What’s Behind your More Expensive Coffee? It’s the Widening Global Trade Finance Gap

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By Siddharth Chandani

The global trade finance gap, defined as the shortfall in the amount of trade financing available compared to the actual demand for it, widened to a record $2.5 trillion in 2022. Challenging economic conditions and ongoing geopolitical conflicts including bilateral trade frictions are set to exacerbate the gap further, escalating the problem of food insecurity. Prepare to read more about:

• Global trade finance gap explained
• SMEs disproportionally bore the wider burden of a larger trade finance gap
• The ongoing geopolitical conflicts threatens to widen the gap further

Ever wondered why your latte now costs more than $7 plus taxes?¹ Prices of inputs – from milk to coffee beans, rents and labor wage costs have increased markedly. On the surface of it, supply chain bottlenecks, increase in pent-up demand, inflation and wage cost pressures, climate change and expensive real-estate are driving prices upwards. However, the invisible culprit behind your more expensive morning coffee is the widening trade finance gap.  This gap represents a significant issue in international trade, especially for small and medium-sized enterprises (SMEs) and businesses in emerging markets, which often face challenges in accessing the necessary funds to engage in international trade.

Global trade finance gap explained

According to Asian Development Bank (ADB), trade finance gap² represents the disparity between requests for financing to facilitate imports and exports and the actual approvals granted. This gap widened to a record $2.5 trillion in 2022 from $1.7 trillion in 2020. Rising interest rates leading to the lack of adequate and cheap bank financing, supply chain and logistics bottlenecks and increase in risk aversion owing to geopolitical conflicts have forced banks to scale back on credit.

Global trade finance gap widened to a record $2.5 trillion in 2022

Figure 1 The global trade finance gap

Source: ADB. 2023 Trade Finance Gaps, Growth, and Jobs Survey—Banks; and World Trade Organization data. Notes: all values are in US Dollar ($), unless otherwise stated.

Figure 1 above shows a record widening of the global trade finance gap. This is attributable to an increase in rejection rates of trade financing requests. Despite global trade and exports (as %) rebounding on the back of sharp consumption recovery after pandemic, the economic risks are yet to subside. On the contrary, a series of black swan events such as the Russia-Ukraine conflict, and as of this writing, the Israel-Palestine war have made the world for banks, an even riskier place to lend³. These heightened risks have in turn made secured financing more difficult to obtain, especially for SMEs, thereby widening the global trade finance gap.

SMEs disproportionally bore a wider burden of the larger trade finance gap

Since the trade finance gap is calculated based on rejected applications for trade finance funding, SMEs disproportionately bear the burden of rejected credit applications compared to larger firms. Figure 2 below shows that SMEs accounted for 38% of the funding applications received by banks, but they bore a larger- 45% share of rejections. On a comparable basis, the rate of rejection for larger and mid-cap businesses was much lower at 31 percent.

SMEs bore a larger share of trade finance application rejections in 2022

Figure 2 Trade finance application and rejection by major client segment in 2022

Source: ADB. 2023 Trade Finance Gaps, Growth, and Jobs Survey—Banks

Now that we have a fair understanding of the concept and drivers of the widening trade finance gap, we revisit our expensive latte example. Since most of the coffee is cultivated via labor intensive methods, 70% production of coffee beans globally falls under small holder farmers⁴. Lack of collateral for applying traditional credit and applications, lack of relationships with banks, insufficient credit history and poor market conditions deprive them of adequate, timely and cheaper funding. Collectively, most coffee bean SME suppliers such as Sucafina Brasil Industries, Olam Agricola Ltd and Nutrade Commercial Expportadora Ltd for instance from Brazil- world’s largest coffee bean producing country may find their trade financing applications rejected. Next time if you do not see your favorite coffee on the supermarket shelves, the consignment/ shipment could be stuck due to a payment default by a SME.

The ongoing geopolitical conflicts threatens to widen the gap further

As argued, the Russian Ukraine conflict and the ongoing war escalation between Israel and Palestine have already fragmented major commodity markets⁵. Along with the world becoming more inward looking, countries have since then restricted trade in commodities. Research from International Monetary Fund (IMF) suggests that the “geoeconomic fragmentation could lead to turmoil in commodity markets, causing large price swings”. IMF measured that “trade-restricting measures on overall trade increased 3.5 times in 2022”. These events threaten food security as elevated protectionism and nontariff barriers, will likely make business more challenging during the rest of 2023 and 2024.

Price rise closely follows the number of applied trade interventions

Figure 3 Number of trade interventions and prices of coffee

Source: Global Trade Alert data and Macrotrends. Note: Price of coffee as measured in $ per pound.

The data presented in Figure 3’s dashboard above illustrates some level of synchronicity between the number of trade interventions and price increases. The charts in Panel 1 and 2 delve deeper into this relationship, revealing that as the count of coffee trade interventions rose, coffee prices hikes followed suit. Trade interventions include tariffs, quotas, subsidies, and other government actions intended to protect domestic industries or to penalise other countries for trade practices deemed unfair. Price volatility can also be caused by such market interventions because of countries becoming more inward looking. The implementation of trade interventions directly impacts cost of commodities. The synchronicity observed in between Panel 1 and 2 suggest that as the number of trade interventions increases, so do the prices, indicating a visual correlation. When interventions are high, higher corresponding prices follow.

It can be seen from Panel 1 that there were 8 coffee trade interventions carried out in between 2021 and mid-2022 (circled in red), resulting in one of the most notable coffee price surges in August 2022, as depicted in Panel 2.

Hence, it is apparent from the preceding analysis that price fluctuations remain highly responsive to disruptions as the geopolitical rivalries can escalate into trade wars. Moreover, these unforeseen and exceptional events such as bilateral trade wars and conflicts will worsen the already worsened global trade finance gap, thereby excluding SMEs from bank-led financing and, potentially forcing them to resort to relatively costly private sector financing.

Stakeholders in global trade, particularly financial institutions and policymakers should take steps to mitigate the impact of geopolitical events on the trade finance gap. Financial institutions must develop and offer more accessible and competitive trade finance solutions, especially for SMEs who are disproportionately affected by the trade finance gap. Alternative financing models beyond traditional bank lending, such as peer-to-peer lending platforms, supply chain financing, and trade credit insurance have a transformative role to play. Governments and trade organizations should consider establishing support mechanisms for SMEs, including guarantees and subsidies that can alleviate their financial burdens.

References:

1. Emily Stuart, why your $7 latte is $7? (Oct 2023). https://www.vox.com/money/23896266/latte-price-pumpkin-spice-starbucks-coffee-inflation ↩︎
2. Steven Beck Et Al., Global Trade Finance Gap Expands to $2.5 Trillion in 2022, (Sep 2023). https://www.adb.org/news/global-trade-finance-gap-expands-25-trillion-2022 ↩︎
3. Clarrisa Dan, SIBOS 2023, five key takeaways from trade finance, (Oct 2023). https://flow.db.com/trade-finance/sibos-2023-five-key-trade-finance-takeaways#1 ↩︎
4. Utrilla-Catalan R, Rodríguez-Rivero R, Narvaez V, Díaz-Barcos V, Blanco M, Galeano J. Growing Inequality in the Coffee Global Value Chain: A Complex Network Assessment. Sustainability. 2022; 14(2):672. https://doi.org/10.3390/su14020672 ↩︎
5. Jorge Alvarez, Mehdi Benatiya Andaloussi, Martin Stuermer, Geoeconomic Fragmentation Threatens Food Security and Clean Energy Transition, (Oct 2023), https://www.imf.org/en/Blogs/Articles/2023/10/03/geoeconomic-fragmentation-threatens-food-security-and-clean-energy-transition. ↩︎

Siddharth Chandani is a seasoned financial services research analyst with six years of experience specialising in market research and content creation in transaction and corporate banking and covering macroeconomics research. Siddharth holds a master’s in applied economics from National University of Singapore and is currently enrolled at the Research Analyst Program at Humber College. This blog article was chosen as one of the winners of the best research bloggers contest organized in Fall 2023.