All the major Export Credit Agencies (ECAs) of the world have long-standing associations with financing projects in Asia. However, the story of their involvement in Asia can be likened to that of fashion trends: pleated trousers versus straight front trousers, long hair versus short hair, slim ties versus broad ties - they each take turns in being in and out of fashion.
The recent emerging market crisis has raised the interesting question of whether ECA-supported financing is back in vogue again - as all the evidence would seem to indicate, and whether it is likely to remain in fashion. A trip down memory lane may well provide us with an interesting insight and also point to future trends.
In the post-colonial era, most countries in Asia embarked on a self-sufficiency and industrialization process to transform their primarily agricultural and resource-based economies. This involved not only the development of domestic infrastructure but also the building of industrial capacity.
This in turn required substantial investment and import of capital equipment from the technology-rich OECD countries that had to be paid for in foreign currency. However, as most of the local companies in Asia did not have the necessary funds nor adequate balance sheets to raise the debt, governments or government-owned entities had to create the initial impetus by providing part of the funds required.
This still left debt to be raised at a time when the commercial banking market was still in discovery mode in Asia and shy in taking on term exposures. In stepped the ECAs, who provided the much needed credit enhancements to support the financing of these huge technology and capital equipment imports. This trend continued well into the 1980s, establishing ECAs as one of the dominant vehicles in supporting the financing of regional industrialization.
This evolutionary process also generated a market dynamic of its own. The exporters not only provided the commercial bids but also the financing packages with support from their Banks and the ECAs - very often, the availability of financing was crucial to winning commercial contracts. Consequently, exporter-Bank-ECA relationships became dominant determining forces in many projects requiring capital equipment imports. In addition, the support of local governments or government-owned financial institutions was taken for granted.
However, nothing is more certain than change. From the mid-1980s, as the Asian economies started to come of age, it became apparent that the enormous need for capital could not be borne by the government sector alone and that private investment, both domestic and foreign, was required. This paved the way for deregulation and privatization attracting investors and multinationals with ready funds for investment who were seeking low-cost manufacturing bases, proximity to markets and international expansion. The international banks followed in their wake with large balance sheets and credit appetites.
This sparked yet another change in the fashion trend and by the mid-1990s, ECAs were no longer in fashion as they were increasingly viewed as cumbersome, costly and bureaucratic in comparison to the fast moving commercial markets. With the resulting apogee of the commercial lending and project finance boom and the withdrawal of government/bank guarantees, ECAs were forced to come to terms with a new set of demands from savvy sponsors, both local and foreign, to undertake project risks on a limited or non-recourse basis.
This spawned much soul-searching and most ECAs subsequently launched initiatives to build up in-house expertise to evaluate project risks and meet these new challenges. The schemes were reevaluated to meet the new and changing realities.
This period also saw a redefinition of the role played by the banks. The old exporter-ECA-bank relationship ceased to be the sole determining criterion for winning business as the sponsors could now force competition between the exporters, ECAs and banks by taking independent decisions on the commercial contracts and financing packages.
With sponsors increasingly taking responsibility for the financing packages and terms, many banks started revising their marketing strategies, resulting in the relocation of expertise to Asia.
Then came the Asian financial crisis of 1997. The sound of commercial capital fleeing the region was thunderous. The commercial market dried up and the region realised that credit enhancements are a sine qua non for any term fund raising, even for the most well structured transactions. It seemed that the cycle had turned full circle again and the region was back to the pre-1980s era. Dire predictions about the future abounded.
However, reality is shaping up differently to predictions from both ends of the opinion spectrum. The process of recovery, albeit slow, has already begun for most of the Asian economies. New investments are already being made for the build-up of new capacities as well as the upgrading/replacement of old technologies with new and more efficient ones to meet the continuous cost pressures generated by globalization.
However, investors are likely to be more prudent and cautious than before and would now look at the addition of capacity more selectively, taking into account regional demand and supply. As such, we could expect a gradual and more mature approach towards new investments.
Today, exporters and importers also have to contend with the inexorable forces of globalization as economies become increasingly interwoven and cross-border flows of capital continue to rise. New investments in industrial production continue to shift apace to low cost environments and suppliers of capital equipment and technology are becoming increasingly borderless in their effort to cut down their manufacturing costs. As a result, projects are becoming more and more denationalized with multi-sourcing of both investments and the equipment. Multi-sourcing of equipment in projects, therefore, will likely become more and more of a norm rather than an exception. This driving force of globalization is already changing the rules of the game for the exporters, importers/sponsors, ECAs and the international banks.
Each of the past crises since the 1980s has resulted in a significantly higher awareness of the risks and mitigants among the international banks and the ECAs, as none have escaped unscathed. As such, we are unlikely to see the dilution in the terms and credit structures seen in the market in the early 1990s, and only well structured and demonstrably viable projects are expected to see the light of day. The credit appetite of the banks is a scarce resource and market liquidity is likely to remain tight until the regional banks, particularly the Japanese and Koreans, are able to recapitalize and clean up their balance sheets. The prognosis, therefore, is that the region may see a very much more measured and mature lending appetite.
Where does that leave the ECAs? Would it be reasonable to assume that ECAs would again be resurgent and be the major players in the region in the financing of projects for a fairly long time to come? Or shall we witness another change in fashion as the Asian economies start to re-emerge from the difficult days and the commercial markets again become resurgent?
The answer to that does not necessarily require crystal ball gazing. The evolutionary pattern evidenced so far points to the direction in which ECA financing in the region is likely to evolve.
We believe that ECAs will continue to play a pivotal role in the recovery of the region. They provide much needed stability through the continuous provision of credit enhancements which act as a counterweight to the volatile commercial capital flows. ECAs are also able to act where market solutions may not be continuously present as they have more risk absorption capacity and patience as compared to the commercial market.
ECAs are also credited for usually being pioneers in untested markets. As such, the role of ECAs in the rebuilding of the industrial infrastructure in Asia is going to be an important one. However, the relationship between the commercial loan markets and ECAs is likely to evolve towards partnership rather than competition.
The last two decades have provided evidence that ECAs are also not immune to the forces of change and globalization. They need to evolve with the times to ensure they do not go out of fashion. The capital markets will continue to push the envelope as they develop new tools for evaluating, managing and mitigating risks. Private insurance and credit derivatives are already making inroads into the credit enhancement markets that have traditionally been seen as the preserve of the ECAs.
This challenge from capital markets and private insurers will only intensify and their relative swiftness of decision-making and market orientation will pose a serious threat to the traditional boundaries of the ECAs. The ECAs will thus have to evolve and change or face the risk of being marginalised. However, they will also have to spruce themselves up and shed the stodgy bureaucratic image generally associated with them.
The build-up of expertise in the project finance area will need to be continued by the ECAs to better analyze risks and tailor solutions. The emerging markets crisis has taught both the commercial market as well as the ECAs a few new things about risks in projects. The lessons of the past few years indicate that the existence of deep pockets alone will not be sufficient to meet new challenges or the survival of another crisis.
To meet the challenges from a more nimble commercial market, without giving up their fundamental objective, the ECAs would need to become more in synch with the market in adopting risk evaluation, management and mitigation tools, pricing of the risks and sharing risks with the private sector. It will also be imperative to develop new know-how and instruments like collateral structures, derivatives and repackaging etc.
A revamp of the various financing and interest subsidization schemes would need to be undertaken to bring them more in line with the market. Credit due diligence processes would need to be strengthened without expense to the time taken for decision-making. More importantly, a more proactive interaction with the market may be needed, and Mohammad may well end up having to go to the mountain to achieve the market orientation.
Two centuries ago, a French philosopher remarked: "If everyone had done exactly as his predecessors did, man would still be living in caves." We are sanguine that ECAs will rise to the challenge, and are not about to return to the caves. Instead, we believe that they will march towards a new future and a brave but complex new world.
Pradeep Mathur is managing director, head of structured export finance, Deutsche Bank.