 2001).16

Estonia

Estonia is a small country and its exports are small (total export value is less thanUSD 3 billion). It is worth noting that Estonia has a most liberal trade regime. Thedevelopment of the Estonian banking system has been dynamic, and in 1998 theGovernment felt that there was more demand for export risk insurance than for directexport finance. Thus, in 1999, the Law on government insurance of export risk wasadopted.

KredEx Fund was established in 2001 on the basis of three funds, namely theExport Guaranteeing and Crediting Fund, Business Credits Insurance Fund, and MortgageInsurance Fund, as the result of a government effort to minimize budgetary expenditure andmake the insurance scheme more cost effective. At present, the volume of reserves isalmost USD 5 million and the total volume of loans that the fund is able to extend amountsto USD 15 million.KredExs major activities include issuing guarantees for bank credits, and,secondly, export credit risk insurance. Since the fund is quite young, at present it offersonly two insurance products: a simple insurance and a framework insurance (wheretransactions with all the clients principal buyers are insured). The minimum premium is0.4 per cent for short term credits, and the maximum amount of guarantees provided cannotexceed USD 17.5 million. () Given the short-term nature of credits, the funds activity

can cover bout 5 per cent of total Estonian exports. Mr. Sergei Semjonov, Officer, Exportand Credit Guarantee Fund KredEx, October 2001.Financial sector dynamics in NIS countries since independenceIn order to understand whether the above model is adapted to SCCA countries, it isuseful to review the evolution of the financial sectors in these and other transitioneconomies. Three basic stages may be identified from the experience in the development oftheir financial sector since 1990. Figure 4 is an attempt to represent graphically the typicalNIS financial sector dynamics, although wide variations exist across countries10. Thisfigure was designed based on information gathered during advisory missions to Mongoliaand Georgia, as well as on a report on the evolution of banking supervision in the CzechRepublic (Czech National Bank, 1999).

In the first stage, the countries convert their banking system into a two-tier system,with one central bank, in charge of monetary policies and financial sector regulations, andintroduce new banking legislation, authorizing the development of private commercialbanks. This typically result in the creation of a large number of small undercapitalisedbanks (over 400 in Georgia, a country with a population of less than 5 million), due to weakor inexistent prudential regulations. The share of state ownership in banks starts fallingsharply as a result.10 Indeed, this representation is highly stylized and does not readily take into account the effect of the Russianfinancial crisis, which adversely affected all CIS economies, but to varying degrees. Financial sector


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dynamics can also expected to vary somewhat depending on whether or not a country preferred a slower moreprogressive approach to transition reforms as opposed to a quicker more radical transition process.17

Figure 4 Typical Timeline of the Changes in the Banking Sector and Trade FinanceInstitutions in Transition EconomiesIn the second stage, the development of banking supervisions mechanisms

(including prudential rules such as minimum capital requirements) and the unravelling ofpyramid schemes setup by smaller banks, as well as the high level of inflation of thenewly created currencies, result in the bankruptcy of most of the private banks, and theneed to privatise some or all of the state-owned banks. In particular, some of the specializedtrade development banks, typically state-owned, disappear or cease activity11. At this stage,trust in the banking system falls in many countries because of (1) failure of many recentlyestablished undercapitalised private banks and (2) high inflation and instability of newlycreated national currencies drastically reducing the value of deposits (originally in rubbles)in state-owned banks. Trust in the government also falls as a result.The third stage, arguably, is characterized by a stabilization of the number of banks,an increase in domestic deposits, and an increase in government involvement in the bankingand financial sector through specialized financial institutions, including EXIM banks and/orexport credit insurance and guarantees agencies (Level II institutions).This last stage has arguably been reached in some transition economies, especiallythe ones being considered for early entry in the European Union. The following economiesin transition have active export credit agencies: Albania, Belarus, Bosnia & Herzegovina,Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Lithuania, Macedonia, Poland,11 Extreme policies sometime had to be adopted, such as an agreement between the World Bank and theGovernment of Georgia suggesting that the Government not be allowed to maintain direct ownership in anyof the banks (Source: David Chkhartishvili, National Training Workshop on Trade Finance InfrastructureDevelopment, Tbilisi, Georgia, 15-16 October 2003) Independence Time Financial and otherreform begins Financial sector restructuring(privatisation) Stable/increasingly favourablemacroeconomic and legal environmento Increased Government Resourceso Development of TFIs and otherspecialized financial institutions,supported by the GovernmentShare of state ownershipin the banking system

Number of private(commercial) banksIncrease or decrease inthe level of trust in

government and bankingsystemSTAGE

III

STAGE

II

STAGE

I

18

Romania, Slovak Republic, and Slovenia12. In addition, (only) two of the SCCA countries


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appear to have active state-owned trade finance related institutions: Uzbekistan, whoseexport credit agency is a member of the Prague Club (Uzbekinvest); and Kazakhstan,whose recently established Development Bank of Kazakshtan (DBK) is expected tobecome the governments primary vehicle for promoting exports in the non-extractingsectors of the Kazakh economy.13

A favourable macroeconomic environment as a pre-requisite to TFISimplementationWhat can be concluded from the TFIS experiences in the countries that have madethe most progress in their transition to market economies and their financial sectordynamics? Probably that the simple trade finance institutional model presented earlier isadapted to the SCCA economies in which the level of trust in both the public institutionsand the banking system is increasing, as measured by a reduction in the level of corruption,the willingness of the private sector to move activities from the informal to the formalsector of the domestic economy, and the growth in government revenue and the overalleconomy.Stage III, during which the proposed TFIS model is to be fully implemented, hasnot been reached by most SCCA countries. Many of these economies appear to still be in

the second stage of their financial sector evolution, where the financial sector structure issupposed to stabilize and where the emerging private sector gains trust in the government,through implementation of reform programs that create an environment favourable toeconomic growth and trade development. Indeed, the third stage can be reached only oncethe trust in the banking sector, often seriously affected in stage II of the transition, has beenrestored. However, this trust in the financial sector will only be restored if people insideand outside the country trust the governing authorities, and if internal and regionalterritorial conflicts have been solved.Full implementation of the TFIS model is unlikely to yield positive results ifimplemented before state III is reached. Indeed, the main feature of the model is to createfully or partially state-owned trade finance institutions (Level II) to support traders. If thestate, as represented by its government officials, is no trusted, it is unlikely that relevantprivate sector participants will become clients of the new institutions. Perhaps moreimportantly, governments, in most cases, will not have enough resources to establish andsustain operations of the new institutions, since many of the income-generating activitieswill remain in the informal sector of the economy.12 Based on the list of the Prague Club members, Berne Union Yearbook, 2003 (www.berneunion.org.uk).13 The financial sector in Kazakhstan is widely acknowledged as the best in Central Asia, as reflected by thegood international credit ratings of its banks (see The Economist, 2003). While Kazakhstan also reportedlyhas an EXIM Bank of Kazakhstan (Kadrzhanova, 2003), no information was found that confirmed whetherthis bank is still active.19

Table 2 A Benchmark of Macro-economic indicators for Trade Finance Development fromSelected Asian CountriesCaucasian CIS Central Asian CIS Selected Eastern European Other SelectedESCAP MembersIndicators AM AZ GE KZ KG TJ TM UZ CZ HU PL SK IN TH BenchmarkTRADE FLOWSTotal Trade as a % of GDP 74 79 84 107 94 165 116 83 144 139 66 150 31 126 84 +Cover Ratio as a % 46 106 81 124 88 95 118 114 95 99 81 97 84 114 85 +Change in Total Trade (Y-5 to Y) as a % 38 97 98 61 4 0 23 -15 26 72 49 33 53 1 23 +NET RESOURCESNet FDI Flows as a % of GNI 1 -8 2 -2 -4 0 .. 0 -3 -1 1 9 0 -2 0 +Net Official Development Assistance as a % of GNI 11 3 6 1 18 15 1 3 1 1 1 1 0 1 3 +EXTERNAL DEBT & LIQUIDITYTotal External Debt Stock as a % of GNI 46 24 54 39 150 125 .. 59 43 67 41 50 22 66 59 -


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key advantage of state-owned export credit agencies over private commercial banks, is thattheyoften have the same international credit rating as the government (sovereign debt creditrating).While this is a clear advantage in countries that enjoy a high sovereign debt credit rating, thismay not be in many SCCA countries, where the sovereign credit ratings are often well belowinvestment grade (with the exception of Kazakhstan). Creating or maintaining state-ownedtradefinance institutions in these conditions may unnecessarily mobilize (or even drain)governmentresources, with no tangible benefits to SMEs.Toward a Step-by-step Implementation of the TFIS ModelGiven the prevailing situation in SCCA countries, the proposed TFIS model could beimplemented in steps, as shown in figure 5. Many developing countries have used thisapproach,starting out with (ad-hoc) export financing schemes managed by the Central Bank (level Iinstitutions).

The next step would be to establish a credit insurance and guarantee agency with limitedproducts and scope, perhaps as an extension of an existing trade and investment promotionagency under the Ministry in charge of trade. The establishment of an EXIM bank, or otherspecialized banks (SME banks, Industrial banks,), could come much later, only after athorough needs assessment has bee done, and when the government has enough resources toproperly support and maintain such institutions.21

Figure 5 TFIS Model: Staged ImplementationFeasibility Study /Needs AnalysisFeasibility Study /Needs AnalysisA step-by-step implementation may allow countries to offer the most urgently neededservices to

SMEs before they reach stage III of their financial sector evolution. Note, however, thatcarefulfeasibility and needs analysis should be conducted before any new services or institutions areestablished, so as to identify the sequencing of the institutional build-up, which may varydepending on the need of the countries.

Conclusions and RecommendationsNew and small and medium enterprises in SCCA countries face numerous obstacles thatseriously limit their ability to participate in international trade and reap the benefits of theglobalization process. One of these obstacles is the lack of access to trade finance, includingtrade-related investment financing. However, in contrast with most middle and high incomecountries, SCCA transition economies, for the most part, have not yet developed the trade

financeinstitutions needed to support SMEs international trade activities.Based on the experiences of selected Asian developing countries, a simple national tradefinance institutional structure (TFIS) model was proposed for possible implementation inSCCAcountries, characterized by three levels of institutions, classified according to their relationsto theGovernment. The following recommendations can be made for each of the three institutional


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levels:Level I institutions (Direct Governmental Role) The Central Bank / Monetary authority should take into account the needs of SMEs andtrade development when establishing financial system regulations, includingMinistry of Trade

Trade and Investment

Promotion AgencyCentral Bank

Export Facilitation/Promotion schemesMinistry of Trade

Trade and InvestmentPromotion AgencyExport Credit

Insurance Agency

Central Bank

Export Facilitation/Promotion schemesMinistry of Trade

Trade and Investment

Promotion AgencyEXPORT-IMPORT BANK

Export Facilitation/Promotion schemesExport Credit Insurance and GuaranteesTrade finance and trade-related investment finance services22

simplification of export-related financing rules and procedures. Enforcement of prudentialand other regulations should be strengthened so as to rapidly stabilize the banking andfinancial system. The ministries of finance should also adopt, whenever possible, policies that encouragethe development of SMEs, including possible tax incentives for export-oriented SMEsand streamlining of Customs procedures.

The ministries in charge of trade should play an active role in promoting and supportingSMEs trade. Establishment of a trade promotion organization (TPO) able to provideexpert advice on trade financing would be a possibility. More importantly, theseministries should be able to actively negotiate removal of trade obstacles setup by otheradministrative or regulatory bodies.Level II (Full or partial government ownership, and limited direct management role) Careful needs and feasibility analysis should be done before establishing Level IIinstitutions.o In particular, Level II institutions should not be established if the Governmentcannot readily support them at their early stages of development (propercapitalization is essential).o Another key issue is whether these institutions should be established under theMinistry of Finance and/or Ministry of Trade, and whether they should have tocomply with all the regulations imposed on similar private entities. Strengthening of the macro-economic and legal environment (by level I and otherresponsible institutions) is a pre-requisite to establishment/strengthening of theseinstitutions. Given the lack of resources in many SCCA countries, some of the functions of Level II

institutions could be performed by Level I institutions at the early stage (Central Bank andMinistry of Trade, in particular).


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Level II institutions most adapted to SCCA countries may take the form of public-privatepartnerships, such as in the case of the export credit agency of Zimbabwe. Step-by-step implementation of the institutional model is recommended, as shown infigure 5.Level III (Market driven, no or very limited government ownership) Clear and transparent legislation (developed in cooperation with level I institutions)would be needed to encourage the development of private non-banking financialinstitutions, including leasing companies. Specialized training and education programmes should be made available domestically toupgrade the skills of commercial bank personnel to international standardsIf only one conclusion had to be drawn from this analysis, it would be that creatinggovernment-backed trade finance institutions when the government is too weak to support ormanage them may be counter productive. As a countrys macroeconomic conditionsimproves, asmeasured by international credit ratings as well as trade ratios and other relevant indicators,23

governments may implement an export-led growth strategy that includes development of

level IIinstitutions to support the emerging private sector.In the mean time, a country with limited ability to provide trade finance to SMEs, mayrequest support from a number of international financial institutions (IFI), many of whichhavebeen increasingly active in extending loans to SMEs through existing commercial banks14.Manyof the IFIs are also offering useful technical assistance services on trade and SME finance15.SACC countries, most of whom receive significant amounts of overseas development aid(seetable 2), could also request that part of this aid be redirected to assistance programmes relatedto

SMEs financing for trade development, or to conduct feasibility studies and needs analysis onnational trade finance institutions.While this paper has (partially) addressed the institutional aspects of trade financeinfrastructure development for improving SMEs access to trade finance, it is important torealizethat this is only one facet of trade finance infrastructure development. Indeed, the tradefinanceinfrastructure necessarily includes legal, technological and accounting aspects that have notbeendirectly addressed in this paper. In addition, trade finance infrastructure development shouldbe

taken in the context of the overall development of a country, and fully integrated into thenationaltrade development strategy developed by the Ministry in charge of Trade in cooperation withallthe relevant stakeholders.The simple national TFIS model proposed could be extended to include relevant financialmarkets (foreign exchange and securities markets), and, perhaps, an institutionalized workinggroup on trade finance issues, composed of relevant institutions, including private sectortraderelated


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associations. Regional trade finance institutions could also be included in the model, asregional initiatives could be a more effective way to support trade and SMEs development inmany of the smaller SCCA economies16.Although, as argued in this paper, setting up state-supported trade finance institutions maybe part of the solution, further research is needed to identify innovative ways in which tradefinancing can be made available in developing and transition economies at affordable ratesandwith reduced collateral requirements. This may require answering the following question: towhatextent should the financial policy options and regulations that have proved effective indevelopedcountries be transferred to emerging economies?1714 Major IFIs with active SME and trade finance related programmes include the World Bank, the AsianDevelopment Bank, and The European Bank of Reconstruction and Development (EBRD).15 For example, the Asian Development Bank is implementing technical assistance for trade and SMEdevelopmentin Pakistan, which may be replicated in some of the SCCA countries (See Shah 2003).16 The Islamic Corporation for the Insurance of Investment and Export Credit (ICIED), a subsidiary of the

IslamicDevelopment Bank (IDB) is one option for many Central Asian countries (www.iciec.com).17 A similar question was recently raised by Michael H. Moskow, President and CEO, Federal Reserve Bank ofChicago. See Moskow (2001).24

ReferencesDhungana, B.P., Strengthening the Competitiveness of Small and Medium Enterprises inthe Globalization Process: Prospects and Challenges,Investment Promotion and EnterpriseDevelopment Bulletin for Asia and the Pacific, No. 1, ESCAP, United Nations, 2003.Kadrzhanova, A.How do companies in Eurasia Finance their Trade/Investment Deals?,BISINIS, Almaty, Kazakhstan, January 2003. (www.bisnis.doc.gov).ITC, Trade Finance Pointer: Methodology, Interpretation and Theoretical

Considerations, Unpublished Draft, 2003. (www.intracen.org).ITC,Export Credit Insurance and Guarantee Schemes, Trade Support Services, ITC,1998.Lasfer A. and Levis M., 'The determinants of the leasing decision of small and largecompanies', European Financial Management, Vol. 4, No. 2, 1998.Moskow, M., H., Financial Infrastructure in Emerging Economies,Journal of FinancialIntermediation, No. 11, 354-361 (2002).Shah. M.A.,ADBs Perspective on SME Sector Growth and Development in Pakistan,April 2003, http://www.adb.org/Documents/Speeches/2003/ms2003040.aspStiglitz, J.E. The Role of the State in Financial Markets,Proceedings of the World BankAnnual Conference on Development Economics 1993, IBRD/WB, 1994.Suhir, E. and Kovach, Z.,Administrative Barriers to Entrepreneurship in Central Asia ,

Center for International Private Enterprise, June 2003. (www.cipe.org).The Economist, Finance in Kazakhstan: Small but Elegant, The Economist, May 31st2003 (page 67).USDC, Country Commercial Guides FY 2002 (various countries). (www.usatrade.gov).UNCTAD, Report on the Expert Meeting on Improving the Competitiveness of SMEsthrough Enhancing Productive Capacity: Financing Technology, (TD/B/COM.3/50),November2002.


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