Trade finance in the Mekong region A study of Cambodia, the Lao People’s Democratic Republic and Viet Nam About the IFC The International Finance Corporation – a member of the World Bank Group – is the largest global development institution focused on the private sector in emerging markets. It works in more than 100 countries, using its capital, expertise and influence to create markets and opportunities in developing countries. About the WTO The World Trade Organization is the international body dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible, with a level playing field for all its members. Cover: A worker tests electronic components at a factory in the Bac Ninh Province, Viet Nam. Contents Foreword 3 Acknowledgements 4 Executive summary 5 1. Trade profiles of the Mekong-3 8 Trade dynamics in the Mekong-3 10 The two-speed growth of trade 10 Product diversification 16 Trade of goods at different stages of processing 20 Competitiveness and trade costs 24 Participation in global value chains 27 2. Trade finance in the Mekong-3 32 Local trade finance markets 34 Trade finance instruments 35 Trade finance across sectors 39 Trade finance for firms owned or led by women 40 Trade finance for climate-related activities 41 Trade finance constraints 43 Supply chain finance and reverse factoring 44 Trade finance rejection rates 44 Correspondent banking relationships 49 Trade finance prices 49 3. The impact of closing the trade finance gap 52 The costs of financing international trade under different instruments 54 Five counterfactual scenarios 55 Projected trade cost reductions 55 Projected changes in aggregate exports and imports 58 Zooming in on trade patterns: detailed results for sectors and trading partners 60 Robustness checks 60 Conclusions 64 Annex I. Mekong-3 trade and global value chain performance 67 Annex II. Estimating total trade finance assets: methodology 71 Annex III. Counterfactual analysis 73 Abbreviations 89 Bibliography 90 Disclaimer The opinions expressed in this publication are those of the authors. They do not represent the positions or opinions of the IFC, its Board of Directors or the governments they represent nor do they represent the positions or opinions of the WTO or its members and are without prejudice to members’ rights and obligations under the WTO. Any errors are attributable to the authors. The designations employed in this publication and the presentation of material therein do not imply the expression of any opinion whatsoever on the part of the IFC and the WTO concerning the legal status of any country, area or territory or of its authorities, or concerning the delimitation of its frontiers. Foreword The expansion of trade depends on reliable, adequate and 2022, the first study looked at the trade finance markets of the cost-effective sources of trade financing, which help to fill four largest economies of the Economic Community of West the time gap during which goods are produced, shipped and African States (Côte d’Ivoire, Ghana, Nigeria and Senegal, paid for. Trade finance is routinely supplied to exporters and referred to as the ECOWAS-4). importers by banks and other financial intermediaries, which mitigate the financial and payment risk involved in cross- This report focuses on trade finance in Cambodia, the Lao border trade. While developed countries can often rely upon People’s Democratic Republic and Viet Nam – the Mekong-3. large and advanced economic sectors mobilizing sophisticated It examines the characteristics of trade finance in these trade finance instruments, such as supply chain finance, fast-growing markets, helping to quantify how much trade significant shortages exist in developing countries. These is supported by trade finance, at what cost and how much shortages can have many reasons, both international (inflation, trade could grow further if obstacles to trade finance were availability of correspondent banking relationships, country risk) reduced. The report offers insights into which solutions could and local (level of development and expertise of the financial be promoted, locally and internationally, for trade finance to be sector, cost, access to finance by local firms). a driver of greater trade inclusiveness. To better understand the trade finance ecosystem in The IFC and the WTO are committed to further fostering of developing countries, the constraints to trade finance and gaps trade growth to support development outcomes, drawing in provision, the International Finance Corporation (IFC) and on our knowledge and track record of mobilizing capital. the World Trade Organization (WTO) pledged in November We are thankful to the joint IFC–WTO team that produced this 2021 to enhance their cooperation in this area. They engaged report and look forward to the findings and recommendations in a series of surveys aimed at examining the specific obstacles that will inform debates and decision-making across faced by lenders and borrowers in low-income regions. In various stakeholders. Dr Ngozi Okonjo-Iweala Makhtar Diop Director-General Managing Director World Trade Organization International Finance Corporation FOREWORD 3 Acknowledgements This publication is the result of a joint effort of the IFC and the Phuong Nguyen, Akintunde Ogunmodede, Nim Vonglatda WTO and was prepared under the guidance of Susan Lund, Omany, Lien Anh Pham, Arun Prakash and Phally Puth of the Vice President of Economics at the IFC, and Ralph Ossa, Chief IFC, and Phal-Chalm Theany of the Association of Banks in Economist of the WTO. Nathalie Louat and Denis Medvedev of Cambodia. The Association of Banks in Cambodia, the Lao the IFC and Marc Auboin of the WTO provided leadership for Bankers’ Association and the Vietnam Banks Association the research. Marcio Cruz, Maty Konte, Francesca de Nicola, provided invaluable support with the implementation of the Alexandros Ragoussis and Trang Thu Tran of the IFC and Eddy bank survey. The production of the publication was overseen Bekkers and Alexei Timofti of the WTO managed the project by Ross McRae and Anthony Martin of the WTO. teams across the two organizations. Working team members Expertise and insights on the project were provided by Thomas included: Karlygash Dairabayeva, Milagros Deza and Gianluca James Jacobs, Susanne Kavelaar, John L. Nasir, Phongsavanh Santoni of the International Bank for Reconstruction and Phomkong and Makiko Toyoda of the IFC, and Lori Chang, Development (IBRD); Stephanie Annijas, Gbenoukpo Robert Florian Eberth, Roberta Piermartini, Stela Rubinovà and Yan Djidonou, Sarah Hebous, Ibrahim Nana, Alexander Vanezis Ying of the WTO. and Ariane Volk of the IFC; and Kirti Jhunjhunwala, Saptarshi Majumdar and Ruoyi Song of the WTO. Special thanks go to the peer reviewers Enrique Aldaz-Carroll (IBRD), Banu Demir (University of Oxford) and Ousman The IFC survey of banks and the stakeholder interviews were Gajigo, Ha Thu Nguyen, Lien Anh Pham, Bryce Ramsey Quillin completed through the substantial contributions from Loan Mai and Shawn W. Tan from IFC regional offices for their insightful Thi Cung, Zeynep Ersel, Ngoc Thi Minh Ha, Huong Mai Huynh, comments and suggestions. Christopher James Vellacott of the Ahmed Hanaa Eldin Mohamed, Nhung Cam Nguyen, Hanh IFC provided helpful editorial suggestions on earlier drafts. 4 ACKNOWLEDGEMENTS Executive summary Cambodia, the Lao People’s Democratic Republic (PDR) A question is the extent to which the local financial sector has and Viet Nam – referred to here as the Mekong-3 – have contributed to the integration and internationalization prospects established themselves as one of the most dynamic and of the region. In 2023, the IFC conducted a survey of banks trade-led regions of the world. In 2022, the value of trade flows in the Mekong-3 and a second survey of hundreds of traders surpassed GDP in all three economies. The trade-to-GDP ratio in Viet Nam to gather information on trade finance needed by was particularly high in Cambodia and Viet Nam at over 210 exporters and importers. The surveys revealed that local trade and 185 per cent, respectively – several times higher than the finance is not only relatively scarcely used in the Mekong-3 global average of 62 per cent. The value of total trade flows but also segmented and traditional. In terms of size, has tripled in Cambodia and Viet Nam and more than doubled coverage of trade, sector diversity and range of trade finance in the Lao PDR in the past decade. instruments, Viet Nam’s trade finance market can be regarded as more advanced. The rapid trade growth reflects a complex web of domestic and international factors. The integration into global supply In 2022, Vietnamese banks supported 21 per cent of the chains has been a key driver of trade growth and development, country’s exports and imports, with funds representing 22 per cent of the country’s total banking assets. The local banking underpinned by better export performance and a favourable sector in Cambodia supported a much smaller share of the environment for foreign direct investment. Cambodia and country’s import–export operations, some 3 per cent of total Viet Nam have also benefited from the relocation of production trade, accounting for only 2.5 per cent of banks’ total assets. away from economies with higher manufacturing costs, trade These numbers are low – not only compared to developed diversion linked to trade conflicts between large countries and country levels of 60-80 per cent but also relative to the the fostering of foreign investment. coverage of trade recorded in other developing regions, such as West Africa. However, trade growth in Cambodia and Viet Nam has not been even. It has followed a two-speed trajectory, with exports Viet Nam’s local trade finance market is estimated at US$ from subsidiaries of foreign-owned firms outpacing exports 150 billion in value, about 100 times that of Cambodia, from locally owned supply chains. Foreign investments, most at US$ 1.6 billion, even though the difference in trade flows notably in the electronics and garment sectors, have in the is only 12 to 1. Data collected for the Lao PDR suggest that past decade shifted the structure and direction of imports and local trade finance supports an even smaller share of trade exports in favour of these products, towards large suppliers than Cambodia. Moreover, while the distribution of trade (China) and buyers (United States) who now jointly account for finance between imports and exports is relatively balanced in over 40 per cent of the region’s total trade. Viet Nam, with assets concentrating on intermediate goods and inputs, in Cambodia and the Lao PDR trade finance is As a result, exports in a narrow set of activities controlled by mainly supplied for imports, notably goods for wholesale foreign subsidiaries outpace exports from locally owned supply distribution and construction. chains, for example in (agri-)food and fisheries, industrial parts and manufactures, where growth has also been strong The segmentation of local trade finance markets in Viet Nam and a source of economic diversification for these countries. follows the dynamics of trade in reverse: high-growth and Viet Nam’s import and export product basket is the largest high-value exports of electronics and garments production and most diversified, expanding recently into chemicals, tend to rely less on local trade finance. Local banks are machinery and electric batteries. Starting from a lower base, more likely to support intra-regional trade than global trade the respective import and export baskets of Cambodia and the operations. Lacking more evidence, the existence of alternative, commodity-oriented Lao PDR have been diversifying faster foreign supply chain finance (SCF) arrangements provided than Viet Nam’s. by large multinational companies to their subsidiaries and EXECUTIVE SUMMARY 5 tier 1 suppliers may explain the limited share of trade finance in access to trade finance appears more accentuated in provided by local banks. However, it is unlikely that local, Cambodia and the Lao PDR, where only 37 per cent and 33 lower-tier suppliers within foreign-controlled supply chains per cent of banks, respectively, report allocating trade finance benefit from such SCF. This would be even more unlikely in to women-owned or led SMEs, compared to 47 per cent in the case of Cambodia and the Lao PDR. Viet Nam. However, over half the banks in the Mekong-3 do not track whether or not they provide trade finance to female Removing constraints to trade finance would significantly boost entrepreneurs, which makes it difficult to capture fully the trade flows further and increase trade inclusiveness. Data gender gap in accessing trade finance. collected from banks and traders surveyed in the Mekong-3 were analysed with the WTO Global Trade Model. According Only a small fraction of the banks surveyed fund to the simulations for Cambodia and Viet Nam, increasing the climate-related trade activities. The share of banks in the coverage of trade by local trade finance by an additional 20 Mekong-3 which report that they provide trade finance to percentage points while reducing the cost of loans and letters climate-related trade activities is low. Only 11 and 29 per of credit to international benchmarks would raise imports by cent of the banks in Cambodia and Viet Nam, respectively, more than 5 and 6 per cent, respectively, and raise exports report that they provide trade finance to climate-related trade by more than 8 and 9 per cent annually. This corresponds to activities. Of the banks surveyed in the Lao PDR, none reports annual increases in merchandise trade of more than US$ 3.5 providing trade finance for this category of trade activity. billion in Cambodia and US$ 55 billion in Viet Nam. Harnessing trade opportunities through global value chains Improving the coverage of trade by bank-intermediated (GVCs) and expanding into new products will also require finance holds the greatest potential to expand trade. The deeper and more diverse trade finance markets. The bank survey sectors delivering the largest contribution are textiles, wearing confirms the prevalence of traditional trade finance instruments apparel and leather. The electronics sector plays a moderate (letters of credit and other guarantees, pre-export loans), role in this expansion owing to large shares of related-party routinely provided by nearly all banks involved in trade finance. trade (i.e. trade with subsidiaries of multinational enterprises and large conglomerates), which are less likely to use domestic Short-term working capital lines are often used by importers trade finance. The trade partners that stand out as the largest and exporters as a substitute to more structured and beneficiaries of this scenario are China and East and Southeast documented trade finance instruments – particularly in Asia on the import side and Europe (for Cambodia) and North Cambodia, where 40 per cent of total trade finance is provided America, China and East Asia (for Viet Nam) on the export side. in this form. Working capital loans are preferred for their flexibility but are also typically more expensive and accessible Increasing the share of trade supported by local trade finance only to clients with sufficient land or building collateral. would require local supply and demand constraints be addressed. The surveys point to macroeconomic constraints Innovative trade finance instruments are still nascent: although weighing on both the demand and supply of trade finance, a quarter of banks surveyed envisage expanding its provision such as persisting disruptions to mobility and operations due within the next two years, SCF currently supplied by local to the impact of the COVID-19 pandemic, inflation and limited banks in Cambodia and Viet Nam accounts only for 2 per cent availability of low-cost funding. Structural constraints include of available trade finance. The potential for growth stems from the lack of information about new trade finance instruments, the fact that, while SCF is provided by foreign banks to large and for which technical and financial assistance is sought. subsidiaries of foreign firms for the export of finished products, High collateral requirements and onerous application the number of local producers of parts and components not processes are moreover highlighted by hundreds of traders involved in such arrangements but involved in international as reasons for not approaching banks in Viet Nam. trade is growing. Women find it more difficult than men to access trade In general, unlocking meagre cash resources trapped in those finance. Only four in ten banks in the survey report that they supply chains is a necessity for local firms – particularly SMEs provide trade finance to women-owned or led small and – to survive, invest and move-up technologically within the medium-sized enterprises (SMEs). The gender disparity value chain. However, many of them still do not have access to 6 TRADE FINANCE IN THE MEKONG REGION trade finance, as exemplified by the low share of trade covered SCF expansion is a priority given the region’s growing by trade finance. At best, some firms will have access only to integration into GVCs. This will require technological solutions expensive working capital. and training for staff in managing credit risk, which according to the survey is in demand. Technological solutions could also Coordinated action by the corporate sector, financial facilitate the adoption of supply chain mapping and digital institutions, national policymakers and international financing, while simultaneously helping banks to develop more organizations could help to increase the uptake of trade sophisticated internal credit risk assessment systems for SMEs finance in the Mekong-3. The most effective measures vary and new entrants in the trade finance markets. by country. In Viet Nam and to some extent Cambodia, they include: diversifying the range of trade finance instruments; A higher level of digitalization could help to reduce the strengthening the regulatory framework; broadening the local processing costs for trade finance, which remain high in less customer base for trade finance to SMEs; and improving banks’ developed countries of the Mekong region. Banks and other agility, risk management capacity and international relationships. institutions can also provide training and outreach to firms currently excluded, to better inform them of which trade finance In Cambodia and the Lao PDR, the capacity of the local solutions are available and help them access markets. banking system to support the internationalization of the economy is more limited than in the case of Viet Nam. Actions Further evidence-based studies of trade finance and additional in these two countries could focus on the expansion of efforts by the research community would be welcome in traditional trade finance instruments such as letters of credit identifying markets where shortages occur and the potential and basic capabilities of banks, without neglecting ways to for trade finance expansion exists. This present study on the promote the use of innovative instruments such as SCF to Mekong-3 and the earlier IFC–WTO study on West Africa facilitate the integration of smaller, local producers into GVCs. Examples of successful engagements of development finance outline how trade finance can lead to increased trade inclusion institutions in other countries in Asia suggest that progress and economic integration for countries with different trade towards these objectives is possible. Making data available to structures and comparative advantages. They serve as guides support decision-making, offering a modern and predictable to explain how the level of development of domestic financial legal framework on recourse for SCF creditors and providing sectors and their orientation towards cross-border transactions for effective enforcement of rules for collateral could all impact the ability of economies to participate more fully in the significantly broaden access to trade finance in the Mekong-3. global trading system. EXECUTIVE SUMMARY 7 C HAPTE R 1 Trade profiles of the Mekong-3 A worker checks circuit boards at an electronics factory in Hung Yen Province, Viet Nam. Key findings The Mekong-3 – Cambodia, the Lao People’s Democratic Republic (PDR) and Viet Nam – form one of the most dynamic and trade-led group of countries in the world. In 2022, the value of trade flows surpassed GDP in all three economies. The trade-to-GDP ratio was particularly high in Cambodia and Viet Nam at over 210 and 185 per cent, respectively – several times higher than the global average of 62 per cent. China and the United States have grown to become the main export destinations from the Mekong-3, jointly accounting for over 40 per cent of the region’s total trade. Trade growth in Cambodia and Viet Nam has followed a two-speed trajectory. Exports to China and the United States have grown by a factor of five since 2012, while exports to other regions also grew, albeit at a slower pace. East Asia and Pacific countries continue to account for most of imports into Cambodia and the Lao PDR at over 58 and 70 per cent in 2021, respectively. Although intra-regional trade among the Mekong-3 has grown in value, its relative importance has declined. The growth of Viet Nam’s electronic industry and Cambodia’s textile exports are primarily driven by foreign investors. In 2021, multinational enterprises contributed to around 70 per cent of Viet Nam’s total imports and exports. Large and mega firms contributed more than 80 per cent of exports from the country. The Mekong-3 rely significantly on the import of intermediate goods and inputs, which more frequently require letters of credit. As a share of total imports in 2020-2022, intermediate goods comprised 64 per cent in Cambodia, 45 per cent in the Lao PDR and 60 per cent in Viet Nam. Cambodia and the Lao PDR are diversifying fast. They have both expanded imports considerably, connecting with new markets. From 2012 to 2021, the number of products imported by Cambodia and the Lao PDR increased by more than 13 and 10 per cent, respectively. There has been significant growth in chemical products imported in Viet Nam, as well as machinery components in all of the Mekong-3. Exporters in all of the Mekong-3 have improved their performance. The expanded global footprint of Mekong-3 exporters can be attributed to distinctive developments within each country – including excess capacity from trade diversion, high-value exports along these routes and significant improvements in the productivity of their exporters. Trade costs remain a challenge for the Mekong region. While Cambodia witnessed reductions in trade costs of 13-22 per cent to its top ten partner economies between 2008 and 2018, trade costs for Viet Nam fell only for exports. The Lao PDR experienced a sharp rise in average costs for exports of more than 35 per cent and 15 per cent for imports – both of which from a high initial base. This chapter provides a summary of key trade dynamics in the Mekong-3 that are relevant to trade finance, starting with trade flows in the region and an overview of what is traded and with whom. The chapter then explores: product diversification; the trade of goods at different stages of processing; the competitiveness of exporters in the Mekong-3 and the trade costs incurred; participation in global value chains; and the role of multinational enterprises and firms of different sizes as drivers of growing demand for trade finance. Trade dynamics in Trade-to-GDP ratio in 2022 the Mekong-3 Export-oriented nations depend disproportionately on trade, and by extension on trade finance, as a driver of prosperity 210% 185% Cambodia Viet Nam (see Box 1.1). The Mekong-3 have established themselves as one of the most integrated and trade-led regions of the world, with respectively. These economies have also tended to depend a trade-to-GDP ratio surpassing 100 per cent in all three less on trade over time, while Cambodia and Viet Nam have economies and over 210 and 185 per cent in Cambodia and consistently increased trade flows relative to GDP. Viet Nam, respectively (see Figure 1.1). This is over three times higher than the global average of 62 per cent and has turned Lao People’s Democratic Republic Cambodia and Viet Nam into trade leaders in Southeast Asia. The Lao PDR presents a separate case within the Mekong-3. Unlike Cambodia and Viet Nam, it has only recently experienced a sizeable increase in its trade-to-GDP ratio, surpassing 100 per cent of GDP for the first time in 2022 (see Figure 1.1). Since Cambodia and Viet Nam have become 2014, trade as a share of GDP had fluctuated around 75 per trade leaders in Southeast Asia. cent, which is still above the global average of 62 per cent and is a reflection of the continued importance of imports and exports for the country’s development. Cambodia and Viet Nam The two-speed growth While a high trade-to-GDP ratio is common in smaller economies, its growth over the last decade points to of trade accelerating internationalization, with trade flows steadily outpacing GDP growth of between 5 and 8 per cent annually – To comprehensively gauge the requisites and provisions of well above the average for East Asia and Pacific. Viet Nam trade finance in Mekong-3, the dynamics of trade across exemplifies and leads this trend for the region as a whole. origins, destinations and beneficiaries are examined. Since 2012, the value of total trade flows more than tripled to The structure of imports and exports from the Mekong-3 has US$ 754.8 billion in 2022 – and is now valued at more than undergone significant changes in the past decade – driven 185 per cent of GDP (see Figure 1.1). not only by local development but also by the global geopolitical landscape. Cambodia has followed a similar trajectory, tripling the value of its trade since 2012 to US$ 60.2 billion and surpassing 210 China and the United States began mutually escalating tariffs per cent of GDP in 2022 (see Figure 1.1). For comparison, on hundreds of billions of dollars’ worth of trade flows in Malaysia and Thailand, two notable economies in the region, 2018. The study by Fajgelbaum et al. (2021), revised in 2023, have trade flows that exceed GDP at 146 and 123 per cent, argues that, while the two economies largely taxed each other 10 TRADE FINANCE IN THE MEKONG REGION FIGURE 1.1 Trade flows and GDP in the Mekong-3 (in current US$ billion and as a share of GDP, and total GDP in 2022) 900 800 700 Trade value (US$ bn) 600 500 400 300 200 US$ 754.8 bn 100 US$ 16.4 bn 0 US$ 60.2 bn 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Cambodia Lao PDR Viet Nam 250% 210.8% 200% 185.7% Trade value/GDP 150% 100% 107.0% 61.8% 50% 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Cambodia Lao PDR Viet Nam World GDP in 2022 Viet Nam US$ 406 bn Cambodia Lao PDR US$ 29 bn US$ 15 bn Source: IFC–WTO calculations using WTO–UNCTAD estimates for goods trade and IMF WEO and Balance of Payments for GDP and services trade, respectively. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 11 BOX 1.1 What is trade finance and why it matters? International trade is an important driver of of global trade volumes (Auboin and Engemann, productivity, jobs and development – but, to be 2014). The share of merchandise trade supported effective, adequate trade finance is essential. by trade finance is relatively low in many developing Trade finance, an umbrella term including a variety countries: 40 per cent in Africa as a whole and only of financial instruments, helps to oil the wheels 25 per cent in West Africa, as opposed to 60-80 of trade by bridging the gap between exporters’ per cent across high-income economies. and importers’ differing expectations about when payment should be made. Trade finance includes Rejections rates for trade finance requests in loans and working capital facilities needed by developing countries can be high. In particular, exporters to process or manufacture products small and medium-sized enterprises (SMEs) are and by importers to buy inputs, raw materials and disproportionally affected by high rates of rejection. equipment. Insufficient trade finance increases As a result, even though trade finance is one of the risks of the trade transaction (i.e. not receiving the largest sources of cross-border capital flows payment or delivery) and trade costs (i.e. opportunity (valued at over US$ 10 trillion annually), major gaps costs of using scarce cash resources). still persist. The Asian Development Bank reports that the global trade finance gap – the difference between requests and approvals for financing to support trade – grew to US$ 2.5 trillion in 2022, and mostly in developing countries.* Hence over time, trade finance has taken a more prominent Trade finance at high interest rates position in the development agenda. or with expensive fees is also a trade cost. Global trade finance gap in 2022 estimated at US$ 2.5 trillion Trade finance is important for businesses because access to finance at affordable rates is an important In IFC–WTO studies, local banks are surveyed to element of a business’s competitiveness and its estimate the amount of trade finance supported by integration into global markets. Trade finance the local financial sector in each country and how it thus matters for societies as a whole by enabling relates to trade flows. producers to create better paid jobs and to diffuse technologies for a range of purposes, including, for Although the surveys do not capture financing by example, lowering greenhouse gas emissions and foreign banks provided outside the country, they adapting to climate change (for a recent review, nevertheless provide an important measure of the see Engel et al., 2021). Trade finance can also ability of local financial institutions to support the enhance the benefits of trade for a wide range of country’s participation in international trade. The market participants, such as smaller enterprises and surveys examine the following elements: younger entrepreneurs, which can be exposed to • the trade finance instruments used; greater risks in cross-border transactions. • the cost at which trade finance is available; More generally, trade finance matters for trade • the rejection rate of trade finance requests. because it is not just demand driven. Research Using general equilibrium analysis from the WTO finds that an increase in the supply (or cost) of trade Global Trade Model, these metrics are then used finance is associated with an increase (or decrease) to explore the trade impacts of any potential 12 TRADE FINANCE IN THE MEKONG REGION improvements to accessing local trade finance. As shown in Chapter 3, most of the trade effects For example, how much more trade would be are generated by an increase in the availability of generated by: (i) greater availability of trade finance trade finance. In certain countries where the uptake (a higher share of trade finance covering trade); of trade finance is very low, a reduction in rejection (ii) a reduced rejection rate for trade finance; and rates only impacts the few traders who seek trade (iii) reduced interest rates and fees to align closer to finance and thus only marginally increases the international benchmarks. In this way, a combination coverage of trade by trade finance. of trade effects of these counterfactual scenarios * See https://www.adb.org/news/global-trade-finance-gap- can be explored. expands-25-trillion-2022. Money to service a microloan, Lao PDR. and depressed their bilateral trade flows relative to non-taxed Over the past decade, China and the United States have products, bystander countries increased their exports to the emerged as dominant destinations for exports from the region. United States and the rest of the world. Cambodia and Viet In 2021, the United States was the primary export destination Nam have been two of the major beneficiaries in a relocation for Cambodia and Viet Nam, representing more than 31 and 26 process that started before 2018, owing to an increase of per cent of the total value of exports, respectively (see Figure production costs in China. 1.2, Exports). The Lao PDR, on the other hand, remains heavily oriented towards China and the rest of East Asia and Pacific in both trade directions. The share of Mekong-3 exports to Europe and Japan has dropped by over 10 percentage points for Cambodia, China and the United States have become 6 percentage points for the Lao PDR and 15 percentage the top export destinations from the points for Viet Nam; while intra-regional exports, excluding Mekong-3. China, have been stable in relative terms at one fifth of the total value over the last decade. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 13 FIGURE 1.2 Trade in value in the Mekong-3 as a share of total exports and imports, 2012 and 2021 (in per cent) Exports 11.9% 9.5% 10.7% 7.0% 13.4% 14.6% 21.9% 14.8% 22.5% 34.0% 58.7% 17.3% 26.1% 31.8% 57.3% 29.8% 12.8% 5.5% 5.9% 18.2% 20.0% 23.6% 17.5% 25.7% 27.9% 20.8% 13.9% 7.1% 2012 2021 2012 2021 2012 2021 Cambodia Lao PDR Viet Nam Imports 5.3% 6.0% 9.9% 7.1% 10.5% 5.4% 58.8% 37.6% 73.2% 70.9% 75.1% 37.8% 34.4% 40.5% 31.5% 20.4% 16.4% 22.8% 2012 2021 2012 2021 2012 2021 Cambodia Lao PDR Viet Nam China Rest of East Asia & Pacific Japan United States EU, Switzerland & UK Rest of world Source: IFC–WTO calculations based on World Bank WITS data. In quantity terms, shipments to all countries and regions have Trade flows among the Mekong-3 have also grown over grown. China and the rest of the East Asia and Pacific region the last decade, although they still rank low relative to other account for over 70 per cent of the total export volumes from destinations. Exports from Cambodia and the Lao PDR to the Mekong-3. Despite the decrease of their relative importance, Viet Nam increased by a factor of three to four since 2012, Mekong-3 exports to Europe and Japan remain significant in albeit from a low base. Trade flows from Viet Nam to Cambodia volume and continue to grow (see Figure 1.3, Exports). at least doubled and marginally increased to the Lao PDR. 14 TRADE FINANCE IN THE MEKONG REGION FIGURE 1.3 Trade volume in the Mekong-3, 2012 and 2021 (in million tonnes) Exports 20 160 140 18.0 15 120 6.6 12.7 100 9.9 Million tonnes Million tonnes 12.7 10 80 15.5 38.5 60 8.7 5 6.1 40 16.6 8.0 3.6 54.5 5.4 20 31.8 1.5 1.5 2012 2021 2012 2021 2012 2021 Cambodia Lao PDR Viet Nam Imports 25 200 180 43.4 20 160 140 10.1 8.0 Million tonnes Million tonnes 15 120 100 17.9 10 80 88.8 60 6.8 5 8.1 40 5.4 21.4 4.0 20 33.5 3.1 14.0 0 0 2012 2021 2012 2021 2012 2021 Cambodia Lao PDR Viet Nam China Rest of East Asia & Pacific Japan United States EU, Switzerland & UK Rest of world Source: IFC–WTO calculations based on World Bank WITS data. Missing volumes are imputed using average unit values. Average unit values of trade are calculated by dividing trade values in US dollars by the net weight values in kilograms, for observations with records of both value and quantity in kilograms. The averages are calculated by HS2 sector, origin, destination and year. Average unit values are then used to estimate the volumes where quantity is not reported, or reported in units different than kilogram, by dividing the value reported by its corresponding average unit value. Existing data in the net weight values in kilogram are unaffected by the process. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 15 Two-speed growth trajectory of Cambodia and Viet Nam Trade growth in Cambodia and Viet Nam exhibits a two-speed China has become the largest supplier to trajectory. Exports to China and the United States have grown by a factor of five since 2012. This growth has outpaced the Mekong-3. exports to all regions, which have also grown – albeit at a slower pace. Notably, exports to Europe have more than doubled in value and volume over the last decade, which relative importance has declined behind Chinese imports, indicates expanding market opportunities. Exports to Japan which grew much faster. have grown similarly in both value and volume as trade ties The consequences of increasing reliance on imports from with the Japanese market strengthen. China have a nuanced impact on trade finance markets. It is worth noting that while the value of exports from According to interviews conducted in the Mekong-3, imports Cambodia and Viet Nam to the United States is high, it still from China often involve payment arrangements that bypass represents less than 10 per cent of export volume. This the local banking system. These arrangements, together with indicates that these shipments are relatively more expensive the robust competition among Chinese producers in the global than exports to other destinations. The same holds for market, are some of the unique characteristics of Chinese shipments from China to the Mekong-3, where the value of trade. Moreover, payment terms often depend on relationships, imports has outpaced the growth in volume, suggesting high favouring importers with established, long-term partnerships, relative unit values of imported intermediates (see Figures 1.2 which can yield more advantageous import terms. and 1.3, Imports). Combined, these two observations point to the rise of global value chains (GVCs) in the region whereby Net trade in the Mekong-3 and high-value intermediate components are imported, assembled comparator countries and shipped to the United States as expensive final goods. Shipments from Viet Nam to China and Japan have also grown Viet Nam’s increasing participation in GVCs has cemented its in value by more than volume; albeit not at the scale observed status as a net exporter, with the value of exports consistently for shipments to the United States. surpassing imports since 2016 (see Figure 1.4). This trend highlights the role of trade as a financing mechanism for the The two-speed growth trajectory has also been clear in imports country’s development. Viet Nam’s trade performance follows to Cambodia and Viet Nam. While trade from China and to the the trajectory of more advanced economies in the region, United States has been growing significantly faster than trade with other regions, imports to Cambodia and Viet Nam from such as Malaysia and Thailand. Meanwhile, Cambodia and the all regions have increased in volume (see Figure 1.3, Imports). Lao PDR maintain a relatively balanced trade, with marginal net China and the rest of East Asia and Pacific collectively account imports, as their trading activities steadily expand. for 65 per cent of the total import volume into Viet Nam. However, imports from China and the United States tend to be Product diversification considerably more expensive than imports from other sources. This disparity in aggregate statistics conceals moderate growth The diversification of the product mix crossing borders has an of the second-tier routes and trade flows. impact on trade finance markets. Research shows that different products vary in the coverage by bank-intermediated finance Imports to the Mekong-3 from China and when traded across borders (Crozet et al., 2022). In addition, East Asia and Pacific young traders expanding into new markets have a greater need to mitigate risks with new clients, making them more prolific China has become the largest supplier of imports to the users of trade finance (Antràs and Foley, 2015). Mekong-3, at par with the imports from all other regions combined. By 2021, the total value of imports from China As the demand for finance rises, banks may be hesitant to was three times its 2012 level. Although East Asia and Pacific assume these risks for activities or participants with which continues to represent the largest share of imports into they may be less familiar. By expanding trade into uncharted Cambodia and the Lao PDR, the share has dropped since territories, there is thus a greater need for market intelligence 2012. In Cambodia, imports from Viet Nam in 2021 increased and adaptable instruments to support importers and exporters in value by a factor of three since 2012; although the country’s active in these markets. 16 TRADE FINANCE IN THE MEKONG REGION FIGURE 1.4 Net trade in the Mekong-3 and comparator countries, 2012-2021 (in US$ billion) 60 40 20 US$ billion 0 -20 -40 -60 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Cambodia Lao PDR Viet Nam Malaysia Sri Lanka Thailand Philippines Source: IFC–WTO calculations based on World Bank WITS data. Net trade corresponds to the total value of exported goods and services minus the total value of imported goods and services. The economy in Viet Nam is more diversified than Cambodia With regard to the types of product traded by the Mekong-3, and the Lao PDR, both in terms of imports and exports. electronics, machinery, textiles and food form the bulk of both Viet Nam’s range of products traded has thus remained imports and exports in Viet Nam (see Figure I.1 in Annex I). relatively stable, with only a marginal annual growth rate in the Just three products – integrated circuits, telephones and number of products exported (see Figure 1.5). However, the rubberized fabrics – have consistently accounted for around value of Viet Nam’s exports has been surging at growth rates of 20 per cent of Viet Nam’s imports from China since 2016; 15 per cent annually, which would suggest an ongoing process while broadcasting equipment substantially increased its share of qualitative improvement in similar product categories. The in the value of exports to the United States, from around 2 per same applies to Viet Nam’s imports, indicating a steady and cent in 2012 to approximately 18 per cent in 2021. diversified influx of goods from various sources. Cambodia relies heavily on its garment and textile industry, which comprises nearly half of its exports, with machinery Value of exports, Viet Nam and other consumer goods making up the remaining portion (see Figure I.1 on Annex I). A handful of key products and +15% services, including garments, footwear, rice, cassava and per annum tourism in services, dominate the export basket of the country (World Bank, 2021). CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 17 FIGURE 1.5 Number of products traded by the Mekong-3 (HS 6-digit products) Exports Imports 5,000 4,000 3,000 2,000 1,000 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Cambodia Lao PDR Viet Nam Source: World Bank WITS (mirror data). Figures from different sources show similar trends, although the number of products exported/imported seems higher when based on World Bank WITS (mirror data). The Lao PDR primarily exports energy resources, while heavily cent) and from 1,204 to 1,440 for the Lao PDR (an increase relying on imports for various other products. Notably, gold has of nearly 20 per cent). Starting from a highly diversified base, emerged as a significant import commodity for both Cambodia the expansion of Viet Nam’s export basket has been more and the Lao PDR, possibly accounting for previously moderate than Cambodia or Lao PDR. However, among the underreported trade flows. categories that have experienced significant growth over the extensive margin are chemical products in Viet Nam, as well as machinery components in the Mekong-3 (see Table 1.1). Cambodia and Lao PDR are diversifying fast The dynamics of these sectors highlight the growing Cambodia and the Lao PDR have considerably expanded their capabilities of the manufacturing base in the Mekong-3, imports, connecting with new markets. In 2021, Cambodia albeit from considerably different starting points. This and the Lao PDR imported more than 13 and 10 per cent of expansion of opportunities for new traders in new markets additional products since 2012, respectively (see Figure 1.5). generates expectations of demand for trade finance that Similarly, exported products have grown remarkably, expanding requires adaptation, as it concerns clients active in markets from 1,597 to 2,250 for Cambodia (an increase of over 40 per with which the financial system may be less familiar. 18 TRADE FINANCE IN THE MEKONG REGION TABLE 1.1 Top five HS2 sectors in the Mekong-3 as a share of new products exported, 2012-2021 Difference Share of total Harmonized System 2 (2012-2013 vs difference (%) 2020-2021) 66 12.5 Machinery and mechanical appliances; nuclear reactors, boilers Cambodia 36 6.7 Electrical machinery and equipment and parts thereof 35 6.5 Optical, photographic, cinematographic, medical instruments 24 4.4 Plastics and articles thereof 20 3.8 Iron or steel articles 25 10.1 Machinery and mechanical appliances; nuclear reactors, boilers 24 9.5 Plastics and articles thereof Lao PDR 15 6.0 Electrical machinery and equipment and parts thereof 13 5.2 Paper and paperboard 12 4.6 Iron or steel articles 48 18.2 Organic chemicals 27 10.1 Inorganic chemicals Viet Nam 13 5.0 Machinery and mechanical appliances; nuclear reactors, boilers 11 4.2 Chemical products n.e.c. 11 4.0 Meat and edible meat offal Source: IFC–WTO calculations based on World Bank WITS. The Mekong-3 are expanding their access While the number of exported products from Viet Nam has not experienced a substantial growth, exporters have succeeded to new export markets in diversifying their market reach. This trend suggests that Cambodia and Viet Nam have made remarkable strides in the surplus capacity built in Viet Nam from global trade expanding their reach of export markets, achieving significantly reconfiguration has led to an expansion of trade beyond the routes from China to the United States. A striking example higher export penetration. Exporters in Viet Nam in particular of this development is evident in the export of broadcast have achieved a level of market access on par with their equipment, a dominant category in Viet Nam’s exports to the counterparts in Malaysia and Thailand (see Figure 1.6). United States: exporters in this sector found their way to 113 The Lao PDR has also managed to increase its export global markets in 2010, expanding to 130 markets by 2021 – penetration – albeit from a modest base. a 15 per cent increase in market access. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 19 FIGURE 1.6 Index of Export Market Penetration, 2011 and 2021 22.8 21.0 12.5 12.6 11.7 8.7 6.5 6.8 5.9 6.3 5.8 4.3 1.5 1.7 Cambodia Lao PDR Viet Nam Malaysia Philippines Sri Lanka Thailand 2011 2021 Source: World Bank WITS. The index follows Brenton and Newfarmer (2007) by comparing for each exported product, the number of countries to which the country exports that product relative to the total number of countries which import that product, and then sums across all products exported. The ratio yields the Index of Export Market Penetration (IEMP), which measures the extent to which a country is exploiting the market opportunities from the existing set of export products. Trade of goods at different stages of processing The Mekong-3 rely significantly on the Goods at different stage of processing vary systematically import of intermediate goods. both in the utilization of trade finance instruments they require and in the demand itself for coverage (see Box 1.2 for a description of trade finance instruments). An analysis of letters of credit usage, independently of transaction timing or The Mekong-3 rely significantly on the import of intermediate destination, reveals that capital and intermediate goods are goods, which utilize letters of credit more intensively. Imports more often covered by this type of finance instrument when into Cambodia and Viet Nam largely comprise intermediate they cross borders, compared to consumer goods or raw goods, surpassing global and regional average shares materials (see IFC/WTO, 2022, based on Crozet et al., 2022). (see Table 1.2, Share of total imports). Viet Nam, in particular, While variations exist across categories, this pattern suggests imports intermediate and capital goods in proportions that overall dependence on bank-intermediated trade finance comparable to more advanced economies in the region, is, to an important extent, associated with the structure of such as Malaysia and Thailand. trade and its dynamics. 20 TRADE FINANCE IN THE MEKONG REGION TABLE 1.2 Share of trade in the Mekong-3 by stage of processing, 2020-2022 (including comparator economies and the world) (in per cent) Share of total imports Primary Consumer Intermediate Capital Other Cambodia 9 16 64 9 2 Lao PDR 11 19 45 22 3 Viet Nam 9 15 60 14 1 Malaysia 16 17 52 14 1 Philippines 8 25 51 14 2 Sri Lanka 13 15 57 14 1 Thailand 13 14 58 15 1 East Asia & Pacific 19 18 45 15 3 World 14 21 44 15 5 Share of total exports Primary Consumer Intermediate Capital Other Cambodia 6 83 10 1 0 Lao PDR 34 19 47 0 0 Viet Nam 5 45 37 13 0 Malaysia 19 12 55 14 0 Philippines 15 14 46 25 0 Sri Lanka 5 67 25 3 0 Thailand 7 25 42 23 3 East Asia & Pacific 10 21 46 20 3 World 19 19 43 14 4 Source: World Bank WITS (mirror data). CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 21 BOX 1.2 Trade finance instruments Trade finance instruments can be broadly faces no liability in the case of payment default categorized as the following: or non-conformity of final goods. • instruments that enable cross-border payments; 4. Open account payments usually indicate • instruments that guarantee payments over time; payments that occur following shipment or receipt • credit that enables production; of goods. While cash-in-advance payments • mixed instruments with more than one of the provide full certainty to the exporter, open account above objectives. payments provide certainty to the importer against any risk. Similar to cash in advance, these payment In the absence of any intermediation, payments for arrangements are not bank intermediated. goods that cross borders are made in advance of shipment, with the full risk of default borne by the Payment guarantees importer. These cash-in-advance payments therefore In addition to payments, there are a number of trade represent the highest risk benchmark for any service finance instruments that guarantee future payments provided by banks in this type of intermediation. to the seller/exporter or the delivery of goods or Payment methods services. Payment guarantees and stand-by letters of credit are bank guarantees to pay the exporter on In order from least secure to most secure for the delivery of the goods. Bid bonds and performance importer, payment methods include the following: bonds also fall into this category and help the recipient to mitigate counterparty risk in the delivery 1. Cash-in-advance payments require the importer of goods or services. to pay for goods well in advance of receiving Capital loans them – sometimes by as much as a year. This provides the exporter with payment certainty but Trade finance also includes instruments to enable leaves significant delivery risk for the importer. production for an overseas destination in the form of capital loans, such as: (i) pre-export finance, which 2. Letters of credit are the most widely used finances expenditures before export deliveries take instrument within the category of documentary place; (ii) post-shipment/import finance to enable trade finance. In its simplest form, a letter of the importer to pay the exporter at a subsequent credit is a written commitment to pay and is stage once the goods have been sold; and (iii) typically issued by a bank on behalf of the buyer working capital loans, which are more flexible ways (importer) to the seller (exporter) or its bank. to pre-finance imports and exports. Letters of credit carry a number of obligations to the buyer (delivery conditions, submission Supply chain finance of documentation) and the seller (notably the guarantee that if the buyer is unable to pay, the Purpose-defined categories such as supply chain bank will cover the outstanding amount). finance (SCF) refer to the open account payments discussed above combined potentially with risk 3. Documentary collections refer to the handling mitigation practices to optimize the management of of documents by banks according to working capital and liquidity invested in supply chain instructions received, typically by an exporter processes. SCF can refer, for example, to supplier or their bank, in order to obtain either direct finance or reverse factoring. These are financing payment or acceptance of deferred payment. solutions in which suppliers can receive early This differs to a letter of credit in that the bank payment on their invoices. 22 TRADE FINANCE IN THE MEKONG REGION Reverse factoring refers to an arrangement whereby supplier financing arrangements, including solutions the supplier receives early payment based on the such as dynamic discounting, in which the buyer credit rating of the buyer. The term SCF can also enables suppliers to access early payment on be used generically to describe a broader range of invoices in exchange for an early payment discount. An entrepreneur visiting a bank in Vientiane, Lao PDR. The Lao PDR imports a higher share of all other categories cent of total export value), while the Lao PDR focuses heavily – consumer, capital and primary goods – which is likely a on exporting primary products (34 per cent of the total) and reflection of its stage of economic development. With regard to energy to China. Both economies lag behind in exports of intermediate goods, the Lao PDR mirrors the import patterns of intermediate and capital goods combined compared to more its neighbouring countries. advanced economies in the region, such as Malaysia, the Philippines and Thailand. Similarly, the composition of exports from the Mekong-3 reflects the level of development of the three countries (see This dynamic, however, has been changing. In 2020, there Table 1.2). Exports from Viet Nam encompass a wide range was a slight shift in Cambodia, with a marginal increase in of products, including intermediate and consumer goods, intermediate goods exports. Exports of intermediate goods showcasing the country’s growing industrial capabilities. from the Lao PDR steadily increased from 30 per cent of total Cambodia primarily exports consumer goods (over 80 per exports in 2012 to more than 50 per cent in 2021. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 23 Competitiveness and Exporters in the Mekong-3 notably secured disproportionately larger shares of the Chinese market in product categories trade costs experiencing a simultaneous surge in demand and prices (see Table I.1 in Annex I for more details). Exporters in the Lao PDR experienced the same in the rest of East Asia and Trade finance and competitiveness in international markets Pacific, resulting in a largely positive geographical effect on are inherently intertwined. In a mutually reinforcing cycle, an their export competitiveness. Conversely, Mekong-3 exporters economy’s competitive edge in international markets reflects to Japan faced the opposite trends relative to average growth its capacity to sustain and expand trade flows, which in turn of demand and prices. impact the demand for trade finance. Moreover, a strong trade position enhances exporters’ returns and creditworthiness, With regard to specific sectors, electronics exporters in Viet Nam facilitating access to favourable terms for trade finance. expanded their footprint in products which had concurrent above-average growth in volume, despite below-average Exporters in the Mekong-3 have improved their export growth in prices for the products exported (see Table I.2 in performance, despite adverse conditions. They have Annex I for more details). It is noteworthy that, at the onset of significantly enhanced their global presence throughout the the COVID-19 pandemic, both the price and volume effects last decade – outperforming counterpart economies in the were positive for Viet Nam’s exports in this sector – that is, broader East Asia and Pacific. price conditions were favourable for the products in which Viet Nam had been specializing. Garment exporters in Cambodia Analysis based on the World Bank Measuring Export managed to expand their footprint in products experiencing Competitiveness (MEC) Database,1 updated through 2021, a below-average increase in both global demand and global shows that the expanded global footprint of Mekong-3 prices. Collectively, the specialization and scale effect in these exporters is not primarily driven by an upsurge in global garment segments outweighed the adverse conditions. demand for the products they specialize in, nor is it driven by stronger demand across the board in their primary export Trade costs in the Mekong-3 destinations (see the sectoral and geographical effects, respectively, in Figure 1.7). Rather, this expansion can be Trade involves various costs arising from transportation, attributed to residual performance associated with distinctive regulatory adherence, currency conversion and trade-related developments within each of the three countries – broadly levies such as import tariffs. As an economy’s infrastructure captured as “performance” or “competitiveness effect”. strengthens and trade agreements are established, many of This residual performance includes possible excess capacity these associated costs will tend to diminish. WTO statistics reveal that global trade costs fell by approximately 15 per cent from trade diversion: that is, the shift of production away from between 2000 and 2018 (WTO, 2021). China; high-value exports along these trade routes; as well as improvements in the productivity of local exporters In the Mekong-3, however, progress has been less pronounced, (see ILO, 2022).2 with disparities in improvements across countries. In Cambodia, there were substantial reductions of 13-22 per cent in both import and export costs to its top ten partner economies between 2008 and 2018. In Viet Nam, however, trade costs fell only for exports, with costs for imports marginally increasing. Over the same period, the average trade costs in the Lao PDR Although trade diversion effects can be for exports to its top ten partners rose sharply by more than short-lived, improvements in productivity 35 per cent, and import costs were 15 per cent higher than underpin a more resilient export growth in 2012 – both of which, moreover, from an already high initial trajectory for Cambodia and Viet Nam. base (see Figure 1.8). Importing costs from the region generally followed an upward trend during the first half of the last decade but subsequently Local producers progressively develop both the capacity improved in the latter half. Trade costs with China – the major and capabilities to compete internationally, should future import partner of the Mekong-3 – on both sides have followed geopolitical alignments favour different locations. a similar trajectory over the last decade. 24 TRADE FINANCE IN THE MEKONG REGION FIGURE 1.7 Decomposition of change in export market share (trade values), period averages 2010-2021 11 10 9 8 7 Log first differences (delta log) 6 5 4 3 2 1 0 -1 -2 -3 Cambodia Lao PDR Viet Nam Darussalam Indonesia Malaysia Myanmar Philippines Singapore Thailand Brunei Competitiveness effect Geographical effect Sectoral effect Change in export (push) (pull) (pull) market share Source: World Bank MEC Database. The numbers reported in the tables are log first differences. They represent an approximation of the percentage change in the variable of interest. Strictly speaking, the percentage change in a variable at period is defined as , which is approximately equal to . The approximation is almost exact if the percentage change is small. It is important to recognize that higher trade costs not only impose direct constraints on trade but can also impede access to trade finance. When trade becomes less lucrative Trade costs are falling slowly in Cambodia and profit margins are squeezed, extending trade finance services to importers and exporters becomes riskier for and Viet Nam, while increasing in the financial institutions. Lao PDR. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 25 FIGURE 1.8 WTO Trade Cost Index in the Mekong-3, 2008-2018 Exports 30 WTO Trade Cost Index 20 10 0 2008 2012 2015 2018 2008 2012 2015 2018 2008 2012 2015 2018 Cambodia Lao PDR Viet Nam Imports 15 WTO Trade Cost Index 10 5 0 2008 2012 2015 2018 2008 2012 2015 2018 2008 2012 2015 2018 Cambodia Lao PDR Viet Nam Source: IFC–WTO calculations based on the WTO Trade Cost Database. The index of global trade costs can be interpreted as how many times higher international trade costs are compared to domestic trade costs (WTO, 2021). For example, a value of 2 means that international costs are double the domestic trade costs (ad valorem equivalent of 200 per cent). The box plots display a three-number summary of the trade cost distribution across the Mekong-3 and their top partners (top ten origin countries for imports, top ten destinations for exports). The bottom of each box represents the first quartile, the horizontal line the median, and the top of the box the third quartile of trade costs in each year. 26 TRADE FINANCE IN THE MEKONG REGION Participation in global value chains The growth of both Cambodia’s textile Seizing trade opportunities in GVCs through expansion into exports and Viet Nam’s electronic industry new products and services requires deeper and more diverse trade finance instruments. Over time, the Mekong-3 have is primarily driven by foreign investors. experienced greater GVC integration both in terms of backward participation (i.e. the share of imported intermediates in exports) and forward participation (i.e. the share of intermediate exports New evidence from the 2023 IFC survey of traders in the from the Mekong-3 in third countries’ exports) (see Box 1.3 for Mekong-3 lends support to the key take-away – that foreign definitions). Leading the way in the East Asia and Pacific region, affiliates rely significantly less on local bank-intermediated Cambodia and Viet Nam have demonstrated remarkable growth trade finance than domestic firms or firms of smaller sizes in their participation levels (see Figure 1.9). (see Chapter 2). Two sectors account for the majority of this development. A closer examination of the electronics sector in 2021 reveals Since the late 2000s, when Viet Nam made a pivotal entry that multinational firms accounted for nearly all of the imports into GVCs, the country has been recognized as a second-tier and exports of these goods – domestic firms accounted for global supplier for computer, communication and consumer 0.5 per cent of imports and 1.6 per cent of exports (see Figure products. Yet despite its prominent position, Viet Nam’s role 1.11). Most shipments to Viet Nam (62 per cent) and over 50 within electronic GVCs has primarily involved a transition per cent of exports were undertaken by businesses with more from being a mere integrator of components to engaging in than 5,000 employees – so-called mega-firms. midstream activities that still generate relatively lower value (OECD, 2021). These midstream activities encompass A similar structure can be found in Viet Nam’s garment sector; subassemblies such as displays and special parts, as although a more considerable share of domestic firms engage well as finished products such as consumer electronics, in trade and there is a greater presence of large rather than communications and computers. An essential aspect of mega firms. Small and medium-sized enterprises (SMEs) are Viet Nam’s electronic industry involves significant imports of concentrated in other exports (39 per cent) and imports components and subassemblies, which accounted for about (23 per cent). Combined, these observations help to explain 65 per cent of imports in 2019. the two-speed trajectories of trade growth in Viet Nam – where large multinational conglomerates outpace smaller, Cambodia’s garment manufacturing sector has experienced a albeit growing, domestic sectors. flourishing trajectory. A distinctive feature of this sector is the prevalence of cut–make–trim firms, which rely heavily on imported The prospects of local bank-intermediated trade finance in the materials for their production processes and often operate along region will likely depend on further integration of local firms into narrow profit margins. This unique model has contributed to the GVCs – a process that has been gaining traction. Tier 1 and 2 sector’s growth and impact on the broader economy. suppliers in Viet Nam to Samsung, a manufacturer based in the Republic of Korea, witnessed a ten-fold increase from 2014 to Foreign investment drives trade growth in 2022, from 25 local companies to 257.5 Furthermore, Samsung Cambodia and Viet Nam has partnered with 400 Vietnamese firms to improve product quality in this supply chain – generating US$ 72 billion in local revenue. The landscape of Viet Nam’s trade is prominently shaped by the activities of multinational enterprises, which contributed to roughly The situation in Cambodia is similar, although access to firm-level 70 per cent of the merchandise imports and exports in 2021 (see information is more challenging. The garment industry relies heavily Figure 1.10).3 Large and mega firms (conventionally defined as on foreign capital, with approximately 90 per cent of garment those employing over 5,000 employees) contributed more than enterprises under foreign ownership, primarily from: China; 80 per cent of goods exports from the country. These shares are Hong Kong, China; the Republic of Korea; and Chinese Taipei significant in terms of trade finance, as subsidiaries of multinational (Calabrese and Balchin, 2022). The advantage of these foreign enterprises and large conglomerates tend to rely to a greater extent entities lies in their access to capital, expertise, well-established on intra-firm financial solutions and syndicated arrangements networks and a skilled labour force – resources that are not as with international banks (Nguyen and Almodóvar, 2018).4 readily accessible to their domestic Cambodian counterparts. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 27 BOX 1.3 Forward and backward participation in global value chains Economies participate in global value chains (GVCs) Backward GVC participation by importing foreign inputs to produce the goods and services they export and also by exporting Backward GVC participation is the share of foreign domestically produced inputs to partner economies value-added content of exports to an economy’s in charge of further production stages. total gross exports. This is the sourcing side in GVCs, where an economy imports intermediates to Forward GVC participation produce its exports. Forward GVC participation is the share of domestic Source: See https://www.wto.org/english/res_e/statis_e/ value-added content of exports to an economy’s miwi_e/explanatory_notes_e.pdf. total gross exports. This is the supply side in GVCs, where an economy exports intermediate goods to third economies for further processing. A local footwear manufacturing plant, Cambodia. 28 TRADE FINANCE IN THE MEKONG REGION FIGURE 1.9 Forward and backward GVC participation in the Mekong-3, 2000 and 2021 (in per cent of trade) 2000 8.4% 26.3% Cambodia 2021 15.5% 31.8% 2000 22.7% 10.1% Lao PDR 2021 28.1% 7.8% 2000 11.9% 20.7% Viet Nam 2021 6.0% 46.8% 2000 14.7% 25.5% Malaysia 2021 16.6% 27.0% 2000 21.9% 14.0% Philippines 2021 17.2% 19.2% 2000 17.1% 23.0% Sri Lanka 2021 9.9% 21.0% 2000 15.0% 26.0% Thailand 2021 12.9% 27.4% Forward Backward Source: World Bank WITS, GVC Trade Table. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 29 FIGURE 1.10 Viet Nam: Share of exports and imports by ownership, industry and firm size, 2021 (in per cent) Exports 100% SME 80% Other Mega Foreign 60% 40% Electronics Large 20% Domestic Apparel 0 Ownership Industry Firm size Imports 100% SME Other 80% Mega 60% Foreign Electronics 40% Large 20% Domestic Apparel 0 Ownership Industry Firm size Source: IFC–WTO calculations based on 2021 Vietnam Enterprise Survey and Custom data from the General Statistics Office of Vietnam, excluding data from the services sector, except wholesale and retail. Foreign – firms with at least 10 per cent foreign ownership; SME – 1-100 employees; large – 101-4,999 employees; mega – 5,000+ employees. Electronics includes ISIC Rev. 4 divisions 26 and 27 and apparel includes divisions 13-15. 30 TRADE FINANCE IN THE MEKONG REGION FIGURE 1.11 Viet Nam: Share of exports and imports in apparel and electronics industries by ownership and firm size, 2021 (in US$ billion) Exports Imports 140 140 10.4 120 120 67.2 100 100 90.1 65.8 75.6 10.7 US$ billion US$ billion 80 80 146.0 57.9 126.0 60 60 66.4 23.5 40 40 46.9 73.5 60.4 55.4 54.8 8.3 41.6 24.1 36.4 20 20 21.9 22.5 15.2 7.7 0 0 Apparel Electronics Other Apparel Electronics Other Domestic Foreign SME Large Mega Source: IFC–WTO calculations based on the 2023 IFC firm-level survey of trade finance. Foreign – firms with at least 10 per cent foreign ownership; SME – 1-100 employees; large – 101-4,999 employees; mega – 5,000+ employees. Electronics includes ISIC Rev. 4 divisions 26 and 27 and apparel includes divisions 13-15. Endnotes 1. See Gaulier et al. (2013) for more details on methodology and indicators of the shift-share analysis. 2. The International Labour Organization (ILO, 2022) notes that from 2010 to 2019, Viet Nam experienced the fastest growth in the average annual real minimum wage in Southeast Asia (11.3 per cent); exceeding the annual productivity growth over the same period by a factor of two. The ILO (2022) concludes that: “While this may signal lower competitiveness for low-cost manufacturing activities, Viet Nam’s average minimum wage is still lower than other competitor production countries in the region. It also reflects that labour productivity can be raised to match higher wages by increasing the value-added of production activity”. 3. The Centre d’Études Prospectives et d’Informations Internationales (CEPII) reports similar results for 2019 (Fouquin and Caponnière, 2020). 4. The United States Census Bureau’s Related Party Trade database reveals that 31 per cent of the total US$ 101 billion goods imported into the United States from Viet Nam in 2021 were between related parties, with the electronics goods category representing the overwhelming majority (90 per cent, equivalent to US$ 28 billion). A share (possibly high) of these intra-company flows is likely to be financed by large global banks outside Viet Nam and not captured in this publication. 5. See https://vir.com.vn/vietnamese-suppliers-to-become-part-of-samsungs-global-value-chain-99735.html. CHAPTER 1: TRADE PROFILES OF THE MEKONG-3 31 C HAPTE R 2 Trade finance in the Mekong-3 Bank transactions during the COVID-19 pandemic in Cambodia. Key findings Local trade finance markets in the Mekong-3 were worth nearly US$ 152 billion in 2022. Vietnamese banks supported about 21 per cent of exports and imports with trade finance, a substantial contribution which represents 22 per cent of total banking assets in the country. The local banking sector in Cambodia supported a much smaller share of the country’s import and export operations, some 3 per cent of total trade, accounting for only 2.5 per cent of banks total assets. Data collected for the Lao People’s Democratic Republic (PDR) are rather weak, but a rough estimate suggests that local trade finance supports an even smaller share of trade. In Cambodia and Viet Nam, the existence of alternative, foreign supply chain finance (SCF) arrangements provided by large multinational companies to their subsidiaries and tier 1 suppliers may explain the limited share of trade finance provided by local banks. The extent and nature of these arrangements is not captured by the data. Local banks have a limited role in supporting trade arising from the production of consumer electronics, textiles and clothing by foreign-owned firms. Greater involvement is found in locally owned sectors of wholesale and retail trade, agriculture and fishing, and intermediary industrial products (metals, plastics). Local banks are also more likely to support intra-regional trade than global trade. Supply and demand constraints impact the availability of locally provided trade finance. On the supply side, 60-80 per cent of banks surveyed identified disruptions to mobility and operations due to the COVID-19 pandemic as the main constraint. The banks also report the need for technical and financial assistance to create trade finance capacity for instruments that they do not provide. On the demand side, the high cost of finance, along with collateral requirements and unfamiliarity with trade finance are highlighted by survey. Banks offer mostly traditional trade finance instruments such as letters of credit, guarantees and pre-export loans. Short-term working capital lines are often used as a substitute to trade finance, particularly in Cambodia, while SCF supplied by local banks in Cambodia and Viet Nam accounts for only 2 per cent of available trade finance. Promisingly, a quarter of surveyed banks intend to introduce SCF in the next two years. Trade finance usage differs significantly across different types of firms. Large firms (at least 100 employees) are over 65 per cent more likely to use external trade finance than firms with 5-99 employees. Perhaps more counterintuitively, foreign-owned and high-tech manufacturing firms tend to use trade finance much less often: domestic companies are twice as likely to use trade finance than foreign-owned companies. Similarly, the share of wholesalers and retail traders using trade finance is almost twice that of firms in high-tech manufacturing. This chapter uses new primary data collected by the IFC through two surveys covering the supply side (banks) and the demand side (exporters and importers) of trade finance. The 2023 IFC survey of trade finance in the Mekong-3 covers the banks currently in operation in the region. The 2023 IFC firm-level survey of trade finance is based on a nationally representative sample of firms engaged in international trade in Viet Nam. Local trade finance markets Bank-intermediated trade finance as Based on the data collected from local banks, the current share of total bank assets value of the local trade finance market is estimated to be US$ 1.6 billion in Cambodia and US$ 150 billion in Viet Nam (see Table 2.1). There is insufficient data to estimate the local trade finance market in the Lao PDR. However, rough calculations 2.5% 22% Cambodia Viet Nam indicate it to be around US$ 0.5 billion – less than a third of Cambodia’s market.1 Source: IFC–WTO staff calculations based on the 2023 IFC survey of trade finance in the Mekong-3. There is a significant difference in magnitude among finance markets in the Mekong-3 – Viet Nam accounts for 98 per cent of the total – and the extent to which local financial sectors SCF programmes have recently been introduced by local contribute to supporting trade flows. Local banks supported banks. KPMG, a major consulting firm, estimates the potential 21 per cent of trade flows in Viet Nam, 3 per cent in Cambodia of the SCF market in Viet Nam to be close to US$ 50 billion and possibly less in the Lao PDR (see Table 2.1). annually. However, only a minor part of such potential has yet been exploited.3 According to the survey, SCF supplied by As described in Chapter 1, Viet Nam’s share of trade (exports local banks accounts for only 2 per cent of the total estimated plus imports) expanded to 185 per cent of GDP2 in 2022, trade finance. which reflects its growing participation in global supply chains. The mobilization of domestic financial assets for trade The local trade finance market in Cambodia is smaller both facilitated the fast expansion of trade operations in Viet Nam. in absolute and relative terms (see Table 2.1). The estimated The estimated share of trade finance in the total banking trade finance portfolio of banks was about US$ 1.6 billion, assets of Viet Nam is about 22 per cent – a large share by any out of US$ 52 billion in trade flows in 2022. Cambodia shares international estimate. a common characteristic with Viet Nam of having a high trade-to-GDP ratio, which exceeded 210 per cent in 2022. Although the local trade finance market in Viet Nam supports Support by the financial sector to the integration effort of only one-fifth of total trade flows, the survey did not cover Cambodia is therefore important for the competitiveness of its SCF arrangements provided by foreign banks to subsidiaries traders in international markets. However, the survey confirms of foreign firms in Viet Nam producing goods for export. Only previous analysis (Kingdom of Cambodia, 2018), according to a global survey involving, for example, global banks and banks which the 3 per cent share of trade supported by formal trade from China, Europe, the Republic of Korea and the United finance instruments was relatively small by international standards. States could capture additional trade finance flows. These differences may result from a range of triggers, such as: • underreporting in the survey owing to a narrow interpretation of trade finance by respondent banks; • the existence of foreign financing flows sourced outside Cambodia; Local trade finance markets in the • intra-company financing from abroad; • the existence of temporary imports – where garment Mekong-3 are worth nearly US$ 152 billion. factories are directly provided with inputs for local processing before re-exporting to the country of origin. 34 TRADE FINANCE IN THE MEKONG REGION TABLE 2.1 Bank-intermediated trade finance in the Mekong-3 Total Cambodia Lao PDR Viet Nam No. of banks surveyed 143 61 39 43 No. of respondent banks 61 33 8 20 Respondent banks’ share of total banking assets 75% 81% 61% 74% Share of respondent banks involved in trade finance 87% 82% 88% 95% Total merchandise trade (US$ billion) 798 52 15 731 Size of bank-intermediated trade finance (US$ billion) 152 1.6 0.5* 150 Average share of bank-intermediated trade finance 19% 3% <3% 21% Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3 (see Box 2.1). * The estimated size of bank-intermediated trade finance in the Lao PDR is based on data received from three banks providing this information. Total bank assets for the Lao PDR refer to the 2021 due to unavailable estimates for 2022. While foreign finance was outside the scope of the survey, instruments and associated risks. There are clear leaders in it should not be assumed that such financing arrangements the Mekong-3. are systematic. Survey interviews indicated both a variety In Viet Nam, the five largest banks by assets account for over of financing models and no financing at all. In some cases, 50 per cent of the trade finance market by US dollar value, the import of inputs is provided by the parent company and and the ten largest banks account for over two-thirds of total does not involve any financing. In other cases, foreign estimated trade finance assets. Although the banking sector suppliers require cash-in-advance payments, with either has historically experienced high levels of concentration in local banks or foreign banks of the suppliers offering East Asia (Lapid et al., 2023), the shares of assets of the overdraft or working capital credit lines to local factories top three banks have declined considerably in Cambodia (normally fully collateralized by property) to purchase and Viet Nam over the last decade and are below levels of the imported goods. Local producers may also apply for more advanced countries in the region such as Malaysia, the collateralized lines of credit via the subsidiary of the bank Philippines or Thailand. Despite remarkable progress, the operating with the main exporting country. Lao PDR still records high levels of concentration of banking assets, which reflects its level of financial development.4 Trade finance instruments Certain subsidiaries or branches of international banks might not have large domestic asset portfolios in the Viet Nam. Local trade finance is mainly supplied by large banks, through However, compared to their local banks’ assets, they have traditional trade finance instruments and working capital. rather important trade finance assets. The survey generally Scale matters in trade finance, as international trade operations finds that a relatively wide range of trade finance products of banks require infrastructure, such as correspondent banking and solutions are offered by banks in the Mekong-3 relationships (CBRs), and skills in handling trade finance (see Figure 2.1). CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 35 BOX 2.1 The 2023 IFC survey of trade finance in the Mekong-3 Following the model of the IFC Global Trade Sample size Finance Program (GTFP) survey and the expanded regional survey of trade finance in the Economic The sample included all the banks listed on the Community of West African States in 2021, the IFC central bank websites of the Mekong-3 as of surveyed banks in Cambodia, the Lao PDR and December 2022. Viet Nam on the state of trade finance for 2022. The survey included around 30 questions to collect a wide range of information about the cumulative asset volumes of trade finance recorded by local 61 39 43 Cambodia Lao PDR Viet Nam banks for 2022, the trade finance products offered, their prices and the sectors of the economy that received trade finance from the banks. Private, state-owned and foreign-owned banks were included in the sample, conditional on having a The survey also enquired about constraints to the local presence in the Mekong-3 and listed with their demand and supply of trade finance, support actions central bank. The IFC collected the contact emails of that may help banks to diversify their products, and the trade finance units of these banks and emailed each country’s outlook for trade finance as perceived the survey link directly to them. When contact details by their respective banks. of the trade finance units could not be tracked, the IFC used the banks’ generic email addresses. The survey protocol included several follow-up actions to ensure completion and to revise inconsistent responses. In addition, the bank associations in the Mekong-3 shared the survey link with the banks in their network to increase response rates. Banks completed the survey between April and August 2023, and all responses up to 20 August are included in the results. Bank assets The assets of the banks that responded to the survey represent 81 per cent of the 2022 total bank assets reported by central banks in Cambodia, 65 per cent in the Lao PDR and 74 per cent in Viet Nam. Information was collected from banks of different sizes, including four of the top five banks in Cambodia and Viet Nam, and medium and smaller banks. In Cambodia and Viet Nam, the three top banks that responded held around 39 and 36 per cent of the total bank assets in the country, respectively. Although the response rate to the survey in the Lao PDR was lower, its largest bank, with over 40 per cent of the assets, is also the main contributor to trade finance data captured.* * Annex II contains further information about the relationship Diamond Island, the commercial hub in the heart of Phnom Penh, Cambodia. between bank size and trade finance portfolio based on regression analysis and the methodology used to estimate assets. FIGURE 2.1 Trade finance instruments offered by banks in the Mekong-3, 2022 (as a share of banks in per cent) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Letters of credit Guarantees and counter guarantees Standby letters of credit Documentary collections Bid/performance bonds General working capital used for trade Post-shipment financing Equipment imports financing (medium & long term) Pre-export financing Supply chain financing (factoring, reverse factoring, forfaiting) Other forms of import financing (e.g. avalized draft) Bank payment obligations other than above Specialized offering for climate change abatement support Cambodia Lao PDR Viet Nam Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. Surveyed banks routinely offer traditional trade finance only a few banks in Viet Nam – and even fewer in Cambodia – instruments such as letters of credit, documentary collections are really active in providing it to their clients. and other guarantees on the import side, and loans that largely The data show that a non-negligible share of each country’s comprise short-term, working capital and pre-export finance. imports is paid cash in advance, leaving a fraction of imports A third of banks in Cambodia and close to two-thirds of banks to be supported by formal trade finance instruments, mainly in Viet Nam indicate that they are in a position to offer some guarantees such as letters of credit and documentary form of SCF. However, estimates from the survey suggest that collections, but also import loans (see Figure 2.2). CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 37 FIGURE 2.2 Trade finance instruments in the Mekong-3 for imports and exports, 2022 (as a share of all instruments, in per cent) 9% 16% 18% 45% 40% 73% 34% 44% 21% Cambodia Lao PDR Viet Nam Export financing (loans & working capital) Import letters of credit Other import financing Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. According to the survey, import letters of credit represent perhaps most importantly, perceived uncertainties owing to about 34 per cent of the 2022 trade finance assets in collateral requirements. Viet Nam (see Figure 2.2), which would bring the value of the market for the instrument to approximately US$ 51 billion.5 Other than letters of credit, the survey highlights the The share of letters of credit in Cambodia in total trade finance importance of working capital used for the purpose of trade. assets is similar to Viet Nam. With an estimated local trade Working capital in Cambodia captured in the survey is finance market of US$ 1.6 billion, a 40 per cent share would estimated to be around US$ 0.6 billion, representing around value letters of credit at around US$ 0.6 billion in trade finance 40 per cent of the total trade finance assets in the country in 2022, supporting about 2 per cent of imports. In the Lao and covering 1.2 per cent of the total trade in 2022 (see PDR, letters of credit are provided by one in five of the banks Table 2.2). The survey shows that US$ 29 billion in working surveyed, supporting less than 1 per cent of imports and capital is used in Viet Nam for the purpose of trading. This is a highlighting an overall limited use of trade finance products in smaller share of trade finance assets than in Cambodia (20 per the country. cent against 40 per cent) and supports 4 per cent of its total merchandise trade. While banks can routinely arrange letters of credit and other documentary credits, survey interviews confirm the existence There are several reasons for the use of working capital. of several obstacles for their use, such as a lack of available Exporters of finished goods (e.g. garments) are typically paid documentation to support their issuance, market power from on a 90-day basis – without the possibility to benefit from suppliers originating in larger economies (i.e. China, Thailand, cash advances often involved in SCF. Facing pressure from Viet Nam) often demanding a pre-payment for their inputs; and their own suppliers to pay cash-in-advance for their inputs, 38 TRADE FINANCE IN THE MEKONG REGION TABLE 2.2 Working capital for trade finance, 2022 Cambodia Viet Nam Working capital (US$ billion) 0.6 29 Working capital as share of total trade finance 40% 20% Working capital as share of total merchandise trade 1.2% 4% Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. the only way to avoid being cash-strapped is either to secure trade growth shown in Chapter 1, local banks have a limited working capital lines or to receive trade loans (import and or no role in supporting trade arising from importing inputs or pre-export loans). However, as observed in Cambodia, exporting locally produced goods by foreign-owned firms in revolving, short-term working capital lines are preferred for their the electronics sector and, to a lesser extent, textiles and flexibility against more structured loan agreements. Generally, clothing sector. Local bank services are rather oriented toward they are available only to clients with sufficient land or building locally owned activities (e.g. food, fisheries) or import-intensive, collateral and are typically more expensive. fast-growing sectors (e.g. construction). For many new small and medium-sized enterprises (SMEs) Which sectors received trade finance by local banks varies with limited credit history and no land collateral, these are across the Mekong-3. Viet Nam’s local trade finance supports non-starter conditions. According to local surveys, 70 per the greatest number of sectors. Survey results establish that cent of SMEs in Viet Nam have difficulty accessing such all 18 industries covered benefited from support by at least working capital and must use their own money or borrow from 50 per cent of the banks, while ten sectors received trade informal sources at higher costs.6 In industrial supply chains finance from 80 per cent of the banks (see Figure 2.3). The involving many SMEs, the difficulty to access trade finance distribution of total trade finance between imports and exports through working capital – as a substitute for even more formal in Viet Nam is relatively balanced (55 per cent to 45 per cent; and documented forms of trade finance – may be just one of see Figure 2.2), concentrating on intermediate goods and many reasons why the coverage rate by local banks of certain inputs (e.g. plastics, metals, textiles), agriculture and fishing sectors such as textiles and clothing and electronics is so low.7 products, and construction materials. Most of the local banks surveyed report that they do not The distribution is less homogeneous in Cambodia and the provide SCF because of insufficient demand from clients. Lao PDR, where trade finance is mainly supplied for imports Some of the local banks provide distribution finance, covering (84 per cent and 91 per cent, respectively; see Figure 2.2). mainly domestic flows, with banks remaining the main suppliers In Cambodia, different banks supported different sectors. of SCF. Major bottlenecks are the lack of reliable local SCF Hence, most sectors received trade finance from less than platforms and conservative credit culture. 40 per cent of the banks. The sectors of construction8, food products and beverages, and wholesale and retail received most of the trade finance from the local financial sector in Trade finance across sectors Cambodia: 62, 52 and 48 per cent of the banks surveyed supported trade activities in these three sectors, respectively. Wholesale and retail trade, agriculture and fishing, and In the Lao PDR, agriculture, forestry, fishing and wholesale and intermediary industrial products (metals, plastics) are the retail receive the most trade funding: 100 and 68 per cent of main sectors to receive bank-intermediated trade finance the banks, respectively, and the only sectors listed by more (see Table 2.3). Consistent with the two-speed trajectory of than half of the banks. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 39 TABLE 2.3 Distribution of trade finance across the surveyed banks’ top three sectors, 2022 (in per cent) Cambodia Viet Nam Agriculture, forestry, fishing 8.1 27.0 Chemicals 0.0 0.0 Coke & refined petroleum products 3.3 3.0 Computer, electronics 0.0 0.0 Construction 1.4 25.0 Electricity, gas, steam & air conditioning supply 29.2 2.1 Food products, beverages 19.4 0.0 Metals 11.9 16.4 Motor vehicles & transport equipment 0.0 0.3 Other manufacturing 0.0 0.7 Pharmaceuticals 2.4 0.5 Plastics 0.0 1.6 Textiles 0.0 8.2 Transport 0.4 0.0 Wholesale and retail trade 24.0 15.4 Total 100 100 Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. Trade finance for firms medium-sized enterprises (MSMEs) owned or led by women (see Figure 2.4), which makes it a challenge to discuss with owned or led by women any certainty the gender gap in access to trade finance. Around 41 per cent of banks report that they provide trade Research indicates that firms owned or led by women are finance to women-owned or led MSMEs and only 7 per cent often small businesses and more dependent on trade finance of the banks do not. These numbers mask some heterogeneity: (World Bank and WTO, 2020). Yet, evidence from the Asian the gender disparity in access to trade finance is more Development Bank (ADB, 2016, 2017, 2021) shows that accentuated in Cambodia and the Lao PDR, where only 37 per trade finance requests made by women-led businesses have cent and 33 per cent of banks, respectively, report allocating a higher rejection rate and fewer than 20 per cent of the trade finance to women-owned or led MSMEs, compared to women interviewed had received trade finance. 47 per cent in Viet Nam. However, few banks reported actual The information collected in the survey reveals that around 51 numbers. Of those that did, 3 per cent was the highest share per cent of the surveyed banks in the Mekong-3 do not track of the bank’s total trade finance allocated to women-owned or whether or not they provide trade finance to micro, small and led MSMEs. 40 TRADE FINANCE IN THE MEKONG REGION FIGURE 2.3 Bank-intermediated trade finance in the Mekong-3 by sector, 2022 (in per cent) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Agriculture, forestry, fishing Chemicals Coke & refined petroleum products Computer, electronics Construction Electricity, gas, steam & air conditioning supply Food products; beverages Metals Mining Motor vehicles & transport equipment Other manufacturing Other services Pharmaceuticals Plastics Telecommunications, information technology Textiles Transport Wholesale & retail trade Cambodia Lao PDR Viet Nam Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. Trade finance for of the banks report that they provide trade finance to climate-related activities and 26 per cent do not (see Figure climate-related activities 2.5). In Viet Nam, almost 29 per cent of the banks finance climate-related trade against 24 per cent which do not. In the Despite the urgency of mitigating or adapting to climate Lao PDR, 33 per cent of the banks surveyed do not finance change, only a small fraction of the banks in the survey fund climate-related trade activities. Furthermore, large shares of climate-related trade activities. In Cambodia, only 11 per cent banks surveyed in the Mekong-3 fail to track such data. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 41 FIGURE 2.4 Share of banks in the Mekong-3 providing trade finance to MSMEs owned or led by women, combined and by economy, 2022 (in per cent) 53% 47% 67% 41% 51% 6% 11% 47% 37% 33% 7% Mekong-3 Cambodia Lao PDR Viet Nam Yes No Do not track Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. FIGURE 2.5 Share of banks in the Mekong-3 providing trade finance to climate-related activities, combined and by economy, 2022 (in per cent) 18% 47% 63% 67% 56% 26% 24% 26% 33% 29% 11% Mekong-3 Cambodia Lao PDR Viet Nam Yes No Do not track Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. 42 TRADE FINANCE IN THE MEKONG REGION Trade finance constraints affected the growth of their trade finance portfolio in 2022 (see Figure 2.6). Around 60-80 per cent of respondent banks identified disruptions to mobility and operations due to the The respondent banks identify constraints relating to the COVID-19 pandemic9 as the main constraint. Inflation and COVID-19 pandemic, the rise of inflation and strong competition in the market were mentioned by some 40 per competition between banks as factors which negatively cent of banks in Cambodia and Viet Nam. FIGURE 2.6 Main constraints to trade finance growth in the Mekong-3, 2022 (share of banks affected by each constraint, in per cent) 0% 10% 20% 30% 40% 50% 60% 70% 80% COVID-related mobility or operational disruptions Inflation/commodity prices Competition US$/€ liquidity constraints Corporate finance shortage for reasons other than liquidity constraints Local currency liquidity constraints Other Lack of access to foreign markets for the banks Supply chain disruptions Regulatory challenges, including anti-money laundering & combating the financing of terrorism Intra-regional business relocation Conflict disruptions Cambodia Lao PDR Viet Nam Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 43 Inflation and its heterogeneous dynamics across countries may cent of the total trade finance portfolio and only 0.4 per cent of impact trade finance markets, for example, when transaction the respondent banks’ total assets (see Table 2.4). ceilings are not adjusted to rising prices of traded goods or by reducing returns over time to working capital loans. In the The numbers are significantly lower in Cambodia, where SCF Lao PDR, unlike in Cambodia and Viet Nam, access to local is estimated at US$ 40 million, which is equivalent to 2.4 and foreign currency liquidity are reported as major constraints per cent of the total trade finance assets and 0.1 per cent of by 57 and 43 per cent of banks, respectively. Some 11 per the surveyed banks’ total assets. Figures for both countries cent of banks in Cambodia and Viet Nam report the regulatory refer exclusively to local bank-intermediated SCF and can environment as one of the top three constraints to trade be considered a lower bound given that foreign banks and finance growth, implying that a sound institutional environment development finance institutions also provide this type of is often a prerequisite for productive economic activities finance in Cambodia and Viet Nam. (Asteriou et al., 2021). The respondent banks report the need for technical and financial Nevertheless, banks in Viet Nam are generally optimistic assistance to create trade finance capacity for instruments about future trade finance growth, with 78 per cent expecting that they do not provide (see Figure 2.8). Overall, the request growth in their activities in the year ahead. Banks’ perception in Cambodia and Viet Nam is for help with more sophisticated in Cambodia is less optimistic; only 56 per cent of the products such as SCF and climate change abatement. Banks in respondents expect an increase in their trade finance portfolio. Cambodia would also like to have technical and financial support However, 22 per cent of the banks did not provide information for pre-export and equipment import financing. about their trade finance growth expectation. In the Lao PDR, the percentage is smaller, with 43 per cent of the banks expecting an increase within the 12 months following the Trade finance rejection rates survey, but with many missing values recorded among the Viet Nam has a more dynamic and active trade finance banks surveyed in the Lao PDR. ecosystem, while Cambodia takes a more risk-averse approach The respondent banks rated the key constraints affecting their to trade finance business. The survey revealed that banks capacity to meet the trade finance demand of their customers reject an average of 15 per cent of trade finance requests, on a scale from 1 to 5. The higher the rating, the higher the which accounts for around US$ 21 billion in unmet demand constraint. Limited availability of low-cost funding is the most (see Table 2.5). The rejection rate varies significantly between constraining challenge, with an average rating of 3.3 out of 5 Cambodia and Viet Nam. While the rate of 12 per cent in Viet (see Figure 2.7). Constraints relating to internal risk rating and Nam is in the same range as the average rate of 9.5 per cent customer collateral requirements are second, with an average for the emerging markets that participated in the IFC Global rate of 3.0. Increased correspondent bank requirements, new Trade Finance Program (GTFP) 2023 survey10, the 23 per cent trade finance products entering the market, insufficient line rejection rate for Cambodia is twice as high. The 10 per cent limits from correspondent banks and a lack of information rejection rate in the Lao PDR is the lowest of the Mekong-3. about market segments all scored above 2.5. However, the insufficient sample size makes it difficult to consider this result representative. Supply chain finance and These survey insights depict the different risk appetites reverse factoring and supply–demand balance in these two markets. Box 2.2 provides further evidence on the demand for finance from firms engaged with international trade in Viet Nam. Alleviating these supply-side constraints will help banks to support client requests better. Importantly, promoting modern trade finance instruments such as SCF/reverse factoring (see Box 1.1 in Chapter 1) has the potential to boost bank capacity to meet the demand of their customers. As discussed earlier, the intake of SCF is very low compared to traditional trade Rejections of trade finance requests are finance instruments. Only half of the banks in Viet Nam offer this attributed to a lack of collateral, high credit product, compared to one in four in Cambodia and none in the Lao PDR (see Figure 2.1). The total SCF volume is estimated at risk and information asymmetry. US$ 2.9 billion in Viet Nam, representing in relative terms 2 per 44 TRADE FINANCE IN THE MEKONG REGION FIGURE 2.7 Key constraints on banks in the Mekong-3 to meet trade finance demand, 2022 (1 = not a constraint, 5 = top constraint) 1 2 3 4 Limited availability of low-cost funding Internal risk ratings and/or collateral requirements for customers Increased correspondent bank requirements New trade finance products entering the market that we do not yet support Insufficient line limits from correspondent banks Lack of information about certain segments, sectors or other market attributions Macroeconomic or political instability Inadequate capital to deploy for additional trade finance to my bank's custom Regulatory environment Insufficient tenors from correspondent banks Correspondent bank processing delays Lack of sufficient US$/€ liquidity from cross-border financial institution Insufficient clearing/settlement accounts with correspondent banks Lack of sufficient US$/€ liquidity from central bank Other Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. TABLE 2.4 Supply chain finance and reverse factoring, 2022 Cambodia Viet Nam Supply chain finance/reverse factoring (US$ billion) 0.04 2.9 Supply chain finance as share of trade finance 2.4% 2.0% Supply chain finance as share of surveyed banks’ assets 0.1% 0.4% Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 45 BOX 2.2 The 2023 IFC firm-level survey of trade finance: How firms in Viet Nam finance trade operations Firms’ ability to finance their operations affects their in the literature as evidence of credit constraints participation in international trade. The riskiness and (Fazzari et al., 1988, 2000). Despite the potential for longer time lag in cross-border transactions require trade finance to bridge the short-term capital gap, both financing of working capital over short horizons only 16 per cent of importers and exporters report and insurance to protect against counterparty defaults. having used trade finance. Between June and August 2023, the IFC surveyed Trade finance instruments a representative sample of manufacturers and traders in Viet Nam that had engaged at least once The use of trade finance leans largely towards in international trade between 2019 and 2021. The traditional trade finance instruments. Mirroring the bank survey focused on how firms finance international survey’s results, firms report predominantly leveraging trade, explored their demand for and access to trade letters of credit (57 per cent), irrespective of firms’ size, finance products and captured heterogeneity by ownership type (domestic or foreign) or main sector of firm’s characteristics and pricing conditions. Foreign operations. General working-capital borrowing is the affiliates indicated that they were producing only second most used and most demanded trade finance for the foreign parent company and did not need product, echoing the bank’s survey results on the additional financing. importance of working capital for trade. Trade finance need The demand for other trade finance instruments is more sparse and likely to depend on specific firm Three out of four firms trading internationally report no characteristics. For example, bid/performance need for trade finance. Exporters and importers report bonds are more likely used by domestic, trading predominantly relying on internal funds to finance small and medium-sized enterprises (SMEs). their working capital over external finance. This Non-traditional trade finance instruments such as overreliance on internal funding is typically interpreted supply chain financing are largely non-existent. Trade finance use in Viet Nam (in per cent) 16% Trade finance needed 26% 9% Applied for bank-intermediated trade finance Approved at least once 3% Other 0% Pre-export All 14% 1% Post-shipment firms 2% Working capital 2% Never approved 8% Letters of credit 74% Never applied for bank-intermediated trade finance Trade finance not needed Source: IFC firm-level survey, 2023. The results presented are from an interim sample of 653 firms. Trade finance use Collateral (in per cent of financing received) Trade finance use differs significantly across different 200 200 types of firm. Large firms (at least 100 employees) are over 65 per cent more likely to use external trade 150 150 finance than firms with 5-99 employees. Perhaps more counterintuitively but consistent with the 100 100 bank survey results, foreign-owned and high-tech 50 50 manufacturing firms tend to use trade finance much less often: domestic companies are twice as likely 0 0 to use trade finance than foreign-owned companies. Similarly, the share of wholesalers and retail traders Overall SME Large using trade finance is almost twice that of firms in 200 200 high-tech manufacturing. 150 150 This differential use of trade finance likely reflects 100 100 differences in the structure of supply chains as well as the differences in the risk-return profiles of firms 50 50 or transaction types. For example, foreign-invested 0 0 firms may receive financing from their parent company as well as having access to banks located Domestic Foreign Low-tech High-tech Wholesale/ outside Viet Nam. Firms in high-tech manufacturing, manufac. manufac. retail trade a sector likely dominated by electronics Source: IFC firm-level survey, 2023. Results are conditional on type of trade manufacturing, are the least likely to use bank- finance instrument. intermediated trade finance. This sector includes large subsidiaries or affiliates of multinationals Differences in firms’ risk profiles are evidenced that either have a lower need for working capital by the collateral requirements and approval time financing or are able to access finance from their for trade finance applications. Foreign firms and parent companies. firms in high-tech manufacturing have lower collateral requirements. The collateral requirement Share of firms using bank-intermediated differential between SMEs and large firms is not trade finance (in per cent) as conspicuous, suggesting that foreign firms and firms producing electronics are likely to obtain better lending conditions, regardless of their size. More 21% favourable lending terms are not limited to the lower cost of funds. Firms in high-tech manufacturing appear to have their trade finance applications 16% 15% approved significantly faster – at around one-third 14% 13% 13% of the time required by firms in trade or low-tech manufacturing. 8% 8% The speed in processing does not reflect differences in how firms file their applications. Irrespective of a firm’s size or sector, most of the applications are filed on paper. This low usage of online processes, Total SME Large Domestic Foreign Low-tech manufac. High-tech manufac. Wholesale/ retail trade as well as the lack of more modern instruments, such as platforms or supply chain finance, suggests ample scope for improvements in efficiency in trade Source: IFC firm-level survey, 2023. Results are unconditional means. finance provision in Viet Nam. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 47 FIGURE 2.8 Trade finance technical and financial assistance needs of respondent banks, 2022 (in per cent) Technical assistance Financial assistance 50% 40% 30% 20% 10% 0% 0% 10% 20% 30% 40% 50% 60% Specialized offering for climate change abatement support Bank payment obligations Other forms of import financing (e.g. avalized draft) Supply chain financing (factoring, reverse factoring, forfaiting) Pre-export financing Equipment imports financing (medium & long term) Post-shipment financing General working capital used for trade Bid/performance bonds Documentary collections Standby letters of credit Guarantees and counter guarantees Letters of credit Cambodia Viet Nam Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. TABLE 2.5 Trade finance gaps and rejection rates in the Mekong-3, 2022 Total Cambodia Lao PDR Viet Nam Size of bank-intermediated trade finance (US$ billion) 152 1.6 0.5 150 Average approval rate of trade finance requests 85% 77% 90% 88% Average rejection rate of trade finance requests 15% 23% 10% 12% Size of the trade finance gap (unmet demand) (US$ billion) 20.8 0.5 0.05 20.3 Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. 48 TRADE FINANCE IN THE MEKONG REGION High rejection rates disproportionately affect SMEs, which are often unable to produce bankable credit files given that they frequently do not have established organizational structures, customarily struggle to produce and maintain High rejection rates disproportionately records acceptable for financing, or lack sufficient collateral. The main rejection reasons given by the banks surveyed affect small and medium-sized enterprises, included: insufficient collateral (30 per cent); insufficient which often lack sufficient collateral or documentation (27 per cent); and high credit risk of struggle to produce and maintain applicants (see Figure 2.9). financial records. The difficulty in assessing a client’s credit risk and loan requests exceeding the client’s limit are also important factors. In Viet Nam, an applicant’s high credit risk and insufficient When asked about their main constraints in accessing CBRs, collateral are the primary reasons for rejecting a trade finance local banks report the increased regulatory requirements to request, accounting for over half of rejections (see Figure combat money laundering and terrorism financing, insufficient 2.10). In Cambodia, insufficient documentation is the main line limits, increased cost of financing and tenor (i.e. repayment reason why a third of credit applications are rejected. In the period) restrictions (see Figure 2.10). Lao PDR, half of the rejections were because of insufficient collateral, pointing to risk aversion and the low maturity of the local banking system. Trade finance prices For letters of credit, banks charge fees to compensate for risk, Correspondent banking which is affected by the credit history of the client, the country of operation, the nature of the transaction, its duration, as relationships well as any foreign exchange risks. For trade loans, the cost of funds for the bank is an important element of pricing, along Broadly defined, a correspondent banking relationships (CBR) with the transaction’s overall risk and the market structure. is where a bank has an arrangement with a third-party financial institution to receive services and/or act on its behalf in another Letters of credit fees in Cambodia and Viet Nam and interest jurisdiction. A bank’s access to CBRs allows them to execute rates on trade and working capital loans for traders are trade transactions regionally and globally. It is an important generally higher than the global emerging market benchmarks, condition for being able to supply trade finance. Sufficient as well as the rates observed in more advanced economies. access to correspondent banking means, for example, that The average fee for letters of credit in Cambodia and Viet the local demand and clearance of international transactions Nam is reported to be 3.25 per cent of the transaction value – in foreign currencies can be met, particularly in US dollars compared to a 2 per cent global average for emerging markets and euros, and that letters of credit can be issued and and a 0.25-0.50 per cent lower bound typically observed in confirmed internationally. advanced economies (see Table 2.6). In Viet Nam, around 29 per cent of the banks surveyed A short-term working capital pre-shipment finance is priced have fewer than 10 CBRs and 53 per cent have 10-50 at around 8 per cent in Cambodia and 7 per cent in Viet Nam, corresponding banking relationships. Three Vietnamese banks while refinancing rates for import finance is between 6.25 per display large numbers of 300, 641 and 1,163. The average cent and 8 per cent (see Table 2.7). In Cambodia, prices for number of CBRs per bank is 15 (excluding the three outliers). some types of letter of credit (post-shipment) can be as high In Cambodia, the range of the numbers of CBRs reported as those of loans, which is in effect, discouraging their use in is more homogenous, with a maximum value of 24 and an an already narrow market. average of five relationships per bank. Therefore, access to CBRs is more of a constraint in Cambodia than in Viet Nam. Moreover, such access has been stable, with almost three quarters of respondent banks reporting no change in their network in 2022, and 16 per cent reporting an increase in access. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 49 FIGURE 2.9 Main rejection reasons reported by banks in the Mekong-3, combined and by economy, 2022 (in per cent) 6% 13% 8% 25% 17% 7% 11% 27% 20% 28% 27% 50% 24% 28% 30% 33% 25% 22% Cambodia Lao PDR Viet Nam Mekong-3 Insufficient Insufficient High credit risk Request exceeds individual Unknown credit risk documentation collateral of applicant customer loan limits of applicant Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. FIGURE 2.10 Correspondent banking relationship constraints in the Mekong-3, 2022 (in per cent) 8% 4% 23% Increased requirements (AML/CFT) 8% Insufficient line limits Increased cost of financing Tenor restrictions 15% Slow transactional response time 23% Too many CBR rejections within current line limits Increased cash collateral requirements 19% Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. AML – anti-money laundering; CBR – correspondent banking relationship; CFL – countering the financing of terrorism. 50 TRADE FINANCE IN THE MEKONG REGION TABLE 2.6 TABLE 2.7 All-in prices for confirmed Average prices for selected letters of credit, 2022 trade finance instruments, 2022 (in per cent) (in per cent per annum) Cambodia Viet Nam Cambodia Viet Nam Minimum 2.25% 1.20% Cost of funds 3.50% 4.25% Average 3.25% 3.25% Letter of credit 8.00% 6.25% Maximum 4.00% 5.00% post-financing Export financing 8.00% 7.00% Import financing 8.00% 7.00% Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3. All fees are annualized, reported as a percentage of the transaction value Source: IFC–WTO calculations based on the 2023 IFC charged per annum. survey of trade finance in the Mekong-3. Endnotes 1. The estimates of local trade finance are expressed as a range and in the case of Cambodia and Viet Nam were produced using the methodology developed for the purpose of this publication based on the observation of a sufficiency large share of bank trade finance and total assets in the country (see Annex II for a description of the methodology). For the Lao PDR, the available data were insufficient to complete a regression-based estimation of the local trade finance market. A rough estimate based on reporting by banks accounting for 50 per cent of assets, assuming a proportional relationship between total assets and trade finance assets, would suggest that the country’s trade finance market would be rather small, at around US$ 0.5 billion. 2. Calculated as sum of exports and imports divided by GDP. 3. See https://vir.com.vn/supply-chain-finance-a-solution-to-support-msmes-and-promote-the-economy-86403.html. 4. Data on banking concentration are available from the World Bank Development DataBank (https://databank.worldbank.org/home). 5. This estimate is consistent with data previously collected by the SWIFT banking network prior to the COVID-19 pandemic. The International Chamber of Commerce (ICC, 2020a: 41) reports that SWIFT data show that Asia and the Pacific received 3.1 million letters of credit in 2019, more than any other region. Of this, Viet Nam received 106,114, a slight increase from 105,668 in 2018. According to ICC (2020a), the average value of import letters of credit in the region was US$ 430,000. If this average is used for the number of Viet Nam’s letters of credit, the total amount would be over US$ 45.6 billion. A 2021 working paper by the International Monetary Fund finds that Viet Nam had one of the world’s highest correlations between its import flows and the flows of letters of credit and documentary collections (Ghazaryan et al., 2021). 6. See https://vir.com.vn/supply-chain-finance-a-solution-to-support-msmes-and-promote-the-economy-86403.html. 7. See General Statistics Office (2022: 388 and 394). While structured around the presence of large foreign corporations, the electronics sector in Viet Nam has a large eco-system of small companies and vendors operating local factories of parts (semi-conductor circuits, chips, camera modules, phone batteries) produced for local assembly and export of the final goods. Around 68 per cent of the 4,476 companies operating in the electronics sector employ fewer than 50 people; 84 per cent of companies employ fewer than 200 people. 8. Construction is generally a sector that imports a high volume of materials and therefore depends on trade finance. 9. While COVID-related constraints are in principle temporary, there can be delayed and persisting impacts to which the banks may be referring. 10. Based on global survey of over 100 IFC clients participating in the GTFP, which extends and complements the capacity of banks to deliver trade financing by providing risk mitigation in new or challenging markets. CHAPTER 2: TRADE FINANCE IN THE MEKONG-3 51 C HAPTE R 3 The impact of closing the trade finance gap Microfinance repayments to a local bank, Lao People’s Democratic Republic. Key findings Based on WTO Global Trade Model (GTM) simulations, an increase in the coverage of trade by local trade finance by 20 percentage points and a reduction in financing costs of export and import loans and letter of credit fees to levels prevailing in more advanced economies could raise imports by more than 5 per cent in Cambodia and 6 per cent in Viet Nam, and raise exports by more than 8 per cent and 9 per cent, respectively. This would correspond to a permanent increase in the annual volume of merchandise trade by US$ 3.5 billion in Cambodia and US$ 55 billion in Viet Nam. Raising the coverage of trade by local trade finance provides the largest contribution to the projected trade increase, followed by the reduction in the financing costs of export and import loans. The reduction of fees for letters of credit would play a marginal role. The sectors which deliver the largest contribution are textiles, wearing apparel and leather. Electronic equipment plays a moderate role owing to the large share of foreign-owned firms engaged in related-party trade (i.e. trade with subsidiaries of multinational enterprises) thus employing less domestic trade finance. The trading partners with the largest contribution to the total projected change in trade are China, Southeast Asia and East Asia on the import side and Europe (for Cambodia), North America (for Viet Nam), and China and East Asia (for Viet Nam) on the export side. This chapter explores the potential impact of an expansion of trade covered by trade finance and a reduction in the costs of trade finance instruments. This is simulated using the GTM, which is a computable general equilibrium model that describes the economic interactions between countries.1 The costs of international trade are an important determinant of trade flows in the model and comprise a range of transaction costs of which the costs of financing international trade are an important part. The two main components of the costs of financing international trade are intertwined: (i) costs associated with the transaction risk that the counterparty will not pay or will not deliver the goods; (ii) the financial costs to bridge the time when goods are in transit and the costs of using instruments to manage transaction risks. The costs of financing Total trade costs associated with financing international transactions are calculated as a value-weighted average of international trade under the costs of each of the four modes of financing. These trade costs are part of three types of trade cost in the model: export different instruments taxes; import taxes; and iceberg trade costs.3 The financial costs as well as the letter of credit fees are incorporated in The analysis distinguishes between four modes of payment export and import taxes, reflecting that banking is typically or financing employed, each differing in financial costs and characterized by an oligopolistic market structure with profits. transaction risk: Hence, the financial costs can be considered a tax imposed by the financial sector on the rest of the economy. The costs (i) cash in advance; associated with aversion to risk are modelled as iceberg trade (ii) export and import loans; costs, because they reflect a pure loss of resources. The costs (iii) exports financed with working capital; of the different trade finance instruments, the share of trade (iv) letters of credit. covered by trade finance and the importance of the different trade finance instruments are based on information from the For example, in using cash in advance, the importer pays for surveys for Cambodia and Viet Nam and data from international goods upfront and in doing so, pre-finances the exporter’s institutions and the academic literature for the other regions.4 cash-flow, while incurring a (transactional) risk of not receiving delivery on time or at all, without the benefit of collateral. Using cash in advance, therefore, means that the importer faces a maximal transaction risk relative to other identified instruments and a high financial cost – the opportunity cost of using the In the model, the transaction risk and the firm’s own cash flow and engaging its capital, which could be financial costs are calculated for each of completely lost if the other party does not deliver. the four modes of financing. Under the terms of letters of credit, most of the transaction risk is transferred to the bank and no funds are engaged by the importer until it receives the merchandise. The exporter, Sectoral variation in trade finance coverage is introduced however, has to pre-finance the production and shipment of based on the share of exports and imports by foreign-owned the exported goods until it is paid for, although the payment is firms and the share of related-party trade.5 More specifically, guaranteed by the letter of credit.2 based on the analysis of firm level data, it is assumed that foreign firms are half as likely to employ domestic trade finance. In the model, the two trade costs associated with financing Furthermore, the share of domestic trade finance varies international transactions, the transaction risk and the financial between sectors depending on the sectoral share of costs are calculated for each of the four modes of financing. related-party trade. As a result, the share of domestic trade 54 TRADE FINANCE IN THE MEKONG REGION finance is, for example, relatively low in the sector “Computers Scenario 3: letter of credit fees are reduced and electronic equipment” because both the shares of foreign-owned firms and related-party trade are high. Letter of credit fees are reduced to the level of China, which acts as a benchmark in the region for Cambodia and Viet Nam. Finally, it is assumed that in sectors with a high share of This change reduces only import and export taxes. related-party trade, there is less scope to extend the share of domestically provided trade finance because trade finance is already provided by foreign banks. Further details on the Scenario 4: costs of trade finance technical specification of the model are described in Annex III. instruments fall The costs of trade finance instruments (price of import and Five counterfactual scenarios export loans and the loans to pre-finance exports under letters of credit) are reduced by targeting the global average margin The survey indicates that the shares of trade covered by trade between trade finance costs and the interbank rates. More finance provided by domestic institutions is relatively low – specifically, the difference between the costs of trade finance 3 per cent for Cambodia and 20 per cent for Viet Nam. In instruments and the interbank rates are reduced to 50 per cent view of these low shares and the high costs for trade finance of this difference globally on average. This change reduces only facilities, the following five counterfactual scenarios explore the import and export taxes. potential impact on trade patterns of raising the trade finance coverage and reducing its costs. Scenario 5: combined Scenarios 2-4 The shocks in Scenarios 2-4 are combined to generate one set Scenario 1: local trade finance increases of projected trade cost reductions.8 by 10 percentage points The share of local trade finance is increased by 10 percentage Projected trade cost points. Since comprehensive data on the rejection rates of banks to trade finance requests, which could guide the reductions counterfactual, are missing, increases by 10 percentage points are modelled in the counterfactual. To obtain this change in the Under the five counterfactual scenarios, the model generates model, the overall share of trade finance is increased until the trade cost reductions both when the share of trade finance trade-weighted average of trade (exports plus imports) covered increases and when financial costs of trade loans and letter of by trade finance instruments is increased by 10 percentage credit fees are lower. An increase in the share of trade covered points.6 When the share of trade finance instruments increases, by trade finance, for example through more letters of credit and the shares of other instruments (cash in advance and internal more export and import loans, reduces overall trade costs for working capital) fall proportionally.7 two reasons: the financial costs are lower for these instruments relative to the opportunity cost of paying cash-in-advance or of Scenario 2: local trade finance increases using scarce internal (non-borrowed) working capital and the by 20 percentage points transaction risk is smaller in case of letters of credit, since it is taken over by the bank in exchange for payment of a fee. The share of local trade finance is increased by 20 percentage points. Given that the global share of trade finance coverage The letter of credit fees are reduced to the regional benchmark is 60 per cent, as reported by the Bank for International (China) in the counterfactual. Letters of credit opening fees Settlements (BIS, 2014), this represents a relatively modest reflect operational costs involved in executing instruments, increase in the share of trade finance coverage. Under this while the typically higher letter of credit confirmation fees are scenario the share of trade covered by trade finance increases related to the transaction payment risk of importers. In Scenario across all sectors and trading partners. The costs of financing 3, both opening and confirmation fees are reduced. However, international trade transactions affects the three types of trade firms in Cambodia and Viet Nam only pay letter of credit cost – import taxes, export taxes and iceberg trade costs – confirmation fees for exports when trading with destinations which all fall under Scenarios 1 and 2, given that the financing that are at least as risky as these countries. Hence, projected costs and the costs associated with risk are falling when the trade cost reductions are larger for imports into Cambodia coverage of trade finance rises. and Viet Nam than for exports. CHAPTER 3: THE IMPACT OF CLOSING THE TRADE FINANCE GAP 55 The projected change in the costs of import and export loans is also the financial costs when letters of credit are employed, based on reducing the premium on the financial costs of trade whereas on the import side only the financial costs of import finance over the interbank rate by 50 per cent compared to loans fall. the global average premium. Although the higher premium in Cambodia and Viet Nam may reflect exogeneous factors such 4. Reduced trade costs smaller for exports as perceived or actual country risk, it can be argued that these rates reflect a rationed trade finance market with limited supply than for imports of trade finance in light of high observed interest rates. Hence, The reduced trade costs on the export side in the first scenario they contain an element of “rent” whereby loan rates are higher (an increase of the trade finance coverage by 10 percentage than they could be with better access to trade finance, and points) are smaller than on the import side, whereas this consequently they are modelled as export and import taxes. difference is smaller for the 20 percentage point increase scenario. The reason for this is that there is more scope to Figure 3.1 displays the projected trade cost reductions for raise the share of trade finance on the export side by 10 imports and exports of Cambodia and Viet Nam under the five percentage points given the use of other instruments, whereas scenarios generating four main insights.9 an increase by 20 percentage points requires larger changes to the share of trade finance instruments and thus larger 1. Raising share of trade covered by changes in trade costs. trade finance generates largest trade Before presenting the simulation results, it is important to cost reduction briefly reflect on the way trade is modelled in this study. Raising the shares of trade covered by trade finance would Following much of the quantitative trade literature, trade is generate the largest reduction in trade costs, followed by lower modelled with Armington preferences – a trading structure financial costs of trade finance instruments and finally lower which allows for the possibility that each country imports goods letter of credit fees. The contribution of lower fees is small from each trading partner. Under Armington preferences, firms because the baseline share of trade financed with letters of are not explicitly modelled, so the analysis does not distinguish credit is modest and the fees for this instrument are smaller between extending trade finance for firms already receiving than the financial costs of trade finance loans. trade finance (intensive margin) and increasing the number of firms receiving trade finance (extensive margin). However, distinguishing between the extensive and intensive margin is 2. Trade cost reductions mostly due to a not necessary to simulate reliable counterfactuals. As a matter drop in import and export taxes of fact, the impact of trade cost experiments is equivalent in the Armington and Eaton-Kortum models, with the latter allowing Considering the split between changes in import taxes, for adjustment both along the intensive (the amount traded) export taxes and iceberg trade costs in Figure 3.1, most of and extensive (the number of firms trading) margins (Arkolakis the reductions in trade costs are on account of reductions in et al., 2012). import and export taxes, while reductions in iceberg trade costs relating to reduced risk are more modest. The reason for this is In more specialized models such as the Melitz firm that reduced risk only comes from raising the share of letters heterogeneity model, the impact of counterfactual reductions in of credit, whereas raising the shares of other trade finance trade costs tends to be larger, although the additional effects instruments also reduces the financial costs of trade finance. are in most settings limited (see Costinot and Rodríguez-Clare, 2014). In even more specialized models, shifts in the use trade finance instruments can be studied with firms starting with 3. Trade cost reductions from cheaper letters of credit to establish new trade relationships and then trade loans larger for exports than moving to other forms of trade finance. for imports In this study, the more standard Armington structure is Figure 3.1 shows that the trade cost reductions relating to the employed, since data are lacking on the distribution of trade decrease of the costs of trade loans are larger on the export costs associated with financing international transactions into side than on the import side. The reason for this is that on the costs that are variable and fixed in nature and information is export side not only the costs of export loans would fall, but missing on changes in trade finance instruments over time. 56 TRADE FINANCE IN THE MEKONG REGION FIGURE 3.1 Projected ad valorem trade cost reductions under the five scenarios (in per cent) Export side -8 -7 -6 -5 -4 -3 -2 -1 0 1 TF share +10pp Cambodia TF share +20pp LC fees Costs trade loans Combined scenario TF share +10pp TF share +20pp Viet Nam LC fees Costs trade loans Combined scenario Import side -6 -5 -4 -3 -2 -1 0 1 TF share +10pp Cambodia TF share +20pp LC fees Costs trade loans Combined scenario TF share +10pp TF share +20pp Viet Nam LC fees Costs trade loans Combined scenario Import_tax Export_tax Iceberg_tc Residual_tc Total_tc Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3, data collected from the World Bank, International Monetary Fund and the International Chamber of Commerce and from the literature, as detailed in Annex III. The figure displays the projected change in ad valorem trade costs (in per cent) on exports (upper panel) and imports (lower panel) for the five scenarios, split between three types of trade cost (import taxes, export taxes, iceberg trade costs). The figure shows a simple summation and therefore there is a residual term, which is marginal. LC – letter of credit; pp – percentage points; tc – trade costs; TF – trade finance. CHAPTER 3: THE IMPACT OF CLOSING THE TRADE FINANCE GAP 57 FIGURE 3.2 Projected increase in the volume of trade under the five scenarios (in per cent) 0 2 4 6 8 10 TF share +10pp TF share +20pp Cambodia LC fees Costs trade loans Combined scenario TF share +10pp TF share +20pp Viet Nam LC fees Costs trade loans Combined scenario Imports Exports Source: Simulations with the comparative static version of the WTO Global Trade Model extended with trade costs being a function of the costs and shares of trade finance. the figure displays the projected change in the volume of real imports and real exports for Cambodia and Viet Nam for the different counterfactual scenarios in per cent. LC – letter of credit; pp – percentage points; TF – trade finance. Projected changes in than 8 per cent and 9 per cent in Cambodia and Viet Nam, respectively. The projected increase is larger on the export side aggregate exports and than on the import side, mainly because the costs of financing are larger on the export side as explained above. Although imports not explicitly modelled, these changes reflect a combination of existing exporters trading larger volumes (intensive margin Figure 3.2 displays the projected change in real exports and adjustment) and new firms entering the export market (extensive imports under the five scenarios, namely: increasing the share margin adjustment) because of the reduction in trade costs. of trade covered by trade finance; reducing letter of credit fees; Among the different scenarios, the increase in the share of lowering trade loan spreads: and combining all these changes. trade covered by trade finance has the largest impact, while the Merchandise imports are projected to increase by more reductions of letter of credit fees and of trade loan prices play than 5 per cent and 6 per cent in Cambodia and Viet Nam, a smaller role because they contribute less to the reduction of respectively; whereas merchandise exports would rise by more trade costs. 58 TRADE FINANCE IN THE MEKONG REGION The projected increase in merchandise trade in per cent is larger for Viet Nam than for Cambodia, although the modelled trade cost reductions are smaller. The reason for this is that trade costs in Viet Nam are falling more in sectors with a higher Projected increase in annual trade is trade elasticity, thus provoking a larger response in trade volumes, as further analysed in Annex III. US$ 55 billion for Viet Nam and US$ 3.5 billion for Cambodia in the combined scenario. Figure 3.3 translates the per cent trade changes into volume changes in millions of dollars employing baseline trade values for the year 2022. The projected increase in annual trade is Comparing the counterfactual analysis of trade finance for US$ 55 billion in foregone trade for Viet Nam and about US$ Cambodia and Viet Nam with the analysis conducted last year 3.5 billion for Cambodia. For both Cambodia and Viet Nam, the largest foregone opportunity is for exports. Furthermore, on the role of trade finance in the four largest economies of the the numbers show that the different shocks magnify each other Economic Community of West African States (ECOWAS-4) since the projected increase for the combined Scenario 5 is (IFC/WTO, 2022), there are some similarities and some larger than the sum for Scenarios 2-4. differences. First, in terms of methodology, variation in coverage FIGURE 3.3 Projected increase in the volume of trade under the five scenarios (in US$ billion) Cambodia Viet Nam 0 1 2 3 4 0 20 40 60 TF share +10pp 1.01 TF share +10pp 25.85 TF share +20pp 2.55 TF share +20pp 27.17 LC fees 0.01 LC fees 3.38 Costs trade loans 0.49 Costs trade loans 19.98 Combined scenario 3.55 Combined scenario 55.53 Imports Exports Source: Simulations with the comparative static version of the WTO Global Trade Model extended with trade costs being a function of the costs and shares of trade finance. The figure displays the projected change in the volume of real imports and real exports for Cambodia and Viet Nam in billions of dollars calculated by multiplying 2022 baseline values (rescaled with the aggregate trade values in the WTO–UNCTAD database) with projected per cent changes under the different counterfactual scenarios. LC – letter of credit; pp – percentage points; TF – trade finance. CHAPTER 3: THE IMPACT OF CLOSING THE TRADE FINANCE GAP 59 of trade finance is taken into account this year based on the share of foreign-owned firms. Furthermore, by lack of a study showing the share of trade covered by trade finance in the region and/or clear data on the share of trade finance requests rejected, the counterfactual scenario is designed differently In the combined scenario, the projected (10 and 20 percentage point increase in trade finance coverage). increase is 5% for imports into Cambodia Third, to prevent an artificially large impact of extending trade and 9% for exports from Viet Nam. finance in a subset of countries for their intra-regional trade, an average of the trade cost reduction for trade within the regions subject to the counterfactual experiment is assumed. For Viet Nam, the largest contribution comes from more The results of the counterfactual experiments are similar in terms imports from China and East Asia and an extension of exports of projected increase of exports and imports in per cent. In the to North America and to a lesser extent East Asia and China. ECOWAS-4 study, the increase for the benchmark scenario The most important sectors for both regions are textiles, was 8 per cent; in the current study on Cambodia and Viet Nam, wearing apparel and leather (Tex_wap_lea), other equipment the projected increase is between 5 per cent for imports into (transport, electrical equipment and machinery) and other Cambodia and 9 per cent for exports from Viet Nam. goods (processed food, metals, mineral products, paper products). Computer equipment plays a less important role Zooming in on trade because the size of the shock is smaller, which is driven by patterns: detailed results for the fact that the share of foreign-owned firms is very high in this sector. sectors and trading partners Robustness checks Figure 3.4 displays the projected changes in the volume of trade by trading partner for the combined Scenario 5. The Robustness checks were conducted to validate the accuracy largest increase in exports for Cambodia is projected to occur of the analysis. The establishment of initial trade finance for China in particular, Europe, the Pacific and Southeast expenses relies on a thorough examination of the accessible Asia; for Viet Nam, the largest increase is projected for North data, which outlines the conceptual framework for the America. This pattern is largely driven by the modelled changes counterfactual experiments (see Annex III for details). However, in trade costs, as further analysed in Annex III. Imports from there were two assumptions introduced with limited guidance some trading partners are falling because of trade diversion, from the actual data. These assumptions pertained specifically hence imports from other regions increase more. to the division of trade not covered by trade finance tools The per cent changes do not necessarily reflect the importance between cash in advance and internal working capital, as of different regions in the aggregate changes for Cambodia well as the difference between the financial costs while using and Viet Nam, since some regions might represent only a trade finance instruments and non-trade finance instruments. small share of trade. Combining per cent changes with initial In the analysis, these assumptions were constrained by data values makes it possible to analyse the contribution of each comparing the financial costs of trade finance and of alternate of the regions and sectors to the aggregate change. Table forms of financing. Hence, robustness checks on these two 3.1 therefore displays the projected change in millions of US assumptions are included, as elaborated in Annex III. dollars by trading partner and sector. The outcomes of these checks indicate that these assumptions For Cambodia, the largest contribution to the aggregate do not significantly influence the essence and scale of the trade change comes on the import side from trade with results. More specifically, reducing the difference between Southeast Asia and China. On the export side, most of the increase is driven by more exports to Southeast Asia and to financing costs under trade finance and non-trade finance Europe in particular and to a lesser extent North America. The instruments reduces the projected trade expansion, but the contribution of within-region (Southeast Asia) trade is large effects are modest. The impact of changing the assumptions mainly because of the large initial share in total trade, whereas on the distribution between cash in advance and internal for Europe also the per cent increase in trade is important. working capital are even smaller. 60 TRADE FINANCE IN THE MEKONG REGION FIGURE 3.4 Projected increase in the volume of trade by trading partner, combined scenario (in per cent) Cambodia Sub-Saharan Africa Southeast Asia South Asia Rest of World Pacific North America Middle East & North Africa Latin America Europe East Asia China -5 0 5 10 15 20 Viet Nam Sub-Saharan Africa Southeast Asia South Asia Rest of World Pacific North America Middle East & North Africa Latin America Europe East Asia China -5 0 5 10 15 20 Imports Exports Source: Simulations with the comparative static version of the WTO Global Trade Model extended with trade costs being a function of the costs and shares of trade finance. The figure displays the projected change in the volume of real imports and real exports for Cambodia and Viet Nam by trading partner in per cent under the different counterfactual scenarios. CHAPTER 3: THE IMPACT OF CLOSING THE TRADE FINANCE GAP 61 TABLE 3.1 Projected increase in the volume of exports and imports, by trading partner and sector (in US$ million, combined scenario) Cambodia export volumes Importer Agriculture Chem_pharma Computer_eq Fossil_fuels Other_eq Other_goods Tex_wap_lea China 0.9 1.7 34.2 5.7 59.2 13.8 131.8 East Asia 0.3 -0.7 23.2 1.1 2.8 22.1 65.9 Europe 0.6 3.0 3.0 2.3 131.8 18.1 679.6 Latin America 0.0 0.2 0.3 0.0 1.3 0.6 27.6 Middle East & N. Africa 0.0 0.0 0.0 0.0 0.8 1.1 25.5 North America 0.3 6.7 15.8 0.0 16.8 38.5 261.6 Pacific 0.0 0.0 0.0 0.0 1.2 1.3 19.8 Rest of World 0.0 0.0 0.0 0.0 0.8 0.3 14.6 South Asia 0.1 0.3 0.0 0.0 1.7 0.7 1.8 Southeast Asia -6.8 -26.6 50.4 0.9 42.2 200.4 26.0 Sub-Saharan Africa 0.0 0.1 0.0 0.0 0.5 1.8 3.0 Viet Nam export volumes Importer Agriculture Chem_pharma Computer_eq Fossil_fuels Other_eq Other_goods Tex_wap_lea China 54.5 32.8 27.9 56.0 1,197.3 105.8 311.3 East Asia 109.1 333.5 589.1 385.0 961.4 1,530.1 2,372.5 Europe 194.5 55.8 23.2 6.5 1,103.1 475.7 785.4 Latin America 21.3 31.1 25.0 2.4 672.2 204.2 413.0 Middle East & N. Africa 120.6 31.8 13.9 12.6 1,049.0 241.1 235.0 North America 598.6 279.4 302.1 132.7 2,574.0 3,228.7 7,227.6 Pacific 56.6 24.9 14.1 116.7 314.9 254.2 178.4 Rest of World 41.6 9.2 5.6 1.4 274.4 60.3 125.9 South Asia 71.3 81.0 15.3 44.8 420.6 398.3 121.9 Southeast Asia 30.1 147.2 75.1 54.0 487.0 543.7 418.9 Sub-Saharan Africa 14.6 19.4 4.7 1.0 124.6 151.4 94.3 Cambodia import volumes Exporter Agriculture Chem_pharma Computer_eq Fossil_fuels Other_eq Other_goods Tex_wap_lea China 1.2 7.9 8.2 -0.3 10.1 68.8 248.2 East Asia 0.3 -1.1 0.7 0.0 4.2 21.3 29.9 Europe 56.3 3.5 0.3 0.1 8.0 15.6 6.1 Latin America 0.1 -0.1 0.0 0.0 -0.1 0.1 0.8 Middle East & N. Africa 0.1 -0.5 0.0 -0.3 -0.2 0.2 0.1 North America 9.7 -0.1 0.0 0.0 5.9 8.2 1.9 Pacific 0.9 0.0 0.0 0.0 0.0 3.5 0.0 Rest of World 0.0 -0.3 0.0 0.0 -0.1 0.0 0.0 South Asia 0.0 -2.6 -0.1 0.0 -0.5 0.6 2.6 Southeast Asia 9.1 108.3 57.9 10.8 130.4 498.0 284.0 Sub-Saharan Africa 0.2 -0.1 0.0 -0.3 0.0 0.0 0.1 Viet Nam import volumes Exporter Agriculture Chem_pharma Computer_eq Fossil_fuels Other_eq Other_goods Tex_wap_lea China 740.4 648.9 549.7 226.4 2,064.4 2,454.2 3,400.5 East Asia 21.5 576.2 298.6 119.5 2,778.1 1,182.8 858.2 Europe 98.9 229.2 50.3 12.2 330.3 304.3 106.3 Latin America 87.4 -0.1 0.1 2.7 8.1 129.0 47.5 Middle East & N. Africa 12.5 -12.6 1.2 8.0 3.2 20.5 9.4 North America 368.8 57.1 12.0 14.2 230.3 263.4 76.2 Pacific 262.2 19.0 1.9 83.1 3.1 198.8 9.6 Rest of World 19.7 -2.2 1.5 10.1 2.8 6.6 0.8 South Asia 78.7 5.5 10.0 2.1 13.0 120.5 101.4 Southeast Asia 300.1 383.2 187.4 421.3 502.7 944.3 217.4 Sub-Saharan Africa 266.3 -0.5 0.1 3.0 0.7 37.3 3.4 Source: Simulations with the comparative static version of the WTO Global Trade Model extended with trade costs being a function of the costs and shares of trade finance. The tables display the projected change in the volume of real exports (upper table) and real exports (lower table) for Cambodia and Viet Nam in millions of dollars by trading partner and sector calculated by multiplying 2022 baseline values (rescaled with the aggregate trade values in the WTO–UNCTAD database) with projected per cent changes of the different counterfactual scenarios. The sectors include: agriculture; chemicals and pharmaceuticals; computer equipment; fossil fuels; other equipment; other goods; and textiles, wearing apparel and leather. Endnotes 1. The model is calibrated to data on trade and production from the Global Trade Analysis Project (GTAP) Data Base, Version 11. A description of the model and a detailed outline of the way trade finance costs are modelled as trade costs are provided in Annex III. 2. As discussed in Chapter 2, the survey indicates that factoring/supply chain finance (SCF) plays a marginal role in trade finance provided by domestic financial institutions in Cambodia and Viet Nam. Furthermore, SCF is broadly similar to loans provided to the exporter (risk is not transferred to the bank and the exporter accepts a discount which from a cost perspective is similar to interest paid on loans). Hence, introducing SCF, either in the baseline in the form of SCF provided by foreign banks (or in the counterfactuals in the form of an expanding trade finance coverage manifesting itself in the form of more SCV) would have a marginal impact on the effect of counterfactuals. 3. Trade costs are of the iceberg type when additional resources have to be spent to ship a good internationally. To let one unit of a good arrive in the country of destination, more than one unit needs to be shipped out from the origin with a share “melting away” during transportation. 4. In the framework, the financial costs associated with different instruments to finance international trade transactions vary based on data collected in the survey and other data on lending rates. Accordingly, there is no perfect arbitrage between the different instruments equalizing financing costs. This reflects that there are differences in the degree of risk driven by among others, differences in borrowing constraints relating to the extent to which collateral is available and payments are guaranteed by third parties (i.e. a bank in case of letters of credit). 5. Sources include census data in Viet Nam and the related-party database for US trade with Cambodia and Viet Nam, which is used as a proxy for trade with all trading partners. 6. Since there is variation in the share of trade finance provided by foreign banks across sectors based on the share of foreign-owned firms, the extension of trade finance provided by domestic banks varies across sectors. 7. For some sector importer–exporter combinations, this would imply that shares would become negative. Therefore, the shares of domestic and foreign trade finance are reduced to make sure that shares always sum to 1. 8. In the model, firms are not explicitly modelled, so the analysis does not distinguish between extending trade finance for firms already receiving trade finance (intensive margin) and more firms receiving trade finance (extensive margin). 9. The trade cost reductions for trade between Cambodia and Viet Nam are set equal to the average trade cost reductions for these two countries. CHAPTER 3: THE IMPACT OF CLOSING THE TRADE FINANCE GAP 63 Conclusions The Mekong-3 – Cambodia, the Lao People’s Democratic trade finance instruments, limited engagement in more dynamic Republic (PDR) and Viet Nam – are deepening their trade sectors, the lack of relevant market data and greater demand integration, increasing the volume and value of their exports by smaller enterprises. The most effective measures in Viet and strengthening their participation in global value chains Nam, and to some extent Cambodia, include: (GVCs). This expansion of opportunities for new traders in new markets generates expectations of growing demand for trade • diversifying the range of trade finance products; finance in the coming years. • strengthening regulatory frameworks; • broadening the local customer base for trade finance to Free trade agreements recently concluded between Cambodia small and medium-sized enterprises (SMEs); and China (2021), Viet Nam and the European Union (2020) • improving banks’ agility, risk management capacity and and the United Kingdom (2021), as well as the Regional international relationships. Comprehensive Economic Partnership (RCEP), concluded in 2022 between the Association of Southeast Asian Nations In Cambodia and the Lao PDR, actions could focus on the (ASEAN) and Australia, China, Japan, the Republic of Korea expansion of traditional trade finance instruments such as and New Zealand, will further support these positive trends and letters of credit and basic capabilities of banks, without create new opportunities to leverage trade for development. neglecting ways to promote the use of innovative instruments. Supporting evidence-based solutions would be a prerequisite The role of local banks in supporting the internationalization trajectory of the region has been markedly different across for any initiative involving the improvement in trade finance the Mekong-3. Although a substantial 20 per cent of local markets in the Mekong-3. bank assets in Viet Nam is dedicated to trade finance, results of the 2023 IFC survey of trade finance show that banks are Diversifying the range of more likely to support smaller, local enterprises engaged in intra-regional trade than global trade – with high-value exports trade finance products in the sectors of electronics and garments relying less on local trade finance. In both Cambodia and Viet Nam, the subsidiaries The characteristics of the local banking sector in Viet Nam of multinational enterprises that are driving growth rely less on suggest clear actions that could improve access to trade finance. local bank-intermediated trade finance. Geared towards SMEs that are developing their linkages (including connections with foreign direct investors), banks and Local trade finance in Viet Nam is therefore more than just a traders in Viet Nam would benefit from the development of driver of international competitiveness. It also contributes to less-traditional trade finance instruments, such as supply chain greater inclusion in the process of internationalization of local finance (SCF), which is currently in only limited use. production for activities outside the frontier sectors. This is reflected in the simulated estimates of trade finance gaps: raising A number of more innovative digital products at a nascent the coverage of trade by bank-intermediated finance provides stage of development in the Mekong region could be the largest contribution to the projected trade increase in Viet supported to reduce overhead costs and to improve access Nam; while the share of the electronics sector in total growth is to trade finance. Examples include: promoting common only moderate. sector-level operating infrastructure (e.g. dedicated Coordinated action by the corporate sector, financial electronic platforms) and services for new trade finance institutions, national policymakers and international instruments; building market awareness; and strengthening organizations could help to increase the uptake of trade the capacity of key stakeholders, including banks and other finance in the Mekong-3 and to address the constraints supply chain participants, to offer and take advantage of identified in the surveys – specifically, the focus on traditional related opportunities. 64 TRADE FINANCE IN THE MEKONG REGION Strengthening regulatory Technological solutions could also help banks to develop more sophisticated internal credit risk assessment systems frameworks for smaller companies and new entrants in the trade finance markets. Financial institutions can develop specialized tools and rely more on digitalization – a higher level of which Regulatory conditions may inadvertently generate barriers and could help to reduce the processing costs of trade finance additional risk for financial institutions, which might then result instruments, which remain high among lower-income countries in firms being excluded from trade finance. The absence of a in the region. well-defined legal framework tends to cause banks to be more cautious about taking on risks and less inclined to introduce new products that could even enhance their ability to cater to Improving banks’ agility, risk local markets. management capacity and The Mekong-3 governments can review and update the regulations governing both traditional and new trade finance international relationships instruments, collateral requirements, digital transactions, central bank conditions and accountability frameworks. Improving banks’ agility, risk management capacity and A recent successful intervention in this area has been in the international relationships would allow financial institutions to Philippines, which adopted a regulatory framework to develop expand their reach to riskier segments of new traders, active in less well-known product markets or in new destinations. SCF products, including a secured transactions law – Banks might not be able to compete for lower cost of funds the Personal Property Security Act – considered one of the alone; their strength thus lies in their capacity to provide best in the region, and a central online collateral registry. effective services for high-value traders in dynamic routes. The expansion of innovative trade finance products will require One distinguishing feature of the electronics sector, for broader action at the government level. The impact of the example, is its short product life cycle, which demands rapid COVID-19 pandemic and rising inflation – both of which capital turnover. Local banks should become more effective in constrict banks’ capacity to meet demand – can be addressed, this market. A large number of development finance institutions for example, by expanding guarantees, risk-sharing facilities engaged in the region, such as in China and smaller and syndication arrangements. trade-dependent economies, focus on this type of capacity building through dedicated advisory services. Broadening the local customer base for trade Expanding traditional trade finance to SMEs finance instruments and basic capabilities of banks Banks should be encouraged to expand their customer base of SMEs in dynamic sectors such as chemicals and machinery, In Cambodia and the Lao PDR, the capacity of the local as well as of local suppliers to mega firms in electronics, to banking system to support the internationalization of the support the internationalization of the local economy. SMEs economy is more limited than in Viet Nam. Actions in these would benefit from greater awareness of how to engage with two countries could focus on the expansion of traditional providers of trade finance and the different products available. trade finance instruments such as letters of credit and basic capabilities of banks, without neglecting ways to promote the Successful interventions include Pakistan, where risk mitigation use of innovative instruments such as SCF to facilitate the technical assistance for extending additional financing to new integration of local traders into GVCs. clients has helped banks pilot payable finance programmes to enhance access to finance for SMEs. Knowledge sharing and The expansion of traditional trade finance instruments advisory services were essential complements and resulted in and basic capabilities of banks would involve actions significantly improved access to trade finance for SMEs in the such as liquidity support, updating regulatory frameworks, automotive, construction and manufacturing sectors in the country. setting up mechanisms for collecting market intelligence CONCLUSIONS 65 and assessing risks, as well as expanding correspondent banking relationships. International institutions could support governments and banks with compliance training in areas such as trade-based money laundering. This could help to reassure correspondent banks on counterparty risk and help local lenders to build larger networks. Supporting evidence-based solutions Supporting evidence-based solutions is a prerequisite for any initiative involving the improvement in trade finance markets. Despite data collection and analytical studies – including this publication – examining trade finance, evidence on the size of the trade finance gaps and its determinants in emerging markets remains scarce. Additional efforts are needed by all stakeholders, including development finance institutions, to improve understanding of the market, both its failures and its potential. 66 TRADE FINANCE IN THE MEKONG REGION AN N EX I Mekong-3 trade and global value chain performance FIGURE I.1 Shares of products traded in the Mekong-3, 2021 (in per cent) Cambodia Exports Imports Textiles Precious metals 48.3% 26.4% Other Textiles 10.5% 15.4% Plastics & rubbers Other Footwear 5.0% 8.9% & headwear Chemical Metals Machines 9.9% products 7.4% 9.2% Machines 5.9% 4.8% Animal hides Plastics Transportation Vegetable & rubbers Mineral products Transportation 9.7% 5.2% 1.4% products 2.5% 4.0% 8.8% 7.1% Foodstuffs Metal Animal hides Wood 2.3% 2.3% 5.0% ANNEX I. MEKONG-3 TRADE AND GLOBAL VALUE CHAIN PERFORMANCE 67 Lao PDR Exports Imports Mineral products Mineral products Machines 30.3% 12.8% 18.5% Precious metals Other Transportation 21.0% 9.7% 10.0% Vegetable products Other Metals Precious metals Chemical products 9.6% 10.4% 8.2% 8.8% 9.6% Plastics Foodstuffs Paper goods & rubbers 4.3% 8.8% Foodstuffs 4.0% products 2.3% Textiles Plastics 3.9% & rubbers 9.0% 4.7% Vegetable Chemical Textiles products Machines Paper goods 3.0% 3.5% 5.2% 2.4% Viet Nam Exports Imports Machines Machines 47.4% 40.3% Chemical Textiles Metals products 7.7% 9.4% Footwear & headwear Metals Textiles 7.0% 6.0% 12.3% 5.8% Vegetable products Plastics 4.1% & rubbers Chemical Foodstuffs Vegetable products 2.2% products Foodstuffs Transportation 7.0% Other 1.9% 4.1% Transportation Animal Other 3.2% 3.4% 8.9% 1.6% products 1.8% Plastics 9.7% Mineral products Wood Mineral & rubbers Instruments 5.8% 4.0% products 1.5% 1.7% 3.2% Source: Observatory of Economic Complexity. Aggregate trade covered is not exact match but close to the figures produced in World Bank WITS. A full breakdown is available at https://oec.world. TABLE I.1 Measuring export competitiveness: decomposing the geographical effects (in percentage points, average 2010-2021) Cambodia Lao PDR Viet Nam Global effect Country’s Global effect Country’s Global effect Country’s (“pull”) largest (“pull”) largest (“pull”) largest export export export market market market Contrib. to Contrib. Country’s Contrib. Contrib. to Country’s Contrib. Contrib. Country’s relative to market market to relative market market to relative to market market price share orientation price share orientation price share orientation change change in change change in change change in volume volume volume AFR 0.00 0.00 0.24 0.00 0.00 0.05 0.00 0.01 1.07 China 0.05 0.12 4.21 0.32 0.77 33.34 0.13 0.42 12.82 EA17 -0.06 -0.17 23.02 -0.02 -0.05 5.72 -0.04 -0.13 14.29 EAP -0.01 0.47 16.34 -0.14 1.53 43.16 0.01 0.20 13.70 ECA -0.01 -0.01 2.05 0.00 0.00 0.40 -0.01 -0.02 2.31 Japan -0.03 -0.19 6.47 -0.02 -0.06 3.12 -0.03 -0.23 9.09 LAC 0.00 -0.01 0.78 0.00 0.00 0.07 0.00 -0.02 1.90 MENA 0.01 -0.02 1.18 0.00 0.00 0.37 0.01 -0.01 3.26 OECDnonEU -0.03 -0.14 19.73 -0.04 -0.11 8.34 0.03 -0.04 17.30 RoW 0.00 0.00 0.44 0.00 0.00 0.27 0.02 0.01 1.69 SAR 0.00 0.01 0.22 0.02 0.07 3.30 0.01 0.07 2.35 United States -0.18 -0.01 25.31 -0.02 -0.01 1.86 -0.18 0.00 20.21 Total 0.05 100.00 2.14 100.00 0.25 100.00 Source: World Bank MEC Database. AFR – Sub-Saharan Africa; EA17 – Euro Area (not including Croatia, Latvia, Lithuania); EAP – East Asia and Pacific; ECA – Europe and Central Asia; LAC – Latin America and the Caribbean; MENA – Middle East and North Africa; OECDnonEU – members of the Organisation for Economic Co-operation and Development which are not members of the European Union; RoW – rest of the world; SAR – South Asia Region. ANNEX I. MEKONG-3 TRADE AND GLOBAL VALUE CHAIN PERFORMANCE 69 TABLE I.2 Measuring export competitiveness: decomposing the sectoral effects (in percentage points, average 2010-2021) Cambodia Lao PDR Viet Nam Global sector effect Country’s Global sector effect Country’s Global sector effect Country’s (“pull”) weight (“pull”) weight (“pull”) weight of export of export of export sector in sector in sector in total total total exports exports exports Contrib. Contrib. Country’s Contrib. Contrib. Country’s Contrib. Contrib. Country’s to relative to market sector to relative to market sector to relative to market sector price share specializa- price share specializa- price share specializa- change change in tion change change in tion change change in tion volume volume volume Agriculture -0.26 0.00 5.28 -0.32 0.00 11.74 0.11 -0.08 9.67 Chemicals 0.00 0.00 0.15 -0.18 -0.08 4.47 0.00 -0.01 1.65 Electrical 0.04 -0.01 2.26 -0.16 -0.09 7.19 -0.41 0.92 29.88 Food 0.00 -0.01 0.69 -0.01 0.00 6.91 0.02 0.02 2.32 Footwear 0.28 -0.26 10.52 0.00 -0.04 1.33 0.15 -0.07 8.10 Leather 0.07 -0.12 3.05 0.02 0.01 0.13 0.02 -0.03 1.69 Machinery 0.00 0.00 0.24 -0.01 0.00 0.39 0.01 -0.13 6.67 Metals 0.01 0.02 0.98 -0.29 -0.42 15.62 0.05 0.00 3.92 Minerals 0.00 -0.01 0.42 0.40 0.96 16.88 0.00 -0.12 5.35 Others 0.36 0.22 5.30 0.12 -0.13 8.08 0.06 -0.03 7.41 Plastics/ -0.14 -0.14 2.69 -0.25 -0.19 4.09 -0.10 -0.04 3.72 rubber Textiles -0.04 -1.65 62.44 0.07 -0.15 8.35 0.02 -0.35 16.37 Transportation 0.08 0.02 2.21 0.00 0.00 0.38 0.00 -0.01 1.30 Wood 0.17 -0.23 3.76 0.27 -0.10 14.43 0.04 -0.02 1.94 Total -2.18 100.00 -0.23 100.00 0.06 100.00 Source: World Bank MEC Database. 70 TRADE FINANCE IN THE MEKONG REGION AN N EX I I Estimating total trade finance assets: methodology The estimation of the total value of trade finance in a country considers the relationship between bank assets in the country, based on published data, and trade finance assets identified in the survey. This relationship can take the functional forms of either a power law distribution or the asset variables can be proportional to each other. Power law Proportional The hypothesis is that as banks become larger (in terms of The hypothesis is that the total assets of a bank are not total assets), they gain access to the largest trade finance related to their preference for, or access to, trade finance contracts and have a larger network of correspondent assets. Precisely, a constant proportion of trade finance banks than smaller banks. Therefore, larger banks would assets to total assets of a bank is assumed, regardless have a greater market share of trade finance assets than of the size of the bank. The functional form of this total assets as compared to smaller banks (see Figure II.1). relationship is assumed to be: The functional form of this relationship is assumed to be: where is a number between 0 and 1 (see Figure II.2). where TF and TA are the trade finance assets and total assets of a bank, is the size parameter of the estimated Pareto distribution and is the shape parameter larger than 1. FIGURE II.1 Power law distribution FIGURE II.2 Proportional distribution Ratio TF Ratio TF TA TA • •• • • • • •• • • • •• • • • • • • • • •• • • • • • • • • • • • • • • •• • •• • • • • • • • • • • • •• • • •• • • • • • •• • • •• • • •• •• • • • • • • • • • • •• • • • • • • • • • • • • •• • • • • • • • • • • • • • • • • • • • • • • • • • • •• • • • •• •• •• •• • ••• •• • •• • •• • • • ••• •• • • • • • • • • • • ••• • • • • • •• TA TA ANNEX II. ESTIMATING TOTAL TRADE FINANCE ASSETS: METHODOLOGY 71 Based on the sample survey results, the coefficients of both methodologies using country-specific linear regressions are estimated. When estimating the coefficient in country in the proportional model is straightforward, natural logs of trade finance assets and total assets in the power law relationship are taken in order to estimate the following equation via linear regression: A simple test for the power law is a one-sided t-test for > 1 in the above regression. For ease of interpretation and analysis, the preferred test for the power law is a one-sided t-test for >0 in the regression: The preferred specification chosen for the proportional relationship is a straightforward no-intercept regression of the bank’s total assets on its trade financing: where is the value of trade finance assets of bank in country and is the error term. For both the power law and the proportional relationships, the models are estimated separately for each country to allow for distinct market conditions across the region. The analysis and estimates from this exercise are then used to predict the trade finance lending for non-reporting banks as a function of their total asset holdings. This enables the total trade finance coverage in the country to be estimated. The results indicate that while data on banks in Cambodia sufficiently point towards the existence of a power law in trade financing, banks in Viet Nam fail to exhibit a clear-cut relationship in this direction. Eventually, the rejection of the power law in the framework ( = 1) collapses the model back to the proportional relationship. Hence, the prediction of trade finance coverage does not differ appreciably for Viet Nam whether the power law relationship with ≈ 1 is used or a proportional relationship. Once the coefficients are estimated using the proportional methodology, the trade finance assets of banks that were not in the survey results can be estimated given their known total assets (e.g. from each bank’s annual report) and the estimated coefficients. Finally, the observed and estimated trade finance assets of all banks in a country are combined to estimate the total value of trade finance in that country. 72 TRADE FINANCE IN THE MEKONG REGION AN N EX I I I Counterfactual analysis The bank survey contains information on the costs of trade finance, the share of trade covered by trade finance and the trade finance gap. This information is used to generate projections of the trade effects of changes in the price and availability of trade finance. The WTO Global Trade Model (GTM), a computable general equilibrium model, is used to simulate the effects of changes in trade costs because of changes in the price and availability of trade finance. This annex describes the economic model employed, explores how the trade costs of financing international trade are modelled and outlines how trade finance shares and the costs of the trade finance instruments are calibrated in the baseline and counterfactuals. Economic model The GTM is a quantitative trade model describing the economic interactions between regions. It is designed to provide in-depth insights into the specific impacts of trade policy measures at both the sectoral and national levels. The model accounts for international upstream and downstream linkages between sectors through intermediate production and trade. The GTM model incorporates three distinct types of final demand: private household expenditure; government spending; and investment. The income of a representative household in each country is allocated to private household expenditure, government expenditure and savings. Assuming a fixed trade-balance-to-GDP ratio, investment follows savings. The allocation of private household expenditure across sectors adheres to non-homothetic preferences, where the budget shares of certain sectors (primarily essential goods like food and basic manufacturing) decrease as countries become more prosperous. Conversely, the budget shares of other sectors (especially services) increase. Firms produce with production factors and intermediate inputs, reflecting the presence of intermediate linkages. There are five primary production factors: high-skilled labour; low-skilled labour; and capital, land and natural resources. High-skilled and low-skilled labour, along with capital, are mobile; natural resources are specific to each sector; and land has limited mobility. The model incorporates various taxes, including income taxes, endowment taxes, import tariffs and export subsidies. The baseline is calibrated to data from the Global Trade Analysis Project (GTAP) Data Base, Version 11 for 2017, projected forward to 2022 using standard techniques described for example in Fouré et al. (2017); that is, imposing population and labour force growth and targeting GDP per capita growth endogenizing productivity growth. A technical description of the model focusing on the code is available in Aguiar (2019), whereas a description of the model outlining the economic structure into detail is available in Bekkers et al. (2018). Trade is handled through Armington preferences displaying love of variety by country of origin. The expression for the (physical) quantity ( ) traded is relevant for the modelling of trade finance from source to destination in sector , following a standard Armington formulation: (1) where: is iceberg trade costs; is the export tax rate (in power terms); is the import tax (in power terms); is the costs of transportation (in power terms); ANNEX III. COUNTERFACTUAL ANALYSIS 73 is the export price in source ; is the import price in destination ; is the quantity imported in destination ; is the substitution elasticity between imports from different sources. The costs of trade finance will be incorporated in the import tax, export tax and iceberg trade costs as outlined below. Trade costs of financing international trade The costs of international trade are an important determinant of trade flows and comprise a range of transaction costs incurred in trading goods and services internationally – of which the costs of financing international trade are an important component. These financing costs consist of two main components which are intertwined. First, costs associated with the transaction risk that the counterparty will not pay or will not deliver the goods. Second, the financial costs relating to the cost of using an instrument mitigating such risks, consisting both of fees to cover risk and capital costs, and to bridge the time when goods are in transit. The total costs of financing international trade transactions are determined by the instruments employed. The analysis distinguishes between four modes of payment or financing employed, each differing in cost and transaction risk: • cash in advance (cia); • export or import loans (loa); • exports financed with internal working capital (int_wc); • letters of credit (lc). To keep the model tractable, the costs of trade finance are included as a component of trade costs. To do so, both the financial costs and the costs associated with the transaction risk of each of the instruments are expressed as an ad valorem share of the value of trade. The total trade costs associated with the financing of international trade are then expressed as a value-weighted average of both types of cost over each of the instruments. The two types of cost of each of the instruments and the baseline shares are based on the questionnaire (for the surveyed countries), data from international institutions and data available in the academic literature, as further detailed below. The financial costs paid by importers and exporters are modelled as import and export taxes, respectively. This is a good approximation of a more detailed model incorporating an explicit banking sector to which trading firms would pay the financial costs given that the model features a consolidated representative household collecting both factor income and tax income. The reason is that changes in the costs of trade finance can be seen as changes in profit margins of the banking sector. Hence, the financial costs can be seen as a rent/profit collected by the banking sector and thus as an import/export tax collected by the representative household. The costs associated with the transaction risk are modelled partially as an import/export tax and partially as an iceberg trade cost. The share of goods lost in trade calculated based on default rates is modelled as an import tax for the importer or an export tax for the exporter. Hence, the goods lost in transactions are modelled as a tax paid by one party to the other (e.g. the importer paying a tax to the representative household). Furthermore, the costs associated with risk aversion are modelled as a resource loss for agents involved in international trade in the form of an iceberg trade cost. Limitations of the framework Annex III first describes the calibration of the costs of each of the instruments and then the shares of the different trade finance instruments. Before turning to the details of the calibration three remarks are in order about the potential limitations of the framework employed, First, in the counterfactual experiments the shares of trade finance instruments and their costs are changed exogenously. Obviously, both these shares and costs are endogenous in the real world and driven by a variety of factors. However, modelling these shares and costs endogenously is beyond the scope of this publication and would require extending the trade-oriented model with a full-blown financial sector. Such an exercise 74 TRADE FINANCE IN THE MEKONG REGION would be more complicated than most analyses of trade finance in the literature, given the comprehensive nature of the study, including most trade finance instruments. Second, in the framework the financial costs associated with different instruments to finance international trade transactions vary, based on data collected in the survey and other data on lending rates. Accordingly, there is no perfect arbitrage between the different instruments equalizing financing costs. This reflects that there are differences in the degree of risk driven by among others, differences in borrowing constraints relating to the extent to which collateral is available and to which payments are guaranteed by third parties (i.e. a bank in case of letters of credit). Third, supply chain finance (SCF)/factoring is not included in the analysis as one of the trade finance instruments. The survey indicates that the share of this type of trade finance provided by domestic financial institutions in Cambodia and Viet Nam is marginal. Furthermore, SCF is similar in structure to loans provided to the exporter (risk is not transferred to the bank and the exporter accepts a discount which from a cost perspective is similar to interest paid on loans). Hence, introducing SCF, either in the baseline in the form of SCF provided by foreign banks or in the counterfactuals in the form of an expanding trade finance coverage manifesting itself in the form of more SCF, would have a marginal impact on the effect of counterfactuals. Hence, the listed limitations do not invalidate the analysis conducted. The necessary data are lacking for a more detailed analysis. Going into further detail would be mainly useful for a more detailed analysis of the policy interventions possible both to raise the coverage of trade finance and to reduce their costs. The current analysis instead takes these costs as given. Costs of trade finance The two types of cost (cost of funds, costs associated with risk) are now described for each of the four ways to finance international trade. The starting point, however, is with an exposition of the way the costs associated with risk are modelled. Integrating risk aversion in the model If traders are risk averse, the costs associated with risks of the transaction tend to be larger than the share of goods not arriving in the destination. Hence, the costs associated with risk can be expressed as a function of the probability that goods do not arrive, or importers do not pay for goods shipped. A transaction has a good outcome of 1 with probability 1- . The transaction has a bad outcome of 0 (meaning for an importer that the product is not received after paying for the goods, or the payment never occurs after an exporter shipped the goods) with a probability . The costs associated with the risk is equal to the utility loss because of the risk. This loss is equal to the good outcome of 1 minus the certainty equivalent, which is defined as the certain value for which the agent is indifferent between engaging in the transaction or accepting this lower certain value. To calculate the costs associated with risk, a constant relative risk aversion (CRRA) utility function is assumed for agents involved in international trade with , the CRRA parameter: (2) The certainty equivalent of the transaction, , can be calculated as follows, with the probability of a bad outcome (goods not arriving): (3) (4) (5) Hence, the certainty equivalent is given by: (6) ANNEX III. COUNTERFACTUAL ANALYSIS 75 Having obtained the certainty equivalents (the certain value for which the agent is indifferent between engaging in the transaction or accepting this lower certain value), the costs associated with risk aversion, , can be calculated as the difference between the expected value shipped and the certainty equivalent: (7) The total costs associated with risk, , can be written as the sum of the costs of risk; that is, the probability that goods are lost, , and the costs associated with risk aversion, : (8) As discussed above, the costs of risk (the probability that goods are lost or payments are not made) are modelled as an import tax for the importer and as an export tax for the exporter; whereas the costs associated with risk aversion are modelled as a resource loss for agents involved in international trade in the form of an iceberg trade cost. As shown in Conine et al. (2017), the formulation of risk aversion with a parameter has been largely used in the financial and macroeconomic literature, with a large interval of values. Studies focusing on risky assets markets have privileged estimates of the above 3. Azar (2006) finds calibrated s between 4.2 and 5.4 in a study mimicking the US stock market. A large literature focusing on labour supply chose instead values of below 1, such as Chetty (2006) choosing a coefficient of 0.7. Employing this value for real economy applications instead of financial markets generates intuitive values for the costs associated with risk in the model. Cash in advance Under this payment option, the importer pre-finances the exporter’s cash needs, while incurring the risk that goods would not be delivered. Therefore, the importer bears both a transaction risk and a financial cost linked to using own funds to make the payment. Under cash in advance ( ), exporters do not incur financial costs or costs associated with risk since they would ship the goods only upon receipt of the payment. The costs of using cash in advance ( ) in sector from source (exporter) to destination (importer) thus consists of the costs of financing the transaction by the importer, , the cost of risk in the destination, , the costs of risk aversion in the destination, . The latter two can be written as the probability that goods are not delivered, : (9) (10) Import and export loans Import and export loans are trade finance instruments which can be used to address the liquidity needs for both importers and exporters until they have to pay or they get paid. The financial cost of loans are the interest rates on them. With a pre-export shipment loan, the exporter also incurs the risk of not being paid – this risk is not mitigated by the loan itself. The import loan does not mitigate or alleviate the risk of not receiving the merchandise (only a letter of credit would do that), so the importer similarly bears the risk of not receiving the goods. Hence, the costs of an import loan (export loan) consist of the costs of financing of an import loan, , the costs of risk, , and the costs of risk aversion, , which can be expressed as the probability that goods are not delivered: (11) (12) 76 TRADE FINANCE IN THE MEKONG REGION Exports financed with internal working capital In the absence of the availability of a pre-shipment export loan, an exporter can also decide or be constrained to finance the process of production for the purpose of exporting. Upon order, the exporter would typically receive a small advance from the buyer. In this case, the whole production and shipment cycle would have to be financed, including inputs purchase, salaries, machinery, packaging and shipping, before receiving its export receipt. By doing so, the exporter incurs the opportunity cost of using capital to produce the goods, and the transaction risk of sending the goods before the payment. Hence, the costs of exports financed with internal working capital consist of the costs of financing internal working capital, , the costs of risk, , and the costs of risk aversion, , with the latter two being a function of the probability that goods are sent and no payment is received, : (13) (14) Letters of credit and other documentary credit Finally, letters of credit are a payment guarantee in case of importer’s default. An issuing bank commits to pay for the transaction if the importer is unable to pay. A confirming bank in the exporter’s region could also bear the final payment risk if the issuing bank cannot pay either. To open a letter of credit, the importer incurs an opening fee to the issuing bank, and the exporter pays a confirmation fee to the confirming bank. Only if the exporting region is considered riskier than the importing region is a confirming bank required. While being a guarantee of future payment after delivery, the letter of credit does not provide the exporter the required liquidity to produce and ship the goods – in other words, it is not a substitute for a pre-shipment loan. Under a letter of credit, the exporter would continue to face an opportunity cost if using its own funds for this purpose. However, there is no cost associated with the transaction risk under a letter of credit. Instead, opening and confirming fees are paid by the importer and the exporter, respectively. Hence, the total trade finance costs of using a letter of credit consist of the costs of financing in the source country, , consisting of the capital costs for sending the goods before payment is received, the letter of credit opening fee, , and the letter of credit confirmation fee, if the destination country is considered riskier than the source country . For an importer, letter of credit costs include the letter of credit opening fee, since the costs of financing the transaction are borne by the exporter. Writing trade costs as a function of the costs of trade finance Employing data on the shares of the four ways to finance international trade, the import tax, export tax and iceberg trade costs associated with the costs of financing international trade from source to destination in sector can be written as follows: (15) (16) (17) with as a dummy for the relative riskiness of source and destination equal to 1 if destination is riskier than source . The shares of the different instruments vary by sector as further detailed below. Due to a lack of survey data, the costs of the different instruments do not display sectoral variation. ANNEX III. COUNTERFACTUAL ANALYSIS 77 Calibration of costs Since there are four ways to finance international trade and two types of cost for each trade (the costs of funds and the costs associated with risk) four sets of two types of trade cost have to be calibrated. Costs associated with risk To calculate the costs associated with risk, data are required on the share of non-delivery or non-payment, ND, for the different trade finance instruments. To do so, data from various sources on the probability of default on loans are employed as a proxy. For cash in advance and internal working capital for exports, ND is based on the share of bank non-performing loans to total gross loans from the International Monetary Fund (IMF).1 For import and export loans, ND is based on the International Chamber of Commerce (ICC) Obligor-weighted export and import loan default rates (ICC, 2020b). Financial costs Data on the costs of finance, , come from the survey for surveyed countries and from data provided by international organizations and available in the academic literature. The two groups of countries are discussed separately. (1) Surveyed countries: (a) The costs of financing for export and import loans, and , are based on survey answers calculated as a trade finance portfolio weighted average of the costs of funds across different banks. (b) The costs of financing for cash in advance and exports with internal working capital, and , are for the surveyed countries assumed to be equal to the cost of trade loans multiplied by a factor of two. This assumption is motivated by the fact that the survey answers combined with other data indicate that the interest rates for microfinance are at least twice as large as for trade loans. More specifically, the trade loan costs of financing for Cambodia are between 5.25 and 5.75 per cent, whereas Cambodia established a cap of 18 per cent on interest rates in 2017. In 2016, the average lending rate of banks was 12 per cent in US dollars and 21 per cent in Cambodian riels and much higher for microfinance institutions (Heng et al., 2021). Hence, the ratio of 2 seems on the conservative side. For Viet Nam, the largest microfinance institutions charged annual interest rates in 2020 between 8.75 and 16 per cent (Capital Aid for the Employment of the Poor Microfinance Institution) and 7.6 percent and 17.75 percent (Tao Yêu Mày Tinh Thuong One-Member Limited Liability Microfinance Institution), whereas the trade loans costs of financing according to the survey are 6.5-6.75 per cent (Bevacqua et al., 2021). In light of these numbers, a ratio of 2 is appropriate. (c) The letter of credit opening and confirmation fees, and , are based on survey answers for Cambodia and Viet Nam. (d) The cost of funds for using letters of credit for an exporter, , are calculated by multiplying the costs of financing for cash in advance ( ) and internal working capital (int_wc) for each region by the ratio of the risk on export/import letters of credit – measured by the average default rate on export and import letters of credit from the ICC (2020b) – – and the average default rate on cash in advance and internal working capital measured as the share of bank non-performing loans also employed above, : (18) Therefore, the cost of funds for letters of credit is lower than for cash in advance and internal working capital, reflecting the fact that letters of credit are less risky. 78 TRADE FINANCE IN THE MEKONG REGION (2) Non-surveyed countries: (a) The letter of credit opening and confirmation fees, and are based on average fees in members of the Organisation for Economic Co-operation and Development. (b) The costs of financing for cash in advance and internal working capital, and , are based on lending rates from the IMF.2 (c) To obtain the costs of financing of import and export loans, and , the costs of financing for cash in advance/internal working capital based on lending rates from the IMF are scaled down by a factor of two reflecting that interest rates for microfinance are approximately twice as large as for trade loans as discussed for the surveyed countries. (d) The cost of funds for using letters of credit for an exporter, , are calculated in the same way as for surveyed countries, using equation (18). Calibration of trade finance shares Since there are four ways to finance international trade in the model, four shares are calibrated for region : • import and export loans, , ; • letters of credit, ; • internal working capital, ; • cash in advance, . The analysis proceeds in two steps to obtain the shares of trade finance. First, insights from the survey and from the literature are employed to obtain trade finance shares at the country level. Second, data on the shares of foreign-owned firms and related-party trade per sector are employed to introduce sectoral variation in the trade finance shares. Aggregate trade finance shares The aggregate trade finance shares for the two groups of countries are calculated as follows: (1) Surveyed countries: (a) The share of trade covered by all trade finance (letters of credit, import/export loans), , is calculated based on the data in the survey providing the amount of trade finance relative to the value of trade (sum of exports and imports) with the amount of trade finance corrected for non-response. The shares of individual trade finance instruments (import loans, export loans, letters of credit) are also given by the survey. Since the shares of trade finance are expressed in the model as a share of respectively exports and imports, whereas the share of trade finance is a share of the sum of exports and imports in the survey, the formula is multiplied by and in the formula to obtain the shares of import loans and letters of credit in the importer (destination ) and the share of export loans in the exporter (source ): (19) (20) (21) Multiplying these shares by respectively imports and exports and adding up, the baseline amount of trade finance in the model is equal to the amount of trade finance, , in the survey: ANNEX III. COUNTERFACTUAL ANALYSIS 79 (22) (b) The share of trade covered by internal working capital and cash in advance are assumed to be 80 and 20 per cent, respectively, of the remaining share for exports from source to destination (i.e. Viet Nam, Cambodia), reflecting that firms from developing country have less market power vis-à-vis their trading partners: (23) (24) (c) Furthermore, it is assumed that 20 and 80 per cent, respectively, of the remaining share for imports into destination and are allocated to internal working capital and cash in advance: (25) (26) (2) Non-surveyed countries: (a) The share of trade covered by letters of credit, , is based on trade between the United States and region as reported in Niepmann and Schmidt-Eisenlohr (2017):3 (27) (b) The share of trade covered by import loans and export loans is equal to the share of trade covered by letters of credit based on data in AfDB (2022), indicating that letters of credit and import plus export loans have approximately an equal share in total trade finance: (28) (29) Furthermore, the Bank for International Settlements (BIS, 2014) reports a global coverage of trade by trade finance of 60 per cent. Accordingly, the share of trade finance in non-surveyed countries is rescaled to yield to a 60 per cent coverage of trade finance. (c) Between non-surveyed countries, the share of trade covered by internal working capital and cash in advance are each 50 per cent of the remaining share:4 (30) (31) Sectoral trade finance shares considering foreign-owned firms and related-party trade The share of local trade finance is expected to be a function of the share of sales by foreign-owned firms and the share of related-party trade.5 The crucial reason to embark on this exercise is to ensure that the share of local trade finance in the counterfactual cannot rise if the trade by foreign-owned firms is financed by foreign banks (offshore financing). The shares of trade finance from to add to 1 in the model: (32) 80 TRADE FINANCE IN THE MEKONG REGION Given that data are available on the share of exports and imports by foreign-owned (fo) firms, , exports and imports can be divided into two components, exports/imports by domestic and by foreign-owned firms. The share of trade finance is then calculated for each of these. For sales by domestic-owned firms, the same approach is used as above, provided in equations (19)-(31). On exports from region in sector by foreign-owned firms, the share of domestic trade finance is scaled down by a factor (the superscript sur for surveyed countries) relative to the share of trade finance provided by domestic-owned firms: (33) The use of internal working capital and cash in advance on exports by foreign-owned firms from is also scaled down with foreign-owned firms instead employing trade finance in the destination market in the form of offshore financing (either import loans in destination or letters of credit from destination ): (34) (35) The shares of (offshore) trade finance provided by destination are adjusted to make sure that shares add to 1: (36) (37) Equivalently, on imports into region in sector , the share of domestic trade finance and cash in advance is scaled down by the same factor: (38) (39) (40) And the shares of (offshore) trade finance and the share of internal working capital provided by source are adjusted to make sure that shares add to 1: (41) (42) The scaling factor is defined as the share of trade financed with local trade finance in the surveyed countries for trade by foreign-owned firms relative to domestic firms. It is determined by the share of related-party imports/exports in total imports/exports of foreign-owned firms with inversely related to this share.6 Hence, when the share of related-party trade is larger, the share of trade employing offshore financing is larger and the share employing local trade finance is thus smaller. Besides sectoral variation in determined by the share of related-party trade in trade by foreign-owned firms , there is also country-level variation in set equal to a factor of 0.5 based on evidence from the firm-level survey that foreign firms are half as likely to use domestic trade finance: (43) ANNEX III. COUNTERFACTUAL ANALYSIS 81 Summarizing, the sum of shares on exports from source to destination , can written as: (44) (45) (46) (47) (48) Next, on imports from source into yields: (49) (50) (51) (52) (53) Hence, for exports from , trade by foreign-owned firms does not use any cash in advance in the destination or internal working capital in the source . For imports into , foreign firms do not use cia, but they do use iwc in the source . The initial parameter for the share of trade covered by trade finance, , is adjusted to make sure that the trade-weighted average of trade finance provided by domestic financial institutions is equal to the values in the survey – 3 per cent for Cambodia and 20.5 per cent for Viet Nam. Figure III.1 displays the share of different trade finance instruments in the baseline and the counterfactual Scenarios 1 and 2. Construction of counterfactuals In Scenarios 1 and 2, the coverage of trade by trade finance instruments are raised by 10 and 20 percentage points, respectively. To obtain this change, the overall share of trade finance, in equations (19)-(21) is increased until the trade-weighted average of trade (exports plus imports) covered by trade finance instruments is increased by 10 and 20 percentage points. When the share of trade finance instruments increase, the shares of other instruments (cash in advance, internal working capital) fall proportionally. For some sector–importer–exporter combinations, however, this would imply that shares would become negative. Therefore, the shares of domestic and foreign trade finance are reduced to make sure that shares always add to 1. Letters of credit fees are reduced to the level of China in Scenario 3, and the costs of financing for import and export loans and letters of credit are reduced in Scenario 4, employing a double differencing approach. The difference between the costs of financing and the interbank rates are reduced to 50 per cent of this difference on average globally in the model. Scenario 5 combines the shocks from Scenarios 2-4. 82 TRADE FINANCE IN THE MEKONG REGION FIGURE III.1 Share of different trade finance instruments by domestic and partner banks for domestic and foreign-owned firms, by sector (in per cent) Cambodia 0% 0.1% 0.2% 0.3% 0.4% 0.5% 0.6% 0.7% 0.8% Agriculture Chemicals Electrical Computer & electronic Fossil fuels Leather Metals Machinery Other goods Processed food Pharma, rubber & plastics Transport Textiles Wearing apparel Viet Nam 0% 0.1% 0.2% 0.3% 0.4% 0.5% 0.6% 0.7% 0.8% 0.9% Agriculture Chemicals Electrical Computer & electronic Fossil fuels Leather Metals Machinery Other goods Processed food Pharma, rubber & plastics Transport Textiles Wearing apparel Domestic export loan Domestic import loan Domestic letter of credit Domestic letter of credit partner Foreign export loan Foreign import loan Foreign letter of credit Foreign letter of credit partner Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3, various sources described in the text and data on the share of foreign-owned firms and the share of related-party trade. The figure displays the share of different trade finance instruments provided by domestic banks (export loans, import loans, letters of credit) and by foreign banks (letter of credit partner) for domestic firms and for foreign firms. Figure III.2 displays the share of trade covered by different trade finance instruments. This figure differs from III.1 since it includes also foreign trade finance instruments, such that shares add to 1. Figure III.3 shows the projected reduction in trade costs for exports and imports by trading partner. Although for many trading partners, the projected reduction in trade costs is larger on the import side than on the export side, the regions where it is opposite are more important trading partners – implying that for total trade costs the reduction is larger on the export side. The larger trade cost reductions on the export side are one explanation for the larger projected changes in the export side as explained in the main text. However, there is a second reason related to the general equilibrium nature of the model: services trade is excluded from the results, since trade costs are assumed to stay constant for services trade. On the export side, services trade is projected to fall because of rising factor costs due to the reduced trade costs for merchandise trade and thus the increased demand for factor inputs. On the import side, services trade is projected to rise because of increased demand for intermediate inputs. Given that a fixed trade-balance-to-GDP ratio is assumed, this implies that merchandise exports have a tendency to rise more than imports, since changes in the total value of exports and imports (including services trade) relative to GDP should be the same. Robustness checks Robustness checks are conducted on two assumptions with limited empirical underpinning. First, the survey results only provide information on the share of trade covered by trade finance instruments. However, the distribution of the remaining share of trade between cash in advance and internal working capital is unknown. In the baseline, the assumption is made that 80 per cent of imports into Cambodia and Viet Nam not covered by trade finance were financed by cash in advance and 20 per cent by internal working capital; whereas for exporters from Cambodia and Viet Nam, the share of cash in advance is 20 per cent and the share of internal working capital 80 per cent. For trade between other regions, the shares are assumed to be 50 per cent. A robustness check is conducted assuming that the shares are also 50 per cent for trade with Cambodia and Viet Nam. Second, for the surveyed countries, literature indicates that the assumption is backed up by empirical evidence that the costs of financing of employing cash in advance and internal working capital are twice as large as the financing costs for import and export loans (see Heng et al., 2021, for Cambodia, and Bevacqua et al., 2021, for Viet Nam). For the other regions, the same assumption is made; that is, that the interest rates on trade finance instruments are half of that of other forms of financing. In those regions, however, data on lending rates for other forms of financing are available (through IMF data) and the costs of trade finance were thus calculated by dividing these lending rates by 2. Two robustness checks are conducted first reducing the premium to 1.5 and then raising it to 2.5. Figure III.4 shows that the impact of changing the assumptions on the distribution between cash in advance and internal working capital is relatively modest. With a 50/50 split between cash in advance and internal working capital, the projected increase of both exports and imports is smaller than in the benchmark because there is less scope to expand trade finance. The reason is that trade finance is replacing cash in advance and internal working capital and with the assumed 80/20 split trade finance can be expanded more. For imports into the surveyed countries, there is more cash in advance in the surveyed countries with 80/20 in the benchmark implying that there is more scope to replace this with trade finance. For exports from the surveyed countries there is more internal working capital in the surveyed countries 20/80 in the benchmark, which implies again that there is more scope to replace the use of internal working capital with trade finance. The assumed split is intuitive because in exports from Cambodia and Viet Nam to other more developed regions less use of cash in advance is expected; whereas for imports into the surveyed countries, there is more scope for cash in advance. Moving to the next set of robustness checks, reducing the difference between financing costs on trade finance and non-trade finance instruments will reduce the projected increase in exports and imports, whereas increasing this 84 TRADE FINANCE IN THE MEKONG REGION FIGURE III.2 Share of trade covered by different trade finance instruments in baseline and counterfactual Scenarios 1 and 2 (in per cent) Cambodia 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Agriculture Chemicals Electrical Computer & electronic Fossil fuels Leather Metals Machinery Other goods Processed food Pharma, rubber & plastics Transport Textiles Wearing apparel Viet Nam 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Agriculture Chemicals Electrical Computer & electronic Fossil fuels Leather Metals Machinery Other goods Processed food Pharma, rubber & plastics Transport Textiles Wearing apparel Base loa,imp Base loa,exp Base lc Base int_wc Base cia cf1 loa,imp cf1 loa,exp cf1 lc cf1 int_wc cf1 cia cf2 loa,imp cf2 loa,exp cf2 lc cf2 int_wc cf2 cia Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3, various sources described in the text and data on the share of foreign-owned firms and the share of related-party trade. The figure displays the share of different instruments employed to finance international trade in the baseline and for counterfactual Scenarios 1 (cf1) and 2 (cf2): import loans (loa,imp); export loans (loa,exp), letters of credit (lc), internal working capital (int_wc) and cash in advance (cia). FIGURE III.3 Projected changes in trade costs by trading partner (in per cent) Cambodia Sub-Saharan Africa Southeast Asia South Asia Rest of World Pacific North America Middle East and North Africa Latin America Europe East Asia China -4.5% -4% -3.5% -3% -2.5% -2% -1.5% -1% -0.5% 0% Viet Nam Sub-Saharan Africa Southeast Asia South Asia Rest of World Pacific North America Middle East and North Africa Latin America Europe East Asia China -4.5% -4% -3.5% -3% -2.5% -2% -1.5% -1% -0.5% 0% Exports Imports Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3 and various sources described in the text. The figure displays the projected reduction in total trade costs for imports and exports to and from Cambodia and Viet Nam for the combined scenario. 86 TRADE FINANCE IN THE MEKONG REGION FIGURE III.4 Projected increase in the volume of trade for different assumptions in Scenario 5 (combined) (in per cent) 0% 2% 4% 6% 8% 10% 12% Benchmark Cambodia Premium 1.5 Premium 2.5 Share non-TF 50/50 Benchmark Viet Nam Premium 1.5 Premium 2.5 Share non-TF 50/50 Exports Imports Source: Simulations with the comparative static version of the WTO Global Trade Model extended with trade costs being a function of the costs and shares of trade finance. The figure displays the projected change in the volume of real imports and exports for Cambodia and Viet Nam for Scenario 5 (combined) under different assumptions. Share non-TF 50/50 assumes a 50 per cent share for cash in advance and internal working capital for trade not financed with trade finance (letters of credit, import and export loans). difference would make the projected increases larger. With a premium of 1.5, the projected expansion of trade is only about 4 per cent for imports and 6 per cent for exports for both countries, compared to 5-6 per cent for imports and 8-9 per cent for exports in the benchmark. With a premium of 2.5, the increase would be 7-8 per cent for imports and more than 10 per cent for exports. This would translate into projected changes in the value of trade of only US$ 2.5 billion for Cambodia and US$ 40 billion for Viet Nam for a premium of 1.5, and increases of US$ 3.5 billion and US$ 55 billion in the benchmark (see Figure III.5). These results are expected, since expanding the coverage of trade by trade finance instruments will lead to a larger reduction in total trade finance and thus trade costs when the reduction in the costs of financing drop more. It is important to observe here that in the robustness checks the premium for the costs of trade finance instruments are also modified in the surveyed countries – although the literature provides support for the assumption of a premium of 2 for the surveyed countries. Therefore, the benchmark results are considered robust. ANNEX III. COUNTERFACTUAL ANALYSIS 87 FIGURE III.5 Projected increase in the volume of trade for different assumptions in Scenario 5 (combined) (in US$ billion) US$ billion 0 1 2 3 4 5 Benchmark 3.5 Cambodia Premium 1.5 2.5 Premium 2.5 4.6 Share non-TF 50/50 2.8 0 10 20 30 40 50 60 70 Benchmark 55.5 Viet Nam Premium 1.5 39.8 Premium 2.5 69.3 Share non-TF 50/50 43.9 Exports Imports Source: IFC–WTO calculations based on the 2023 IFC survey of trade finance in the Mekong-3 and various sources described in the text. The figure displays the projected reduction in total trade costs for imports and exports to and from Cambodia and Viet Nam for the combined scenario. Endnotes 1. See Financial Soundness Indicators, available at https://data.imf.org/?sk=51b096fa-2cd2-40c2-8d09-0699cc1764da. 2. See International Financial Statistics for data files on lending interest rates for 2022, available at https://data.imf.org/?sk=4c514d48-b6ba-49ed- 8ab9-52b0c1a0179b. The data for December 2022 are updated to 30 June 2023, using the change in interbank rates for the same period from a range of sources. 3. To obtain numbers for aggregate regions, trade-weighted averages are employed. 4. This assumption is inconsequential for the working of the model, since trade costs between non-surveyed countries are not modified in the counterfactuals. 5. Only adjustments for trade between and trading partners are incorporated because only for these trade flows will counterfactuals be implemented. 6. The share of trade by foreign-owned firms is based on census data for Viet Nam. The share of related-party trade US data is proxied by shares of related- party trade between the United States and the surveyed countries (see https://www.census.gov/foreign-trade/Press-Release/related_party/index.html). 88 TRADE FINANCE IN THE MEKONG REGION Abbreviations CBR correspondent banking relationship CRRA constant relative risk aversion GTM Global Trade Model GVC global value chain ICC International Chamber of Commerce IFC International Finance Corporation IMF International Monetary Fund MSME micro, small and medium-sized enterprise SCF supply chain finance SME small and medium-sized enterprise UNCTAD United Nations Conference on Trade and Development WEO World Economic Outlook WITS World Integrated Trade Solution ABBREVIATIONS 89 Bibliography African Development Bank Group (AfDB Group) (2022), Trade Bevacqua, R., Nguyen D. and Lambert, D. (2021), Finance Demand and Supply in Africa: Evidence from Kenya “Reimagining Viet Nam’s Microfinance Sector: and Tanzania, AfDB Group. 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Print ISBN 978-92-870-7512-3 Web ISBN 978-92-870-7511-6 WTO Online Bookshop http://onlinebookshop.wto.org World Trade Organization 154, rue de Lausanne CH-1211 Geneva 2 Switzerland Tel: +41 (0)22 739 51 11 WTO Publications Email: publications@wto.org www.wto.org International Finance Corporation 2121 Pennsylvania Avenue NW Washington, D.C. 20433 United States of America Printed by the World Trade Organization. © International Finance Corporation, World Trade Organization 2023 Designed by ACW, London Cambodia, the Lao People’s Democratic Republic and Viet Nam – the so-called Mekong-3 – have experienced rapid trade growth over the last ten years. However, growth could be boosted even further by improving access to trade finance, such as loans and guarantees, for locally owned businesses seeking to trade globally. This publication presents the results of two surveys undertaken by the IFC to determine the level of trade finance available to businesses in the Mekong region. An analysis of the data conducted by the WTO explores the potential impact of an expansion in trade finance and how this could lead to greater integration into world trade and more inclusiveness, with increased participation in global supply chains by small businesses and women-owned enterprises. The publication is intended to serve as a guide to how domestic financial sectors can reorient their operations to support cross-border trade and enhanced access to global markets. 9 789287 075123