Article

by Mark Ford

Political currents have long helped shape the letter of credit market. Politicians are well aware that policies employing L/Cs can be used to boost cross-border trade, force or block geopolitical change as well as to support or protect domestic policy.

While the Arab Spring has inspired positive sentiment in many quarters, it has made life difficult in some parts of the L/C market. In post-Mubarak Egypt, importers have found difficulties obtaining L/Cs for some imports. According to local sources, L/Cs for fuel imports became either very much more expensive, or in some cases unobtainable after the June 2012 election of President Mohammed Morsi. Heavily indebted Greece, where all types of credit are tight, has had to resort to premium priced fuel imports on open account terms from Swiss trading houses Glencore and Vitol, which reportedly levy hefty premiums on their selling price in return for their support.

More stable countries

In countries where the political climate is warming, L/C availability is improving. Private banks in Myanmar have begun to offer L/Cs as the country's political rehabilitation readies it for a normal position in the global trading community after years of exclusion. Myanmar is also making moves to simplify its L/C market.

The International Finance Corporation (IFC) has been supporting Libya's economic restructuring efforts, while the Central Bank of Libya announced in June 2012 that it had reduced the cash deposit required for L/C openings from 25 to 15 per cent in an effort to simplify the process and to stimulate economic recovery.

After more than half a century of tension and instability, relations between Taiwan and China have improved since 2008 when the two states agreed to restore relations. Establishing frameworks for L/C business has been a priority, and Taiwan's banking regulator has been issuing licenses to mainland Chinese banks.

Sanctions

International sanctions imposed by the UN, the EU, and especially the US on a third country's financial institutions that stem L/C flows, have proved one of the most potent geopolitical tools of recent years.

Syria has become one of the latest countries to have its ability to conduct L/C business limited by international sanctions. In November 2011, the EU followed the US by freezing transactions with the Commercial Bank of Syria, which handles all L/Cs for the regime of President Bashar Al Assad. But the idea is not new - the US embargo on Cuba has been in place since the 1960s. No bank in the US or overseas branch or subsidiary of a US bank may advise an L/C involving Cuba or a Cuban national, nor may it process documents referencing Cuba.

One important aspect of sanctions is their impact beyond the country or entity imposing the sanction and the state on which the sanction is imposed. "It took us time to realize what the impact would be of US and UN sanctions imposed on Iran because of their nuclear program. If Malaysians want to keep warm relationships with the US and the UN then we have to comply with their wishes," one Malaysian banker told DCInsight.

The raft of international sanctions on Iran has had a big impact on the country's ability to enter into L/Cs transactions, with banks in some places calling a halt to L/C business even when they were not legally obliged to do so. "Since 2010, Hong Kong bankers have generally said they will not touch anything to do with an Iranian transaction. This means banks simply took the blanket decision to not deal with anyone with an Iranian connection in any way to appease the Americans," according to a Hong Kong banker.

Many major Iranian L/C providers, such as banks in Dubai and Oman, continued to resist international pressure to cease business, but buckled under much tougher US and EU sanctions on Iran when these were imposed in 2012.

There is some debate about how completely international sanctions on Iran have curtailed the market for Iranian L/Cs. Smaller banks are reportedly still providing L/Cs for legitimate trades with Iran. One Swiss banker told DCInsight that banks in the country still provide L/Cs for properly authorized trades. They can charge premium prices, typically, she says, around six per cent higher than prices charged for conventional trade finance products.

Iran has played down the impact of sanctions, with the semi-official Iranian Fars News Agency (FNA) reporting that Russia was contemplating reintroducing L/C transactions. The FNA has also reported that negotiations for banking facilities for wheat transactions have been also been held with a bank in India.

But the sanctions are biting. Dubai's Iranian expatriate trading community complains vociferously about the L/C shortage. In October 2012, Sri Lanka said it had arranged L/Cs to purchase oil from Oman and Saudi Arabia because it could no longer obtain L/Cs for Iranian purchases.

Domestic considerations

Governments can facilitate L/Cs to help implement policy or support the domestic economy. State guarantees for L/Cs supporting private power projects in India are routine. State-owned Pakistan Steel Mills was recently able to open L/Cs to buy coal, but only once a bailout package was provided by Pakistan's government.

Governments can insist importers use L/Cs to protect foreign reserves. The Central Bank of Iraq (CBI) has mulled requiring Iraqi importers to do business on bank guarantee or L/C terms in response to suspect transactions and foreign currency smuggling. CBI's deputy governor, Muzher Mohammed Saleh, told local media that the bank was responding to hard currency losses due to "murky deals and smuggling of foreign cash".

Recent reports point to relatively low levels of lending to small- and medium-sized enterprises (SMEs) in the UAE and the wider Gulf Cooperation Council (GCC). According to one local banker, this means there is potential for growth in SME financing in the region, including the provision of L/Cs.

The world's newest country, South Sudan, found support from Qatar to secure L/Cs to help stem the country's estimated US$1 billion a year hard currency losses due to informal trading with Kenya and Uganda. South Sudan secured a US$100 million deal from Qatar National Bank (QNB) to be used to issue L/Cs for imports of essential goods. Qatar has been very supportive of South Sudan since it gained autonomy in July 2011, so this facility could also be seen as a geopolitical move by QNB, which is 50 per cent owned by the Qatari government.

That one state is prepared to help another in this way underlines how important a functioning framework for L/Cs is for an economy. This was recognized by politicians worldwide who, in the wake of the global financial crisis, backed support measures introduced or expanded by development agencies to make L/Cs more available, particularly in less developed countries. Today, schemes such the IFC's US$3 billion Global Trade Finance Programme (GTFP) provide structural support in some of the world's toughest L/C markets.

Around 80 per cent of the GTFP's guarantees support L/C transactions, and the program has played a role in what it describes as 15 fragile states and challenging markets, including Democratic Republic of the Congo, Haiti and Liberia.

But in Somalia, which has not had a government since 1991, the political vacuum is so great that international support for financial markets is unavailable. That does not mean that the prospects for L/Cs in this troubled part of the Horn of Africa are nil. Dahabshil Bank International, which operates out of Djibouti with a strong focus on serving the Somali diaspora, says it plans to open two fully licensed banks in the unrecognized East African state of Somaliland, one in the semi-autonomous state of Puntland and another in the capital of Somalia, Mogadishu.

It's clear that as long as L/Cs are key to functioning economies, they will continue to be subject to political pressures.

Mark Ford's e-mail is markford@gotadsl.co.uk