An export credit agency (ECA) is a financial institution that provides financing to domestic companies for international export operations and other activities. Some ECAs operate as government departments while others operate as private companies. A major part of the role of an ECA is to ensure that its country's exporters are able to meet the demands of an overseas buyer in a competitive global marketplace. To achieve this aim, ECAs offer loans and insurance to domestic companies to help eliminate the risk and uncertainty of exporting to other countries, thereby encouraging exportation and international trade.
Traditionally ECAs have provided support in the main trading currencies, such as US dollars, pound sterling and euros. However, often large projects involving power, transportation and infrastructure do not generate foreign currency revenues meaning the borrower may prefer a loan in its home currency. In addition, the borrower may not always have access to the main trading currencies to be able to service a loan granted in those currencies. Local currency financing helps to fill this gap.
Under a local currency financing scheme, the ECA provides finance in the borrower's home currency. Some of the advantages of such a scheme include:
- helping the borrower reduce foreign currency risk as it is not subject to exchange rate risk between the hard currency financing source and the currency through which its operations are run;
- the exporting company can provide more competitive payment terms;
- the borrower's creditworthiness can be assessed on its ability to pay the debt in its 'own currency'; and
- this reduces risks related to foreign currency-denominated debt which adds financial stability in the local market.
Although there are many advantages for the borrower, local currency financing does create some difficulties for the ECA. These include the risk of local currency conversion and the exchange rate risk arising from potential fluctuations in the market to which the ECA will be exposed in the case of a default. The exchange rate risk can be mitigated for the ECA by including an applicable exchange rate clause, known as a 'crystallisation clause' in the finance agreement. However, these clauses are not always legally possible. This clause automatically adjusts the value of any security based on exchange rate fluctuations.
Despite these challenges, local currency financing can be an effective tool to promote trade and financial stability. In particular, it can help solve Africa's infrastructure gap provided all stakeholders are willing to negotiate some very complex challenges.