This will support exporters with specialised financing to assist in credit and risk management. Commercial banks in Sri Lanka currently tend to provide only a narrow range of export finance instruments. Especially smaller exporters in Sri Lanka are disadvantaged by the lack of innovative financing instruments that are available in competing countries.
In this explanatory piece, Colombo-based think tank Verité Research introduces the broad concept of export financing and an EXIM bank, and discusses how Sri Lanka may want to take it forward.
What is export finance?
Export finance refers to financing facilities offered to assist the export sector. The most commonly understood function of export finance is facilitating payment terms between the exporter and the buyer such as letters of credit (LCs) and documentary credit (DC). These trade finance instruments help the exporter and buyer to share risks associated with the international transaction (Figure 1). This is the narrowest definition of export finance.
In addition to facilitating international payments, export finance instruments help mitigate risks borne by exporters. This function is becoming more important in the international market, where buyers with higher bargaining power set the payment terms. For example, buyers are increasingly moving away from instruments such as LCs to open accounts and demand longer credit periods. To secure export orders, exporters have to meet buyers’ requirements. doing so, they bear most of the risk associated with the payment delay and possible default. Therefore, export insurance instruments play an important role in helping exporters insure themselves against such risks.
Delays in payments become more of a burden for exporting SMEs. Such delays often create cash flow problems, resulting in them needing finance to meet their short-term working capital requirements. Access and the cost of export working capital financing become critical to enable SMEs to export.
A broader definition of export finance encompasses financing facilities extended to build the capacity of exporters, especially for exporting SMEs to upgrade technology, skills and the quality of products. Financing schemes of this nature become very important for agricultural exports, where the final exporter is dependent on a large number of SME suppliers.
Why is export finance important to promote Sri Lankan exports today?
Sri Lankan exports have been stagnating at around $10-11 billion since 2011. Exports as a share of GDP have been steadily declining from 33% to 15% over 2000-2014. Diversifying products and markets is a key challenge facing the country’s export sector. Apparel and tea exports account for over 50% of export revenue in terms of products, and the US and EU account for over 50% of export revenue in terms of markets. Export finance is a policy tool available to the government to assist in overcoming these challenges and reviving the export sector. Unfortunately, this is one of the most underutilised policy instruments in Sri Lanka.
Export finance can help the country in its efforts to diversify markets by taking over part of the payment delay and default risk borne by the exporter in doing business with a new buyer in a new country. Payment delays and defaults can occur due to the buyer not honouring the contract, or result from sudden changes in taxes, policies and regulations of the importing country.
[pullquote]A broader definition of export finance encompasses financing facilities extended to build the capacity of exporters, especially for exporting SMEs to upgrade technology, skills and the quality of products[/pullquote]
Thus, the risk of doing business with new developing country markets with weaker institutions and unstable policies can be higher. Limited availability of reliable and updated information in such markets makes it difficult to assess the level of risk incurred, making private banks reluctant to finance such transactions or compelling them to impose a higher risk premium on such lending. Government-guaranteed financing facilities provided for exporters venturing into new, developing country markets can help overcome this problem. Furthermore, risks associated with such transactions can be reduced, and effectiveness can be enhanced through market information and guidance services provided by the respective Commercial Sections of Sri Lankan embassies and export promotion agencies like the Export Development Board (EDB).
Sri Lanka’s export revenues depend heavily on a few established exporters as well. The number of new Sri Lankan companies that enter the export market remains low. The cost new exporters and SMEs have to incur to access finance is generally high. The lack of experience, exposure and training in exporting is a key factor that compels private banks to consider such exporters as high-risk borrowers.
This problem can be addressed by combining export finance facilities with export market guidance and training provided by export promotion agencies like the EDB. Such training and guidance programs will increase the creditworthiness of exporters, and banks will be more willing to lend to such exporters at a lower cost.
Such schemes will help incentivise domestic market-oriented companies to enter international markets. Encouraging companies to export help in making them more competitive, innovative and efficient due to higher competition in international markets compared to companies that depend only on the domestic market. Government-supported financing schemes, coupled with export market guidance/counselling facilities, are often used by countries to encourage SME exporters. A good example is Small Business Administration (SBA) of the United States, which provides training, counselling and financing for small businesses to export.
What is the situation of export finance in Sri Lanka at present?
At present, Sri Lanka does not have such specialised financing facilities and programs to support the export sector compared with other countries. This is an area that has received little attention in the country’s overall export strategy.
A study done by Verité Research identified critical demand and supply constraints that prevent export finance from playing a more proactive role in facilitating exports in Sri Lanka. These relate to three areas: information, institutions and instruments.
Information: Sri Lanka’s export finance sector suffers from two types of information deficiencies. First, limitations in buyer, market and exporter information. Second, the lack of awareness and information among exporters about export finance solutions and benefits.
Reliable, accurate and up-to-date information about markets and buyers is critical for exporters and financial institutions to assess, mitigate and manage risks. Demand for export finance facilities also remains low due to low awareness among exporters (especially SMEs) of the types of export finance solutions available, its costs and benefits.
[pullquote]Export finance can help the country in its efforts to diversify markets by taking over part of the payment delay and default risk borne by the exporter in doing business with a new buyer in a new country[/pullquote]
Institutions: Sri Lanka has a number of institutions that can facilitate and promote the use of export finance in the country. These institutions can be divided into two broad categories in terms of their core functions: those that provide export finance (e.g. SLECIC, commercial banks); and those that are established to provide information, training and guidance to the export sector (e.g. EDB). The effectiveness and cost of export finance is also determined by the quality of other services available to exporters such as information, training and guidance. Such services become very important when financing facilities target new markets, new exporters and SMEs. At present, the quality and availability of such services is low in Sri Lanka, and financing and promotion agencies in the country work in isolation, with very little cooperation and coordination. Furthermore, limitations in skills, capacity and expertise within institutions, and a low level of focus in government policy on export finance also undermine the role institutions can play in promoting export finance in Sri Lanka.
Instruments: The variety, availability and sophistication of export finance solutions in the market remain limited. For example, compared with other countries, Sri Lanka does not offer special financing facilities targeting SMEs and first-time exporters. Furthermore, some financial instruments that are widely available in other countries are not available in Sri Lanka such as export factoring, buyer credit and bilateral export credit lines.
In addition, the utilisation of available export finance instruments such as Value Chain Financing, export credit and payment default guarantee schemes is low mainly due to the cost of such instruments, the low risk profile of the current export structure and limited knowledge among the exporter community about export finance.
How critical is the need for an “EXIM bank” in Sri Lanka to promote export finance?
The need for an export and import (EXIM) bank in Sri Lanka is evident. Opposition to such a bank arises mainly due to the lack of confidence in the ability of the government to institute and operate an efficient and professional bank devoid of political intervention. Therefore, developing “ability” before “action” is critical to ensure that the bank does not become a “burden” but an “asset” to the country.
In addition to the trust deficit, Sri Lankans in general are familiar with EximBank of China, which provides financing to Sri Lanka for large-scale projects, and feel that is the core function of an EXIM bank, therefore, Sri Lanka does not need such a bank. This is a misconception. Project financing is not the only function of EXIM banks in the world, and EximBank of China is incomparable to EXIM banks in other countries.
[pullquote]An The EXIM bank helps address the low risk appetite of exporters and banks by assuming the payment delay and default risks associated with international transactions that the private sector is generally unwilling or unable to take[/pullquote]
An EXIM bank is a specialised financial institution commonly found in countries that provide financing for the export sector. An EXIM bank helps address the low risk appetite of exporters and banks by assuming the payment delay and default risks associated with international transactions that the private sector is generally unwilling or unable to take. The bank, being a specialised institute, has expertise that is not available in the commercial banking sector about exports, markets and associated risks. Therefore, in addition to providing financing, an EXIM bank, unlike private commercial banks, is able to provide information, training and guidance to exporters, in addition to financing. Most EXIM banks in the world operate under the ownership of the government or in partnership with the government.
Although an EXIM bank is a new concept to Sri Lanka, such banks have been in operation around the world for a long time. For example, although EXIM Bank of the United States closed down last year, it has been in operation for over 80 years, supporting the US export sector. Being a latecomer, there is a wealth of learning Sri Lanka can take from the successes and failures of other countries in designing an EXIM bank locally.
The study done by Verité Research highlights a number of initiatives that can be taken to improve the availability of export finance in Sri Lanka. These include improving the availability of information, and introducing new financial instruments and facilities within the existing institutional framework. Given the significant trust deficit the public has in government-run institutions in terms of governance, efficiency and competency, it is best to work on an EXIM bank as a medium-term strategy rather than short term. In the short run, the government can work on improving export finance within the existing institutional structure, while learning from the experience of other countries. Furthermore, it must work on building its capacity and ability to institute a professional and independent EXIM bank in a couple of years.