IV Financial Strains and Structural Change in Official Support for Export Credits
- International Monetary Fund
- Published Date:
- March 1990
Official export credit agencies have fulfilled their mandate to facilitate and promote national exports through two principal means: channeling financial “subsidies to export credits and providing cover on terms better than those available in the market. The first of these involved explicit, though often opaque, subsidies that had a strong measure of domestic political support. The second was long perceived as a nonsubsidized, even profitable, activity, since with the full faith and credit of government treasuries behind them, agencies could offer insurance for political risk that was potentially too catastrophic for private insurers to handle. The risk itself was perceived to be less, since agencies, as official creditors, were thought to be able to count on eventual, even if delayed, repayment of sovereign credit.
In the 1980s perceptions changed. Budgetary strains in most industrial countries have been accompanied by a declining willingness of electorates to subsidize exports. Reflected in, and reinforced by, adherence to the OECD Consensus by OECD member agencies, this trend has reduced the role of agencies as a channel for financial subsidies. At the same time the prolonged cash flow deficits associated with repeated debt reschedulings have led to doubts about the ultimate profitability of export credit insurance, leading to modifications of accounting practices and pressures to increase revenues and cut costs.26 Agencies have responded by the various steps described in this paper.
Against this background of financial strain, institutional developments are reshaping the world of export credit insurance.
Developments in the OECD Consensus27
To limit the subsidization of exports through export finance, the agencies covered by this study have agreed to be bound by the provisions of the OECD Consensus on officially supported export credits, which have gradually evolved since they were first outlined in 1976. The Consensus establishes guidelines concerning financial terms and also sets minimum grant element requirements for mixed credits. It does not, however, extend to the terms and conditions of insurance and guarantees provided by official agencies and thus does not govern the provision of implicit support through the premium structure.
Consensus guidelines were last strengthened in July 1987. For the richer (Category I) countries, interest rates could be no lower than market-related rates in the relevant currency. For the poorest (Category III) and intermediate (Category II) countries, agencies could still use a fixed spread over an SDR-weighted average of market-related rates (the matrix rate), if that were lower than the market-related rate in the relevant currency. The 1987 reforms also changed the rules governing the use of mixed credits. The required level of concessionality for mixed credits was raised to 30 percent (and further to 35 percent a year later) for Category II countries, and to 50 percent for Category III countries. Mixed credits are not permitted for Category I countries.
No agency reported lower demand for export credit cover as a result of the increase in the minimum matrix interest rates or the abolition of the matrix rates for Category I countries. Although the purpose of the increase in the minimum grant element for mixed credits was to discourage their use, OECD data indicate that the volume of offers has increased. Definitive data on new commitments are not available, and as there may be several competing offers for individual projects, it is difficult to form an assessment of the actual level of activity. Nonetheless, there is a general perception that the increase in the required grant element has not yet led to a decline in mixed credits.
Some agencies indicated that it was not their countries’ policy to provide mixed credits, as resources from development aid budgets are primarily channeled to developmental or humanitarian projects, whereas most mixed credits are directed at investment in infrastructure and capital goods imports. Other agencies, however, said that they were prepared to provide such credits to secure an export contract, if a minimum standard was met in terms of its contribution to the importing country’s overall development.
Several agencies noted that there are a significant number of countries, particularly in Asia, where competition among agencies means that mixed credits are virtually a requirement for securing major export contracts. Concern was also expressed that, as there has been little increase in the aid budgets of most major industrial countries, the share of foreign aid going to support mixed credits has increased. In the process some ODA resources may have been diverted away from noncreditworthy poor countries to those countries, often middle-income, where export credit competition is strongest.
Discussions among the participants in the Consensus on further reform are continuing. Agencies and their guardian authorities indicated that issues for possible consideration include (1) further restrictions on the use of matrix interest rates, perhaps starting with abolition of matrix rates for Category II countries, and a general reconsideration of the existing provisions for interest subsidies; (2) lengthening the maximum repayment periods of conforming credits (particularly for Category I countries) to match the longer maturities now offered by commercial lenders for similar projects; and (3) further tightening the provisions on mixed credits, perhaps defining eligibility more closely in terms of developmental criteria.
Competition from Private Insurers
Over time most agencies have found themselves insuring a declining share of their countries’ exports, as private insurers, commercial banks, and self-insurance by exporters increase their role. In part this reflects the growing proportion of exports going to industrial countries, where these other forms of insurance have always played the largest role, but it also represents a declining share of business in most strong markets. This is limiting the opportunities for agencies to use profits earned from business in strong markets to subsidize losses elsewhere.
A number of private companies offer cover for export credits. Some, such as NCM of the Netherlands and Hermes of Germany, provide cover both as agents of the government for officially supported credits and as private insurers for other credits; but others conduct only private business. Their operations are concentrated on trade between industrial countries, but to a limited extent they also provide cover for trade with developing countries, predominantly in short-term business. In practice it is difficult for private insurance companies to compete with officially supported medium-term export credits where there is a substantial transfer risk. Nonetheless, some private insurers are now willing to provide cover up to perhaps three years for political risk and five for commercial risk.
Commercial banks and other financial institutions involved in trade finance often assume all or part of the risk, and a number of agencies noted increasing competition from banks in the better markets. In particular, agencies mentioned that commercial banks had recently been active in supporting trade with the Soviet Union. For medium- and long-term business with Category I countries, for which interest rate subsidies are not permissible, some banks are prepared to offer longer repayment terms than those permitted under the terms of the OECD Consensus.28
The third form of competition is self-insurance. This is particularly prevalent among companies that sell to buyers in industrial countries where there is little political risk. It is also widely used by companies that sell to established trading partners or subsidiary companies. In such situations, companies may feel able to bear the transfer risk, counting on their well-established commercial links and commitment to a long-term involvement to ensure payment, albeit with some possibility of delay.
Agencies have responded to increased competition in a number of ways. With their more flexible premium structures, they are now able to adjust premiums rapidly in the face of recent developments. They have also developed whole turnover policies, which are designed to prevent competitors from taking only the low-risk business. Some agencies have also invested heavily in information technology. This has improved their access to information on the creditworthiness of importers and has significantly reduced the time required to process individual applications.
Possible Consequences of the Single European Market for Official Export Credit Agencies
With the Single European Act, which took effect July 1, 1987, countries of the European Community have committed themselves to remove all remaining barriers to the free movement of labor, capital, goods, and services within the Community by December 31, 1992. Of particular importance to the activities of the European export credit agencies, the members of the Community are committed to the full liberalization of financial markets29 and the cross-border exchange of services, including insurance services.
The liberalization of the insurance industry will place official export credit insurance agencies from all member states on the same footing. Moreover, changes in regulatory and supervisory provisions will subject state-owned or -operated insurance companies to the same legal and regulatory framework as private companies.
The European agencies in this study broadly agreed that introduction of the unified market in 1992 would have an impact on the operations of the export credit support system in the member states, but they believed the changes would be evolutionary rather than revolutionary. There were diverse views on the likely effect of the Community’s legal framework on the ability of countries to offer official export credit support to national exporters.
For intra-European trade, it seems clear that the Single European Act will prohibit any export credit agency from providing insurance cover to its own nationals on terms more favorable than those it would grant to exporters in other Community countries. These requirements will also reinforce the tendency toward harmonization of cover policy for extra-European trade and may, in some instances, lead to privatization of at least some aspects of agency business. For example, a recent report on the future of the United Kingdom’s ECGD proposes that the short-term operations of the agencies should be split from the medium- and long-term business and that private sector involvement and capital should be introduced to the operation.30
But the same report recommends that the medium-and long-term business of the agency should continue to be conducted as a government department. This reflects the view that agencies will still be free to conduct “national interest” business for extra-European trade. Opinions differ on this question, and some argue that a strict interpretation of the law would require any agency to offer cover to all European exporters on the same terms. Nonetheless, most agencies believe that by judicial interpretation or by amendment of the law, “national interest” support for capital goods exports will continue to be permitted.
All the European agencies agreed, however, that it is likely to become increasingly difficult for agencies to operate national content rules. With the progressive integration of European production and trade, the practical problems of ascertaining the national content of exports may become insurmountable. Thus, although agencies are likely to continue to provide cover for medium- and long-term credits to the better markets, the weakening of the link to promotion of national exports may make agencies increasingly reluctant to extend cover for the more difficult cases, even when there are close traditional and cultural links between the countries. Moreover, as export subsidies would no longer be closely targeted on national exporters, there may be further impetus to reform the OECD Consensus, in particular regarding the use of matrix interest rates.
Some agencies noted that there may be other implications of the introduction of the unified market. The close cooperation and exchange of information on cover policy among official agencies might be affected by an environment in which agencies directly competed with each other. A common European export credit agency might also be created; this has been proposed by the Commission of the European Communities but has not been endorsed by members of the Community.