State Support of Exporters: Cui Bono?

An Expert's View about Foreign Direct Investment in Ukraine

Posted on: 12 Jan 2012

 

Prospective of ECA establishment in Ukraine: myths and reality

Mass media pay extremely high attention to Ukrainian export support issue. Our government is again concerned with launch of effective mechanism, though still there is everything but result.

 

Lately, Ukrainian authorities submitted for government’s consideration draft Law # 9373 “On state finance support of export” (hereinafter – the Law). This document provides establishment of state Export Credit Agency (ECA) in form of public joint-stock company under the auspices of Cabinet of Ministers of Ukraine.

Declared and genuinely noble idea of state ECA establishment according to the Law and explanatory note to it (hereinafter – the Note) shall be support of Ukrainian exporters, namely, their finance risks insurance while carrying out international transactions with deferred payment. Both risks of Ukrainian supplier (exporter) and domestic bank, that finances on of the parties to international contract (foreign importer or Ukrainian exporter, depending on finance model), shall be subject to insurance.

 

Something looks great

Let us look at the bright side first. The very idea of state ECA establishment is right and brings nothing but advantages to exporters as well as to state. No need to be genius to understand that state ECA is driven by urge towards promotion of export production. Besides, implementation of such tools like “supplier’s credit” and “customer’s credit”, which are quite familiar to exporters from the EU, is aimed to take international trade relations of Ukrainian companies to a new level.

 

Definitely, legal fixation of export credit concept and the very availability of such loans is a positive point. As a result, Ukrainian banks will develop a new product – export credit that for a long time used to be unknown let alone legally supported. Same can be said about new milestone in the way of insurance sphere development. For the time being, insurance of export in our country is performed only by private insurance enterprises and not always available.

It is important that, fixing of requirements of export credit risks insurance has to be done in accordance with practice, common for EU. It means insurance payouts up to 90% of contract amount for non-commercial risks and 85% for commercial ones. According to European experience, mentioned amount of insurance payout shall be appropriate for exporter, who will get sufficient compensation in case of insured accident. ECA will benefit by saving part of insurance payouts and at the very stage of decision making concerning insurance will be able to plan compensation amounts.

 

Same for us, please!

The Bill provides establishment of Ukrainian ECA similar to those functioning successfully in Western Europe for many years. Naturally, national features to be taken into consideration. WTO membership makes Ukraine cancel all the privileges for national exporters and the only tools left for their support are credit and financing. This mechanism proved its efficiency for many countries. But the Note still rises a lot of questions concerning practical aspect of its implementation in Ukraine.

 

Among reasons why ECA shall be established in Ukraine the legislator refers to Coface (France), one of the biggest ECAs worldwide. And the main point here is Coface’s profitability, though it is not always profitable, as well as the other ECAs’. In given context it’s worth to mention results of ECAs’ performance during and after world finance crisis because correlation between successful and troublesome years is the best marker of its efficiency and profitability.

This is why we carried out an analysis behavior of three biggest actors in export finance sphere, namely, Euler Hermes (Germany), Atradius (the Netherlands) and Coface (France). It should be mentioned that each of these companies has two branches: state ECA, that supports national export of own country, and private one, established mainly for commercial activity.

 

In the meantime, Ukrainian legislator thinks that it is possible for ECA in Ukraine to reach break-even point and even become dividend-paying in a while:“ECA will pass break-even point on fourth year of activity. In a five years result, profit will be $11,85mln in general”.But our draft law is about state support of export, de facto it’s establishment of state insurance company aimed to help national exporter. So, one may wonder, whether the reference to any hypothetic profits of national ECA from insuring national exporters’ risks, as it mentioned in the Note, is actually thoughtful.

One more significant detail: during dozens years of activity, European ECAs accumulated considerable amounts of retained income. In case of launching national Export Credit Agency government should foresee provisions for first-stage transactions. Keeping in mind coming second wave of crisis and consequences that first one had had on results of European ECAs, the real amount of assets for launch may be significantly bigger than forecasted.

 

Not only cakes and ale

Analyzing statistics of foreign insurance companies one may find quite remarkable information: though amounts of deals increased in 2007-2010, their financial indicators decreased significantly. Thereby, in 2009 Coface incurred €193mln of dead losses!

 

Net cash flow of state branch of Atradius (Atradius Dutch State Business) was negative at the end of 2009 and made -33,6mln of Euro. Private branch suffered €113mln losses.

It was only Euler Hermes (both state and private) that achieved some profit during the crisis, but its amount for private branch shrank more than 4 times: from €84mln to €19mln.

 

Second half of 2008 and first half of 2009 appeared to be most tough periods for ECAs. Coface informed that the loss ratio (dead loss amount plus administrative expenses divided by premium income) increased from 55% at the first half of 2008 to 116% at the first half of 2009.

Insurance payments made by Atradius Dutch State Business in 2009 were €254,6mln (compared with €9.6mln in 2008), while premium income decreased from €84.4mln in 2008 to €41mln in 2009. Even relatively slow increase of compensations amount (34% more, from €134mln in 2008 to €180mln in 2009) could not compensate increasing payments.

 

Something to be considered

Today Ukrainian biggest exporters are business groups and holdings that have in their structure companies registered abroad. Companies established in the Netherlands and Cyprus are for commercial transactions, while those in Switzerland and Luxemburg are for holdings’ associated companies. So, big exporters are able to insure their risks in foreign ECAs, which accumulated appropriate funds, debugged business processes and developed network of offices all over the world. This state of affaires makes Ukrainian ECA less attractive for big exporters and their contractors.

 

Besides, Russia, Turkey, Italy, and Poland have been Ukrainian main trade partners for a long time. Export share increases for such countries as Kazakhstan, Belarus, India, and China. The most considerable amount of import has been directed to these countries during 9 months of 2011.
High technology items, the main subject of governmental support, transport vehicles, electric mechanisms and equipment are being exported to countries with middle and high risk level: Russia (level 3 according to OECD rating), Belarus (level 7, the lowest possible), Kazakhstan (level 5). Italy’s economic circumstances are far from stability. Cooperation with so-called “new” European countries like Montenegro (level 6) is in agenda. Production of military-industrial complex is exported to Asia and Africa, to the countries with high risks as well.

Thereby, country risks are to be reflected either in big amounts of insurance premium for Ukrainian exporters or in impossibility of risks insurance for these customers at all.

 

And, finally, the main question is how much this insurance will cost to Ukrainian exporter? Let’s research an opposite case. Now insurance of financial risks for foreign suppliers cooperating with Ukrainian customers (note that Ukrainian rating is level 7, the lowest according to OECD) is 8-11% of international contract amount in case of long-term financing (2 years and more) and 0,7-1,5% for short-term. It is worth mentioning that according to OECD agreements, which regulate ECAs activities on international level, ECAs can not compete, for example ECA in one country can not offer lower rates than ECA in another one to the same customer. Competition is for suppliers.

What is also significant is that for evaluation it is important to consider the rating of exporter’s incorporation country, Ukraine in our case, because economic instability may endanger the fulfillment by national companies of their obligations.

 

So, one may assume that value of credit insurance for Ukrainian exporters, cooperating with customers from countries with low ratings and high risks will be approximately within “Ukrainian” limits. That means too expensive and hardly worthwhile. Though, to be fair, let me note that usually supplier entrusts customer with expenses for insurance. Ukrainian exporters will hardly be different in that.

The Law in details

 

In our point of view there are some aspects to be worked out in the Law itself. First of all, the Law does not provide the possibility to insure and credit all export transactions. Moreover, it limits the range of transactions, subject to insurance and credit. According to the Note, one of the aims of the Law is to support export of high technology goods. And there is no certain definition of these goods.

Even more, mentioned state financial support is only for good of Ukrainian origin (meaning goods with national part not less than 50%) and those in special list, confirmed by Cabinet of Ministers of Ukraine endorsed with the Ministry of Economic Development and Trade.

 

In fact, the state itself sets rules for export credit and insurance market, starting from list of goods subject to insurance, according to the state and ending with such list composition procedure. Though such practice is common for number of European countries (state ECAs also define rules), Ukrainian still has a slight smell of planned administrative economy. Hard to imagine all the efforts honest exporter has to take in order to achieve cherished export insurance.

Author:
Kateryna S. Barabash,
Managing Director, IBcontacts

 


 


Posted: 12 January 2012

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