By Lodewyk Meyer and Lucy Stratton
As stated by President of the African Development Bank (AfDB), Akinwumi A. Adesina, “trade finance is an important instrument for influencing Africa’s long-term economic development and structural transformation”.
According to a report by the AfBB and the African Export-Import Bank (Afrexim), Trade Finance in Africa: Trends Over the Past Decade and Opportunities Ahead, the region was one of the most integrated with the rest of the world in 2011. However, in the last decade, Africa’s trade growth has been one of the worst among the major regions of the world. This is as a result of a number of factors including falling commodity prices, competition, inadequate foreign exchange liquidity, regulatory challenges and access to trade finance, as banks have gradually been scaling back activities from riskier markets.
The study showed that although trade finance remains a popular activity among banks in Africa, the participation rates continue to decrease, falling by 16% between 2013 and 2019. As a result, the trade finance gap in Africa averaged USD 91 billion for the period between 2011 to 2019. Furthermore, the trade uncertainty in Africa was exacerbated by the impact of the COVID-19 pandemic, which resulted in a twin supply-demand shock across the continent. Supply was affected by mass production shutdowns and supply chain blockages and demand for products from Africa decreased globally.
Despite the persistently large trade finance gap, trade remains a key driver of Africa’s social and economic development. As a result, banks such as the AfDB and Afrexim have sought to stay on top of market developments and provide solutions to boost intra-Africa trade.
On 1 January 2021, significant progress was made with the commencement of free trade under the African Continental Free Trade Area (AfCFTA) for African countries that had ratified the AfCFTA agreement and submitted their tariff offers, an initiative that had been in pipeline since 2012.
According to Baker McKenzie’s research with Oxford Economics – AfCFTA’s US$ 3 trillion Opportunity – there are now unprecedented opportunities for Africa, and its trading partners, to reap economic benefits on the back of the possible improvements in transport infrastructure, reduction of red tape for cross-border dealings, renewed funding and improved liquidity.
If successful, AfCFTA will provide the opportunity for African countries to diversify their economies, scale production capacity and widen the range of products made in Africa, in particular boosting the production of manufactured goods (and the potential for multinational companies to set up manufacturing plants in the continent). Closer integration of neighbouring economies is a potential avenue for creating scale and competitiveness through domestic market enlargement, thereby promoting development, and boosting foreign investment through greater efficiency.
In addition to AfCFTA, the AfDB have been at the forefront of finding solutions to decrease the trade finance gap through its “High 5” strategic priorities to: (1) power and light up Africa, (2) feed Africa, (3) industrialise Africa, (4) integrate Africa, and (5) improve the quality of life of the people of Africa.
In July 2021, the AfDB, through its Financial Sector Development’s Trade Finance operations, launched the transaction guarantee instrument as a means to increase trade finance on the continent. The AfDB recently noted that the new instrument would enable local financial institutions to build relationships with international banks, thereby increasing their network of global trade finance partners. It would also improve access to finance for African small and medium enterprises, for example.
According to the AfDB, the instrument will provide regional and international banks with up to 100% non-payment risk coverage, for trade transactions that are initiated by local banks in Africa. The guarantee will cover various trade finance instruments, including confirmed letters of credit, trade loans, irrevocable reimbursement undertakings, avalized bills and promissory notes.
In a recent a presentation given by the AfDB, it was noted that the transactional guarantee would assist in lowering the trade finance gap in Africa for the following reasons:
- It will help to attract correspondent banks to the region and increase headroom for African issuing banks
- It will support transactions for underserved groups and sub-regions with higher than usual rejection rates
- It will assist local issuing banks that are finding it challenging to compete due to lack of correspondent relationships, as well as provide opportunities for capacity building.
Further efforts to increase intra-African trade received another boost on 9 February 2022 when AfCFTA and Afrexim signed an agreement relating to the management of the Base Fund of the AfCFTA Adjustment Fund. It is reported that the Fund will support African countries and the private sector to effectively participate in the new trading environment established under the AfCFTA.
The Funds consists of the following:
- Base Fund – consisting of contributions from State Parties, grants and technical assistance funds to address tariff revenue losses as tariffs are progressively eliminated
- General Fund – to mobilise concessional funding
- Credit Fund – to mobilise commercial funding to support both the public and private sectors.
The Base Fund has been launched to address the urgent needs of countries relating to tariff revenue losses and the transposition costs to enable them to implement the AfCFTA agreement. The General and Credit Funds will be launched in the coming months to address the needs of the private sector including small and medium enterprises, women and youth, according to Professor Benedict Oramah (President and Chairman of the Board of Directors of Afrexim).
The Adjustment Fund follows the Pan African Payment and Settlement System (PAPSS), which was launched on 13 January 2022 in Accra, Ghana. PAPSS is a centralized payment and settlement system for intra-African trade and commerce payments. Wamkele Mene, Secretary General of AfCFTA, stated that PAPSS was critical to the promotion of intra-African trade, as African countries would no longer need to use third party currencies during trade transactions among themselves.
Since the establishment of AfCFTA, there have been significant developments for intra-African trade with the launch of Transaction Guarantee instrument, PAPSS and the Base Fund of the AfCFTA Adjustment Fund. As a result, Africa is slowly starting to show signs of revival. Increased investment, both within Africa and internationally, will ensure a continued decrease in the trade finance gap and a consistent boost to social and economic growth in Africa.
Lodewyk Meyer is a Partner and Head of the Banking & Finance Practice, and Lucy Stratton, Associate Designate at Baker McKenzie in Johannesburg