Economy, Business And Markets

High Export Premiums and Possible Solutions

High Export Premiums  and Possible Solutions
High Export Premiums  and Possible Solutions

The Organization for Economic Cooperation and Development (OECD) published a report back in July showing that Iran was one of the several countries which scored highest on its export credits risk classification list.

The OECD report evaluates so-called ‘country risk’ of developing countries. Country risk is calculated as a composite of the risk traders undergo when exchanging or transferring funds abroad and the risk of force majeure, such as war, revolution, floods and other high-impact events. The measure mostly affects the way trading is conducted and the size of insurance premiums. In the rankings, countries are spread over seven categories, with category seven indicating highest country risk.

The OECD statistics show that Iran’s place in the rankings had fallen by about three spots from category four in 2005 down to category seven in 2007. After 2007, Iran has consistently scored very low, retaining its spot in category seven. The sudden drop of Iran’s place in the rankings is almost without precedent and even African countries that have experienced a sudden outburst of civil war have normally not been downgraded so harshly.

The most important reason for this sudden drop has been the nuclear issue, which has cut off Iran from international money markets and raised transaction controls and costs. One of the most important effects of Iran’s high country risk is that exports have gradually been more confined to a small set of countries. Currently, Iran exports more than 70 percent of its non-oil products to just five countries, which, when ranked according to the amount of exports, are China, Iraq, the UAE, Afghanistan and India. More than 50 percent of exports go to just two countries, China and Iraq.

Not only are Iran’s export destinations undiversified, the export destinations themselves, save for China, also score significantly low on the OECD’s Country Risk Classification. Countries with high risk premiums tend to trade more with other high-risk countries due to the coverage that domestic insurance funds offer. In most countries, the state offers some guarantee when international transactions are conducted. However, when a country is seen as risky, the state of a low-risk country is often not willing to subsidize bilateral trade, leaving it up to individual traders to decide whether the risk is worth the trade. As a result, high-risk countries are progressively pushed away from trading with low-risk countries.

In the case of Iran, the state offers guarantees to non-oil exporters but these cover only about 4 percent of the country’s total value of trade. What is more, the majority of this coverage is allocated to ‘technical and engineering’ exports, while only 40 percent is left for other types of non-oil exports.

 Most Affected

However, Taher Shah-Hamed, the CEO of the Export Guarantee Fund of Iran (EGFI), the state-owned company that supplies most export insurances, does not believe the OECD risk assessment has directly influenced Iran’s exports or its capability to find export markets. In an interview with newspaper Donya-e Eqtesad, Shah-Hamed stated that “it is likely that our exporters change their exports when other countries’ risk evaluations change. However, more than 85 percent of the EGFI coverage is meant for high-risk countries, situated in [OECD] category 6 and 7” while “less than 1 percent of our coverage is meant for low-risk countries and 14 percent is meant for middle-risk countries.” According to Shah-Hamed, the largest effect of Iran’s higher risk evaluation was on foreign exporters which could no longer access their own domestic export funds, or had to pay much higher premiums. Most affected were exporters from OECD countries, notably Germany, Japan and Italy, which before 2005 were major trade partners of Iran, but have gradually been pushed aside as premium costs went up.

OECD statistics show that on the average risk premiums for countries in category 7 (highest-risk) are 10 times more expensive over a period of 10 years than countries in category 1 (lowest-risk).

Although Iran’s country risk is evaluated badly, it does not impact Iran as strongly as it does in some other countries because a significant portion of trade is conducted along traditional lines. According to the CEO of the EGFI, traditionalism entails that trade is often conducted without reference to insurance at all, running instead through family-networks between Iran and the destination countries. Such family networks minimize risk and remain largely unaffected by political decisions, even though these political decisions could have major effect on how their trade business is conducted.

However, the funds allocated to ‘technical and engineering’ exports, which constitute over 60 percent of the EGFI’s coverage, have been essential in keeping exports flowing. Shah-Hamed argues that if this sector had not been covered, “between 70 to 80 percent of its exports would have been destroyed.” Notably, Iran is one of the few countries that supports exports to countries like Syria and Iraq, which have been affected by political crises. Although the crisis in Iraq looks set to negatively impact Iranian exports to that country, as it was the case a few years earlier with exports to Syria, these two markets are destined, due to the EGFI’s support, to remain prime importers of Iranian goods.

 Extra Effort

In the future and with the aim of supporting non-oil exports, the country plans to expand its insurance fund for non-oil exporters to around 10 percent, up from 4 percent now. Globally, average export coverage is around 7 percent. However, considering Iran’s sanctions environment, the country should put in an extra effort to support trade. Shah-Hamed believes that “our country, compared to other countries in the region, has a relatively good situation but […] we should increase our coverage to 10 percent and even more.”

In the first half of the last Persian calendar year (ending March 2014), Iran, through the EGFI, offered more than 45,000 billion rials to non-oil exports’ insurances. This number has increased to about 47,000 rials in the first half of the current year (ending March 2015).

However, insurance payments have rushed up by about 86 percent over the same period, from $10 million last year to $19 million now. This increase in insurance payments should be seen in light of the heavy devaluation of the rial over the last few years, as a result of which many traders incurred unexpected losses.

The government and the EGFI are also trying to involve the private sector, notably financial institutions and banks, to provide financial support to exporters. According to Shah-Hamed, the EGFI is also lobbying these banks to set lower interest rates, which are still often too high.

He said that “the private banks which did not spend a rial in support of exports have now started to do this.”

While on the average countries and their financial institutions supply between 60 to 70 percent of export investments, in Iran the figure is only 7 to 8 percent, or about $2.5 billion out of a total $31.4 billion worth of exports.\\