Trade finance, the "silent engine" of Africa's economic integration and growth

A recent article published on Project Syndicate argues that strengthening access to trade finance is key to boosting intra-African trade and enabling small and medium-sized enterprises (SMEs) to grow and compete. To fully leverage this potential, the article suggest four key measures:

• Innovate Banking Infrastructure: The continent must embrace mobile banking and digital payment platforms, such as the Pan-African Payment and Settlement System (PAPSS), to reduce high transaction costs and increase transparency.
• Develop Inclusive Financial Instruments: Beyond traditional loans, African businesses need access to innovative financial tools like supply-chain finance and trade credit insurance to mitigate the significant risks associated with cross-border commerce.
• Close the Trade Finance Gap: Data from the World Trade Organization (WTO) and Afreximbank show that the trade finance market in Africa covers less than 40% of the continent’s total merchandise trade, leaving a massive gap estimated at $100 billion. Closing this gap is critical for fostering growth and enabling African-made products to replace foreign imports.
• Secure Infrastructure Investment: While trade finance can spur investments in infrastructure like roads and ports, meeting the continent's annual infrastructure needs of up to $170 billion requires partnerships between African governments, the private sector, and development-finance institutions (DFIs).

Our research aligns with the article's conclusions. As we have argued in this post, African businesses often struggle to scale due to a lack of support from a banking sector which in Africa is particularly risk-averse. African banks reluctance to lend generally stems from a high rate of non-performing loans (NPLs). These are loans in which borrowers have failed to make scheduled payments, leading banks to either refuse credit or demand huge collateral to mitigate the risk of default.

With regard to the supply chain finance, we indicated it as a powerful tool to unlock businesses growth in this post.

A shortage of trade finance is clearly one of the most significant barriers to Africa’s economic potential, there is no doubt. The critical question is not what needs to be done, but whether the continent can successfully implement the financial reforms and develop the public-private partnerships (PPPs) outlined in the article. The recent downgrades by Moody's and Fitch of Afreximbank, one of the most important trade finance institutions in Africa, put a question mark on the capability of the continent's to provide access to affordable trade finance. In this post we explained that these downgrades could make it more expensive for Afreximbank to borrow money on international markets, which in turn could increase the cost of the trade finance it provides to African businesses, hindering the implementation of major initiatives like the African Continental Free Trade Area (AfCFTA).

Despite this setback, the need for PPPs is stronger than ever. The AfreximBank downgrades underscore that relying on a few or a single major institution to close Africa's significant trade finance gap is not a sustainable long-term solution. Here's why PPPs are still a realistic and necessary path forward:

• Risk Diversification: Partnerships can spread the risk that is currently concentrated in institutions like Afreximbank. By involving private banks and other DFIs, the burden of high-risk loans is shared, making the overall system more resilient.
• Filling the Gap: The African trade finance market of over $100 billion cannot be filled by a single institution. By pooling capital from various sources, PPPs are essential to meeting this challenge.
• Leveraging Expertise: The private sector brings valuable expertise, technology, and efficiency to the table. Their involvement can help innovate banking infrastructure and develop new financial instruments like supply chain finance and trade credit insurance, which are crucial for enabling SMEs to grow.
• DFIs as Catalysts: Other DFIs, such as the International Finance Corporation (IFC) and the African Development Bank (AfDB) have extensive experience in catalyzing private investment in Africa. They can provide technical assistance, de-risk projects with guarantees, and help African governments create a more favorable regulatory environment for private sector engagement.
• Strengthening Governance: The downgrades are a wake-up call for improved governance and risk management. Partnerships with private and international DFIs often come with stringent governance requirements, which can help strengthen the institutional framework for trade finance in Africa.

The recent challenges facing Afreximbank do not invalidate the potential of public-private partnerships; instead, they reinforce their necessity. By coming together, governments, private entities, and DFIs can build a more robust, diversified, and sustainable trade finance ecosystem, one that is better equipped to handle shocks and finally drive the economic integration Africa so urgently needs.