Africa’s Post-Pandemic Challenges Require Bold and Direct Responses

Gerald Ndosi considers the essentials of trade finance in Sub-Saharan African economies — amid post-pandemic chaos and Russia-Ukraine conflict…

Covid-19 hit Africa hard; there was a sharp decrease in global trade and a rapid contraction of economic output.

Head of Trade Coverage: Gerald Ndosi

The International Monetary Fund (IMF) reported that the world economy shrank by about 3.5 percent — worse than the 2008 financial crisis. Even prior to the pandemic, the continent had been suffering because of a drop in Chinese demand for African commodities, the survey revealed, with oil-exporting countries particularly affected. There was also the impact of the Russia-Saudi Arabia oil price war to consider.

Sub-Saharan Africa (SSA) was on the path to recovery, but that has been disrupted by the Russia-Ukraine conflict. There were disruptions to trade and supply chains in the agriculture, fertilizer, and energy sectors. This has been attributed to trade sanctions imposed on Russia and its supply of commodities to the rest of the world.

SSA countries are net importers of oil, and food commodities have largely been impacted by these sanctions. Russia is the world’s third-largest oil producer and (along with Ukraine) a leading wheat exporter. The sanctions caused increases in prices of major commodities, creating inflationary pressure and threatening economic growth. But commodity-exporting countries stood to benefit from the higher prices.

The Trade Finance Gap

Bank One: Head Office

Africa’s trade finance gap has been largely attributed to the withdrawal of large international banks from the financial services sector, which began before the pandemic. “The supply of trade finance services, which supports more than 80 percent of global trade flows annually, has been one of the key constraints to the growth of African trade,” the IMF report stated.

Africa is trading $1.1tn per annum, and banks only intermediate 40 percent of these flows. That figure should be closer to 80. Post-pandemic, many African banks recorded falls in net foreign assets and some large international banks and financiers cancelled or reduced lines of credit.

African banks responded by increasing digital transactions and trade finance capacity, but global “systemic issues” have emerged, including tighter regulatory controls and difficulty accessing sufficient foreign currency. The IMF said the dominance of the US dollar in trade and finance “is likely to amplify the impact of the Covid-19 crisis”. Its report also highlighted increased demand for trade finance, along with a simultaneous slump in letter-of-credit business and banking operations.

Southern and western Africa, in particular, reported increases in demand for trade finance. Solutions typically provided by institutions such as Bank One are crucial to addressing the rising working capital requirements for SSA importers caused by oil and food inflation. This worsened the challenges highlighted above. Financial instruments such as letters of credit (LCs), standby letters of credit (SBLCs) and trade advances allow businesses to more easily buy and sell goods. These instruments are effective tools for importers and exporters to access capital, ensure business continuity, and guarantee payment to trade counterparties.

Trade and supply chain finance solutions have played a key role in supporting SSA development initiatives and in providing liquidity to the local economies. Trade finance is becoming more inclusive for commercial businesses and SMEs. Small enterprises are vital to global supply chains, and to solutions such as supply chain finance which are backed with sophisticated technology. Businesses in the supply chain gain access to trade finance liquidity by accelerating cash flow and bridging the working capital gap.

SSA banks are raising interest rates due to the Federal Reserve Bank’s decision to use higher rates to curb inflation and mitigate the supply chain challenges due to the Ukraine conflict and Chinese lockdowns. Most African businesses battle to access US dollar liquidity to facilitate their import payments. Emerging economies, including those in SSA, are faced with huge debt-service costs, putting increased pressure on dollar liquidity. These countries do not export enough.

So, businesses struggle to access trade finance credit and foreign exchange and banks find themselves in a situation of limited access to dollars. The cost of funds is excessive, due to regulatory capital requirements and liquidity overheads. Bank One believes it can make a difference. It is strategically positioned in the Mauritius International Financial Centre and has access to substantial dollar liquidity that can be deployed competitively in SSA to address these liquidity challenges and offer trade finance to clients.

Inflationary pressures on oil, fertilizer, wheat and food have created more working capital requirements for importers in SSA. They need more trade finance lines with banks, and Bank One is well positioned to offer that support.

The Way Forward for SSA

Central banks and capital market regulators have to take a proactive approach with the banking industry to create new trade finance liquidity solutions. It will involve the inclusion of other players, such as private asset companies and equity funds.

There is a need for increased correspondent banking relationships to take advantage of growth opportunities and expanding demand. There is also a need for more engagement between central banks and multilateral agencies to explore new trade finance capacities. And there is a need for improved relationships between governments and development finance institutions (DFIs).

Digital trade finance adoption by SSA banks can help in addressing the trade finance gap. They can provide enhanced access to trade credit by expanding the traditional trade finance offerings to deep-tier businesses with insufficient collateral.

Another way of bridging the gap would be to boost the African cross-trade flows — and the only way to do that is via the recently launched initiative on the African Continental Free Trade Area (AfCFTA). It is estimated by Afreximbank that the initiative can bring together a $3tn market and unite more than $84bn in untapped African exports. The implementation of AfCFTA could help to improve intra-Africa trade by 50 percent and support the trade-finance supply chain among the domestic banks. It may also lure more correspondent banks to support the African trade flows, internationally and domestically.

A collective AfCFTA implementation is crucial for success. A collective effort can kick-start and co-ordinate the implementation process for the member states who have ratified the initiative. It is important to note that capital flows have started to come back in some SSA countries where regulators have been proactive to support sectors that are crucial to economies such as oil and food imports.