Food imports account for a large part of the total imports of many developing countries. This study looks at the current practices for financing the major food imports (of wheat, maize, rice, palm oil and soybean oil) of Least-Developed Countries (LDCs) and Net Food-Importing Developing Countries (NFIDCs). It examines the main entities involved in food trade and in food finance, the various national schemes set up to facilitate food finance, and the factors that determine whether certain transactions can be financed and under what conditions. It examines in more detail the major finance mechanisms as used for food import flows, and the constraints inherent in these mechanisms, with a particular focus of the vulnerability of financing mechanisms to price shocks. This issue figured prominently in discussions during the Uruguay Round and the Marrakesh Agreement (which, among other things, led to the creation of the World Trade Organization), and gave rise to the “Decision on Measures Concerning the Possible Negative Effects of the Reform Programme on Least-Developed and Net Food-Importing Developing Countries”, sometimes simply referred to as the Marrakesh Decision (Annex 1 gives the full text). In this, Ministers recognized “that as a result of the Uruguay Round certain developing countries may experience short-term difficulties in financing normal levels of commercial imports and that these countries may be eligible to draw on the resources of international financial institutions under existing facilities, or such facilities as may be established, in the context of adjustment programmes, in order to address such financing difficulties.” This study examines how food financing operates, how short-term difficulties which can impact on food security may occur, and what can be done about it.
While state entities still play an important role in the export of wheat and rice, food imports in LDCs and NFIDCs have been largely privatized. In contrast to the situation ten years ago, private traders and processors now dominate imports of cereals and vegetable oils. Important exceptions are the Comoros, Cuba, Mauritius and Tunisia, where government agencies still have a monopoly on the import of many key foodstuffs. In a number of other countries (Cape Verde, Egypt, Kenya, Malawi, Mauritania, Morocco, Sri Lanka and Zambia), government entities operate alongside private ones. In Egypt, one such government agency, the General Authority for Supply Commodities, GASC, is perhaps the world’s largest grain buyer.
Government import agencies are in a somewhat better position than private entrepreneurs in financing the imports of grains and vegetable oils. They are often able to pay cash on shipment (using their credit lines with local banks); or they may obtain credit from their supplier (e.g. because the supplier can obtain credit risk insurance against the risk of payment default); or they qualify for export credit schemes set up by exporting countries. This does not imply that their financing conditions are good - if their country’s financing position is poor, this has an impact on their access to finance (rates and tenor). They may thus be vulnerable to deteriorations in their environment (e.g. falling export revenue for the country as a whole) and in their situation (e.g. the need to buy more in value terms, either because of the need to buy a larger volume, or as a result of increased world market prices).
Private traders and processors generally do not have easy access to import finance, unless they are part of an international group and the financing is an intra-firm transaction. Processors are slightly better off: their large fixed assets tend to give them access to some form of credit, either by the seller (again, this may be possible because the seller can obtain credit insurance), or by a local or international bank. For private traders, the situation can be difficult. They often have little track record, and few hard assets. If they have lines of credit with their local banks, these often have to be collateralized, and costs are high; similarly, if they wish to open a letter of credit, they may have to provide 50-100 percent collateral. In some cases, they can benefit from government-to-government umbrella arrangements (such as the Palm Oil Credit and Payment Arrangements set up between Malaysia and a number of importing countries, under which importers can obtain a credit for the import of palm oil just by making arrangements with a local bank). In other cases, they have to resort to warehouse receipt finance, a credit form which is highly suitable to risky environments but can be costly.
Financing conditions differ from country to country, from commodity to commodity and from importer to importer. These differences are linked to the physical differences in trade transactions. Wheat, for example, can be transported most economically in large vessels, while rice is often shipped in containers. The differences also depend on the size of market players: rice is often traded as a finished product ready for sale to customers, which means that small traders can buy it; while wheat has to be milled, which requires a rather expensive processing plant. Finally, they are linked to the particular state of a country’s banking system and riskiness: in some countries, there are simply no local banks that have uncollateralized lines of credit with foreign banks. In rice trade, payment on a cash-against-documents basis is common, and letters of credit are rare; for the other major foods covered in this report, the opposite is true. Much palm oil is traded under the government-to-government umbrella arrangement already mentioned above, as is a large volume of rice; but this is rare for other commodities. In some countries, credit may be relatively abundant, or governments may allocate credit priority to Food-Importing companies; in others, credit is scarce, and importers may be faced with a real interest rate in the double-digit range. Even within a country, some importers, such as processors, state-owned entities, subsidiaries of international firms, may have easy access to credit, while others have poor access.
Credit relations have two components: who provides the finance; and who takes the risks. Thus, credit relations can be constrained in two regards: finance capacity, and risk-taking capacity. A North-South divide characterizes finance capacity: capital is abundant and cheap in developed countries, while in most developing countries, it is scarce and expensive (with prime rates in real terms in many cases in the double digit range). There may also be a divide within the country, if the government operates a credit rationing system under which certain priority companies or sectors have preferential access to credits. Risk-taking capacity is a major constraint both between developed country financiers and developing country counterparties, and between developing country banks and their local clients. The burden of food finance can be shifted from the importing country to the exporting one, but this requires the financier in the exporter’s country to take on more risk.
Thus, access to food import finance will be primarily constrained by risk carrying capacity, rather than by an absolute lack of finance. One way of tackling food import finance problems is to provide direct credits to the importer. Another is to create the conditions under which international financiers are able to provide such credits, directly or more likely, through one or more intermediaries such as local banks. The latter is probably more cost-effective and sustainable in the long run; the first is easier in the short run, but its sustainability is doubtful. Providing general balance of payment support may in some cases have very little effect, and even in the best of circumstances is a crude and inefficient instrument for solving food import finance constraints; targeted measures are more appropriate. In other words, one of the possibilities mentioned in the Marrakesh Decision, drawing “on the resources of international financial institutions under existing facilities” in order to deal with short-term problems in financing normal levels of commercial imports”, would seem to be impractical.
It is useful, then, to consider the main constraints for more efficient food import finance. These constraints are at the national level (the cost and scarcity of finance, and the credit relations between the local banks and food importers), and at the international level (the relations between the importers and local banks on the one hand, and between international traders and banks on the other).
If finance is indeed costly and scarce locally, then importers should try to benefit from extended payment terms for their imports, or otherwise “extend” international credit to their own local operations. This is often difficult because of the perceived risk of such finance, and the difficulty of managing these risks. Even local banks often feel uncomfortable with taking the credit risk of food importers. In many cases, they will insist on full cash collateral before opening any international payment instruments. The underlying constraint here is the lack of ability of the local bank to manage the credit risk of food importing clients, which is made worse by an inappropriate legal and regulatory environment for warehouse receipt finance. Often, local banks require collateral in the form of real estate or cash, which means that their clients’ credit availability is constrained and cannot easily be adjusted to increasing financing needs.
Developing country clients, whether they are importers or banks, are generally considered as risky counterparts by developed country traders and banks. Generally, the credit exposure that they have has to be provisioned against (under the rules of their central bank), which makes such credit costly. Also, both international traders and banks have credit ceilings for their exposure to developing country clients, expressed in nominal amounts, which makes them difficult to adjust to increased financing needs. In principle, they can lay off credit risk on the secondary market, but this market is generally not very deep, which means that, if more than a certain amount of paper from a given bank or country is placed on the market, the costs of using the secondary market can quickly rise.
These various constraints reinforce one another. An integrated programme of interventions is necessary. To make the food import financing system for LDCs and NFIDCs more efficient, an integrated programme of interventions is needed. Support should start with capacity building, enabling local banks to become better counterparties for international banks, which will lead to higher credit ceilings; and making them familiar with warehouse receipt finance, the form most resilient to food price increases and providing the largest scope for up-country finance for importers. These banks should also be given more access to advice on matters related to commodity finance; international organizations, with support from the donor community, could consider enhancing their advisory functions. Capacity building should also encompass government officials, so that they know which rules and regulations hinder food import finance and how these can be improved, as well as including potential service providers such as collateral managers. Capacity building is essential: without it, even if one enhances the capacity of local banks to obtain offshore credit lines, local importers may still not be able to meet the bank’s collateral requirements for, say, opening a letter of credit.
Furthermore, extra country risk capacity is necessary. One way to achieve this is to provide extra insurance capacity, for example low-cost sovereign risk insurance for goods in stock. Extra liquidity on the secondary market can also be provided for example through forfeiting facilities, or buying food-trade-related paper from certain countries once the implicit margin on these purchases becomes sufficiently high. Another possibility is to provide currency convertibility risk coverage. On a bilateral basis, Bilateral Payment Agreements can shift country risks from an exporter to his government.
Extra bank credit risk capacity can also be provided. For example, an international agency can add a guarantee to the avals provided by local banks, or provide insurance for local bank credit risk. The range of collaterals accepted by international banks for giving credit lines to local banks could be increased by new insurance facilities.
All these measures work with the system - smoothing the path for certain forms of finance, opening the way for others. In many cases, leverage works to good effect: relatively low-cost actions can make a considerable amount of extra finance available, or lead to considerable reductions in financing costs. It is not necessary to create completely new mechanisms, nor to introduce market-distorting practices. Rather, the benefits of an efficient financial market are extended to food importers in developing countries and, by implication, to the hundreds of millions of food consumers in these countries.
Pursuant to the Marrakesh Ministerial Decision, 17 net Food-Importing countries made a proposal for the establishment of a “revolving fund” to ensure that adequate financing is available to LDCs and NFIDCs during times of high world market prices. The concluding chapter briefly elaborates upon how such a fund could be structured in such a way that it requires no large new bureaucracy, is cost-effective, is efficient in enabling needy countries to obtain timely finance for food imports, and helps to improve the international trade in foods.
A “revolving fund” needs to reach the private sector, to ensure sufficient imports during times of high world market prices, or if a reduction in food imports at concessional terms (e.g. food aid) makes larger imports at commercial terms necessary. However, as argued above, the private sector is already constrained in its access to finance. It normally needs to buy on “deferred payment” terms, meaning that its foreign suppliers need to accept the credit risks of developing countries’ traders. Suppliers can manage this credit risk exposure in several ways, but ultimately, they are constrained through the total credit risk that the market can absorb. Therefore, the currently available private-sector facilities for financing developing country importers meet absolute constraints, and cannot be adapted to sudden increases in financing needs except at great pain, such as large increases in country risk premiums and thus, import costs.
Given these constraints imposed by market mechanisms, a special facility to deal with food trade financing needs in times of crisis can be useful. However, such a facility should aim to relieve import needs when they arise, rather than reimbursing governments many months after the problems arise. To make finance available in time, the “revolving fund” can rely on objective trigger mechanisms, based on world market food prices and known reductions in concessional exports. These factors are not the result of policies of the governments benefiting from the fund’s support, and thus, no review of the food policies of prospective borrowers would be required.
Furthermore, the fund should rely on disbursement modalities that ensure that the companies that actually import the food benefit from the financing; and also ensure that funds are actually used for food imports and not diverted to other operations. Building on the existing modalities of food trade and its financing makes this possible. Current contractual practices and the involvement of banks at several stages of the food trade financing chain give a good basis for a “revolving fund” to provide targeted finance. From these, it is possible to construct fund disbursement mechanisms that make it virtually certain that funds will be used for food imports by experienced local companies with a good track record. How this can be done is discussed in detail in the paper.
It is also essential to ensure that funds are reimbursed. International food trade is not without its problems - contract defaults or even frauds occur - and at a national level, it has often been difficult for food trade financiers to recuperate their funds. By shifting part of the financing risks to banks, the capacity of banks to identify potential problems and prevent them can be optimally used. With sovereign guarantees further backing national reimbursement obligations, serious payment defaults can be made unlikely.
As the proposed mechanism builds on existing information and the market’s current contractual habits and financing mechanisms, and it requires no policy review process, a “revolving fund” of this nature is easy to administrate. It would thus require only a small secretariat. The “revolving fund” itself would not have to be paid-up; rather, donor countries could give “conditional guarantees” against which the fund could obtain financing when required. The overall cost of ensuring that eventual increases in food import bills, resulting from the implementation of the World Trade Organization agreement, will not endanger the food security of LDCs and NFIDCs is thus low. Moreover, it is a temporary cost and there are important positive multiplier effects: the secretariat of the “revolving fund”, by working with national counterparts to improve food financing mechanisms, would create a better functioning of the food sector, and over time, would make itself and the facility superfluous.
