Even if only some of the points raised in the previous chapters are valid, and if only some of the changes described there come to pass, export credit agencies may well be at a watershed. This is especially true of the way in which their political risk business is done.
A not uncommon view in some export credit agencies is that as soon as claims arise, the newly entrant insurers and reinsurers from the private sector will disappear. However, this is surely a misreading of the nature of insurance markets and of the business sense of those in the private sector who engage in this activity. Insurers and reinsurers know that business that never gives rise to claims is business that will constantly be at risk. Either other insurers will enter the field, offering lower premium rates, or, probably more dangerously, the insured parties will begin to opt for self-insurance, and not seek cover from any outside source, public or private. Therefore, insurers and reinsurers expect to pay claims—what they hope is that these claims will not regularly exceed their premium income, although every so often they may.
In addition, the capital markets have shown some clear signs of being willing to finance quite substantial projects through bond issues, again without seeking traditional or, indeed, any insurance facilities from export credit agencies. But a large question mark must be raised over this development until the fallout of the recent problems in Southeast Asia, Russia, and Latin America—and, in particular, the impact of these events on international capital markets—is rather clearer than it is now.
Bond issues are, of course, one form of self-insurance. But the fact that so many bond market investors were—and perhaps are still or soon will be again—no longer afraid of lending for projects in emerging markets must have some effect on the position of political risk underwriters in both the private and the public sector. But as noted earlier, important in this context is the extent to which bonds and bondholders play a full part in debt problems and in their resolution.
A Dilemma for Export Credit Agencies
For many official insurers, their mandates from their governments are likely to come under severe strain. Many have been assigned the dual objective of breaking even over time while not competing with the private sector. Thus they remain, in some ways, insurers of last resort. But these are two increasingly difficult horses for the same person to ride at the same time.
It would make matters worse if, having withdrawn from, say, the short-term trade finance business, an official export credit agency were later compelled by its government or guardian authority, for political or diplomatic reasons, to reenter that area. This could happen if private sector banks or insurers threaten, for whatever reason, to cut all existing lines and exit the business. This possibility not only creates moral hazard, as mentioned elsewhere, but also makes it still harder for official insurers to break even.
If they are to break even, then, like any insurer, they need to be able to spread their risk. But if their mandate is not to seek to do any piece of business that the private sector is prepared to take, the pool of business over which they can spread their risk will inevitably dwindle as private sector activity expands. Thus, an interesting question will be the extent to which the private sector and the public sector can both cooperate and compete.
In the area of investment insurance, signs are already evident of a much greater willingness on the part of both private and public insurers to cooperate. Most of the larger Berne Union members are already engaged in some such cooperation, which has reached the stage of issued cases. A striking and potentially significant example of such public-private cooperation is the recent Quota Share Treaty Reinsurance Agreement between the Multilateral Investment Guarantee Agency (MIGA, an affiliate of the World Bank) and ACE Bermuda Insurance Ltd. ACE will reinsure the full terms extended by MIGA as regards both the spread of risks covered and the horizon of risk.
However, it is difficult for official insurers to work on the basis that any piece or category of business that a private insurer is willing to undertake is one from which public insurers must unilaterally withdraw. This may, in turn, highlight not only the question of what is and is not fair competition, but also the question of what competition between a private and a public insurer really means. For example, whereas private sector insurers are required to pay taxes and are subject to regulation, many public and publicly owned insurers are not. Also, public insurers have facilities that banks can use to get “zero weighting” of various kinds or lower capital requirements or nil provisioning from bank supervisors.
A Dilemma for Project Sponsors and Others
Those on the other side of the export credit transaction, especially those involved in financing and insuring major projects, also face a dilemma. If official export credit agencies are forced to atrophy as the private sector takes over the business, how will they be resuscitated should the international trade and investment climate again change and they are once again needed?
In particular, suppose that over time the impact of the crisis in Southeast Asia proves not to be huge. There may then be a continuation of the trend toward a reduced level of business done by export credit agencies, as other parties are prepared either to lend into projects or to invest in projects without insurance, or as private sector insurers play an increasingly large role. The seemingly inevitable result will be that the ability of the export credit agencies to keep their infrastructure of staff, experience, and expertise in place, to provide once again either export credit or investment insurance facilities when and if required at some future date, will also begin to fall away. It is quite unrealistic to assume that the existing infrastructure of the export credit agencies can somehow be frozen in limbo, to be brought back to life like Sleeping Beauty if and when the situation changes.
Another extremely important question is what will happen in the future when some projects get into difficulties. It is inevitable not only that some projects will have problems, but also that some countries will at some time run short of foreign currency. Indeed, both have already happened in Southeast Asia.
The new conventional wisdom is, perhaps, that the solutions of the past (particularly multilateral debt reschedulings through the London and Paris Clubs) will no longer be needed, since it is the exchange rate that will take the strain. But how realistic is this, particularly where devaluations are large and where infrastructure projects are involved? Take the case of a water project. Consumers may be unaccustomed to paying anything for water, let alone its true economic cost. And even if tariffs are charged, water projects are unlikely to generate any foreign currency. Thus, if a country runs into foreign exchange difficulties and there is a severe depreciation of the local currency, significant increases in water tariffs will be necessary to buy the foreign currency with which to repay foreign creditors and investors.
No one should underestimate the political sensitivity and difficulty of this issue. Nor are water prices alone in this regard: projects to provide electric power, natural gas, and telecommunications—to name a few—are subject to this scenario as well, and their consumers are also voters. Foreign creditors and insurers are not.
For this and other reasons, all lenders to projects should agree at the outset that, if problems arise with respect to repayment or on the availability of foreign exchange, all creditors will be expected to share the pain and grief. Apart from all else, this is the best and quickest way of achieving the concentration of interests and energies needed to solve problems, rather than trying to leapfrog other creditors.
It is dangerously unrealistic for capital market lenders, for example, to assume that they should or will somehow be given, in effect, the status of preferred creditors. Other creditors, including export credit agencies and banks, may prove unreceptive to the argument that there will be “chaos in the capital markets” if capital market lenders are not repaid on schedule. Such blackmail is unlikely to be effective, because official bilateral creditors of various sorts are likely to insist that all creditors bear or share the consequences of debt problems equally, both with respect to the projects in which they are involved and more generally.
It sometimes seems that some creditors and potential creditors have read too much into what happened in Mexico a few years ago and have come to believe that the United States, directly or through the international financial institutions, will mobilize huge sums to rescue creditors faced with losses. Arguably, the most prudent course for all creditors, lenders, and investors to adopt is that Mexico was in a totally unique position and represents no kind of precedent.
Another question that will present challenges for many entities—including, but not restricted to, export credit agencies—is what to do about subsovereign entities such as states and municipalities. Can these be underwritten in their own names? What about their undertakings that are not supported or countersigned by the central government? This kind of problem is not restricted to China and Russia.
Initial Conclusions for Export Credit Agencies
Although it is difficult either to draw conclusions or to make predictions in such a diverse area as export credit, it seems clear that some significant background changes are still in train. The role of creditor governments in exporting and investing countries is undergoing significant change. And so is the role of governments in buying and debtor countries.
The export credit agencies continue to play a role of central importance. However, they have to recognize that their traditional position faces a severe challenge, and that they no longer have monopoly products—in either the short-term or the medium- to long-term end of the business. They must make energetic efforts to make their facilities more user-friendly, not only to respond to competition from other insurers, but also to retain as customers those lenders and investors that may no longer feel the need for insurance.
All export credit agencies are required—by the World Trade Organization and, usually, by their finance ministries—to break even, but doing so will be very difficult to the extent that they become, in practice, only insurers of last resort. The mandate to break even is inconsistent with the view that agencies should be providers only of insurance to transactions that no one else will insure, or financiers of projects that no one else will finance.
Export credit agencies must also become more willing and better able to match their credit terms more closely to the actual cash flow needs of projects. This will involve changes—and much greater flexibility—in the provisions of the OECD Arrangement. Some progress has been made, but more needs to be done. An inescapable fact in this and other contexts is that it is dangerous to try to put all project financings into the same category. For example, a telecommunications project may have a very different cash flow profile than, say, a power project or, especially, a toll road or a subway project.
As has been argued throughout this volume, export credit agencies have played and continue to play a role of real importance in world trade and investment flows. However, both the background to their operations and the market conditions they face continue to be subject to substantial change. In the area of short-term trade finance, export credit agencies now face not only growing competition from insurers in the private market, but also sharper questioning from their own governments about the proper role of public sector entities in this kind of insurance. In the areas of medium- and long-term credit and investment insurance, the basic business model and the nature of projects have changed, from one where the host government was the buyer or guarantor of payment to one of highly complex and sophisticated project financings and security packages. Also, export credit agencies are unlikely to retain a monopoly or even a dominant position, where the credit terms that projects need cannot be underwritten due to restrictions from the OECD Arrangement.
Among the basic challenges that export credit agencies face is the need to keep up with these changes in the marketplace, and this means maintaining the staff and resources necessary to adapt. Another challenge is to address the fundamental conundrum: whether they can be insurers of last resort, doing only that business that other insurers, or banks or capital market lenders, or factors or forfaiters, will not or cannot do, while at the same time breaking even. Export credit agencies need both the income and the expertise and experience that come only from an adequate spread of risk and a sufficient volume of business. They cannot be somehow mothballed periodically when private market capacity is sufficient, to be put back into service when, for whatever reason, that capacity shrinks or disappears.
There are already some clear signs that this basic conflict between the twin objectives of breaking even and being the insurer of last resort is no longer a theoretical one. Heretofore some have suggested that the conflict is not a real one because
The period over which the business of official export credit agencies is expected to break even is a very long one, longer than would be acceptable in the private market
Official export credit agencies do not pay taxes, and
The shareholders in official export credit agencies (i.e., governments) do not expect to receive any dividends.
All of these points deserve careful evaluation. But in the author’s view, although they do demonstrate that official export credit agencies are different from private institutions, they do not prove that it is possible to avoid losses that exceed income if the only cases underwritten are those that no other insurer will take. In any case, the argument that official export credit agencies pay no taxes or dividends is moot if the agencies make net losses on a regular basis.
But one issue that should be of interest to private insurers is that if these three points are applied in practice, they are likely to lead to official export credit agencies charging lower premium rates than private insurers would require to turn an adequate profit. And this, in turn, would raise some very sensitive and difficult issues, not least that of whether it is in any sense the role of official export credit agencies to be supercompetitive, undercutting the premium rates of private insurers.
Put another way, the notion that official export credit agencies can both be insurer of last resort and, at the same time, meet the WTO mandate to break even suggests one of two things. Either it underestimates the skill of the private sector in assessing risks and pricing them to market, or it overestimates the quality of the risks being underwritten. And an insurer of last resort will, in practice, be unlikely to acquire and, especially, to maintain the skills, experience, and expertise required to operate right at the margin of high-risk business.
These issues are not likely to go away, and therefore it would almost certainly be helpful to address them in an open way. They impact not only on the ability of official export credit agencies to break even, but also on whether and on what basis competition will take place between the public and the private sectors.
Thus, export credit agencies face many challenges, but at the core is the need for agencies themselves and their governments to address these fundamental questions, which are essentially practical business questions, not theoretical or philosophical ones. It is perhaps not too much of a caricature to ask what future viability an export credit agency can have if left only with a mix of business from small exporters and projects in difficult and unstable markets that do not generate foreign exchange.
Clearly, these will remain interesting times for export credit agencies, their governments, and their customers.