Role of Export Credit in Export promotion Role of Export Credit in Export promotion Comments by Hamid Alavi World Bank May 10, 2006

2 Non-performance risk Non-payment risk Other risks

Why Pre-shipment Guarantees? Informational asymmetries about ability to execute export orders Financial institutions traditionally:  Provide working capital based on export orders to large firms that can also draw on existing assets for collateral.  Under-invest in systems/training necessary to adequately review and appraise nonperformance risks. Instead, they focused on collateralized lines of credit, which firms use at their discretion. Therefore, many first-time SME exporters in have difficulty accessing preshipment export finance to fulfill their creditworthy export projects. Preshipment export financing, in contrast, is directed at a specific transaction and not subject to borrower discretion. 1

Objectives of Pre-shipment Guarantees Encourage financial institutions to provide preshipment financing to emerging exporters with viable export contracts and good prospects of success, whose perceived nonperformance risk is greater than their actual risk because the borrowers are unable to provide adequate collateral or do not have a suitable credit history to prove they are creditworthy. A catalyst for developing sustainable preshipment financing. Simple design so that participation does not add materially to transaction costs, create uncertainty through the reimbursement mechanism, or create too large a burden on SME exporters through the guarantee fee charged.

5 Buyer’s nonpaymentBorrower loan misuse Borrower nonperformance Remarks Reasons for reluctance of banks to grant preshipment export credit Buyer’s nonpayment risks and other risks stemming from foreign buyer or buying country Exporter’s loan misuse risks Exporter’s manufacturing nonperformance risks Bank’s fears of these risks, especially nonperformance, are higher than the actual risks due to their reluctance to invest in information systems on SME and emerging direct and indirect exporters Instruments to encourage banks to grant preshipment finance Export letter of credit (L/C), back-to- back domestic L/C, or other export order backed by export credit insurance covering preshipment loan default risks from buyer’s side - PEFG agency screens out exporters who lack good faith, and/or lack production facilities to meet export order. - Banks implement modern export loan disbursement mechanism PEFG coveragePEFG agency establishes information network designed to screen out exporters who lack good faith