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LATEST NEWS UPDATES | Domino effect on commodity trade by Nidhi Nath Srinivas

Domino effect on commodity trade by Nidhi Nath Srinivas

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published Published on Dec 1, 2009   modified Modified on Dec 1, 2009

Real estate may be the epicentre of Dubai’s debt crisis, but it is the Indian commodity trade that will feel its aftershocks for months to come.

Two reasons make Dubai important to Indian companies. One, Dubai is the hub of most-traded commodities, from pearls, gold and diamonds to tea, cotton, basmati and sugar. Crucially, it is gateway to west Asia. All the top players in the region, especially Gulf Cooperation Countries (GCC), have a presence there and use Dubai as a convenient and glitzy business centre to meet each other and the outside world. So, to Indian companies, Dubai epitomises their entire west Asian business, whether it is Saudi companies or Iranian traders.

Two, Dubai is attractive because of light-touch regulation and easy finance. Most use the City of Gold as a trans-shipment point and its local banks as moneybags for short-term trade, usually six months.

West Asian companies have never been too sold on the idea of getting their books audited or sharing them with perfect strangers. But this was never a major hurdle till now because the region was all about traditional values like trust, relationships and family name. Not any more.

Since balance sheets are not available, there is no way for an Indian bank or company to figure what is the actual exposure of its potential partner to Dubai’s debt crisis. So, everyone will be presumed guilty unless proved innocent. In other words, trust will be replaced with deep suspicion. The cost of this shift to Indian business will be huge.

Dubai-based importers would reduce buyer’s credit because they will themselves be feeling the squeeze as local banks hunker down. Trade finance will start drying up because the liquidity crisis and higher risk will drive up interest rates on loans and advances.

Indian exporters will reduce open account sales where the goods are delivered before payment is due because they are so risky. Intense competition may have forced Indian exporters to make such sales in the past. Not any more. Right now, their focus will be on getting back the money they are owed.

Nervous Indian banks will start demanding more documents and letters of credit because this substantially reduces risks for both exporters and importers. You can bet on documents meant for Dubai being scrutinised more carefully and a higher rate of rejection. Banks will also charge more for the same trade finance instruments because of exploding counterparty risk. Currently, Dubai’s credit default premium is on par with Latvia.

The volume and value of trade itself may be affected for a while because channels will be clogged with traders trying to exit a crumbling credit market. Stock and sale, the favourite formula for trading, means continued exposure to risk. It will be replaced with a just-in-time mentality, where people will hold cash and get rid of stocks.

In case the UAE chooses the last resort of printing more notes and devaluing its currency, Indian exporters would lose further. Today, at a reported debt of $120 billion and population of 2,50,000, every man, woman and child of Dubai owes the world half-a-million dollars. A decline in purchasing power would mean that many high-value Indian products would become unaffordable. Luckily, Saudi Arabia, Qatar and Abu Dhabi may coordinate to rescue Dubai. In a similar position, Iceland was bailed out by the European Union.

What may seem like a doomsday scenario is hardly far-fetched. Last year’s global debt and banking crisis had the same effect on trade across the world.

The upside — and don’t they say life is about silver linings — is that it might lead to a deeper scrutiny of crony capitalism that has been the leitmotif of west Asian business. Balance sheets and risky investments will be put under the lens and the market will favour the prudent and the secure. More importantly, Indian companies will quickly discover who are the really trustworthy. Inshallah, it would be a reassuringly large number.


The Economic Times, 1 December, 2009, http://economictimes.indiatimes.com/opinion/columnists/nidhi-nath-srinivas/Domino-effect-on-commodity-trade/articleshow/5286308.cms
 

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