Pushkar Mukewar, CEO/Co-Founder at Drip Capital, defining strategic vision & overseeing product, business development & global operations
Trade finance is the backbone of world trade and is thus closely linked to geopolitical stability. In today’s interconnected world, regional conflicts have ripple effects that extend beyond national borders, creating a dent in international trade and economic equilibrium.
Of late, the tensions in Iran, Israel and Ukraine have cast a long shadow on trade finance, reconfiguring risk perceptions, financial flows and market strategies. Below, I’ll discuss how geopolitical conflicts and wars impact trade finance and share key considerations for businesses during these uncertain times.
High Inflation Tension
Conflicts between nations can lead to an increase in the price of goods. For example, the Russia-Ukraine war has driven global oil prices higher. Increased oil prices can create broader economic effects, notably high inflation. With oil being a critical commodity globally, any disruption in its supply can easily flow into various sectors, pushing up the cost of goods and services worldwide.
Fears of inflation are already sharp in the U.S. Generally, with sustained high inflation, central banks keep interest rates high to cool off the economy. These high rates may dampen economic activities as high borrowing costs for consumers and companies reduce spending and slow down investments. This has a ripple effect on trade finance, where higher rates make funding international trade and investment flows more costly.
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Trade Route And Supply Chain Disruption
Conflicts often lead to disruptions in trade routes and supply chains, impacting the flow of goods and services. For example, in Ukraine, the war has severely affected agricultural exports, particularly grains, which are crucial for global food security. Disrupted supply chains increase costs and delay shipments, straining trade finance arrangements.
Moreover, the geopolitical conflicts in the Middle East have brought uncertainties in trade routes. This in turn has further complicated supply chains across the globe. For example, some of the world’s biggest shipping companies were compelled to divert in costly detours after the Yemeni Houthi group attacked ships heading toward Israeli ports.
Higher Risk, Higher Insurance Costs
Wars also create volatility that raises the level of risk for companies engaged in international trade. For insurers, claims go up, followed by increases in premiums and changes in terms of coverage. Trade finance institutions need to recalibrate their risk appetite; credit terms become more conservative, with rising costs for trade finance.
For example, insurance premiums for war risk coverage on shipments through the Red Sea have surged. This is in response to attacks on merchant vessels by Yemen’s Houthi movement and concerns that ships linked to the U.K. or U.S. may be targeted.
Currency Fluctuations And Economic Sanctions
Conflicts also generate currency oscillations, notably in the countries directly concerned. The Iranian rial and the Israeli shekel have gone through periods of volatility that have disturbed both trade finance transactions and their pricing. In addition, the economic sanctions imposed on Iran and, to a lesser degree, the financial restrictions affecting Russia and Ukraine have made cross-border trade and financial transactions more challenging. Typically, these forms of sanctions make transferring funds and issuing letters of credit more complex.
In periods of economic turmoil, investors move their money into safe-haven currencies such as the U.S. dollar, which appreciates. Other currencies, on the other hand, weaken because of the perceived increase in risk.
Shifts In Trade Partnerships And Markets
Businesses might seek alternative markets and trade partners as traditional trade routes and partners become less reliable. Geopolitical tensions can accelerate the trend of trade relationship diversification, as companies try to reduce risks by expanding into more stable regions. This realignment affects trade finance strategies as businesses adapt to new market conditions and seek alternative financial products.
Investment Uncertainty And Capital Flows
Geopolitical instability means investment uncertainty. Foreign direct investment in the theatre of conflict usually goes down, with investors seeking less volatility. It changes trade finance because a decrease in investment may slow the growth of trade and restrict access to capital for businesses operating in or trading with the conflict zone.
Takeaways For Businesses
Geopolitical conflicts and wars impact trade financing—from increased costs due to major disruption in supply chains to the alteration of world trading dynamics.
To protect against the negative impacts of overseas conflicts, firms will need to be agile, changing their strategies and looking for resolute financial solutions to navigate their way out of these choppy waters. Similarly, in this landscape, trade finance practitioners must be agile and knowledgeable regarding risks and opportunities.
Businesses are advised to build diversified trade partnerships and consider the alternative markets available to protect themselves against this geopolitical backdrop. Depending less on high-risk regions and routes will support business continuity even when there is conflict and supply chains are disrupted. In that view, one will want to engage with trade finance providers that specialize in emerging markets to unlock new opportunities while at the same time mitigating risks.
Flexible trade finance solutions in the form of inventory financing or accounts payable financing can enable essential liquidity during rough patches. These could help businesses maintain cash flows and settle dues with suppliers on time.
Further, hedging strategies for currency fluctuations due to war and political risks can protect companies from financial shocks. Additionally, the proper insurance coverage can increase financial security, thereby leading to stability under uncertainty.
The global interrelatedness of trade also means that no nation can be sheltered from the impacts of geopolitical conflicts. It is not a question of “if” but rather “how bad” these kinds of conflicts hit the world economy.
However, one thing for sure is: The longer a conflict lasts, the more negative impacts it has on global trade and economic stability.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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