Given the current pandemic scenario and forecasts of economic recession, the Local Currency System (SML) can contribute as an additional tool to recover the volume of foreign trade for small and medium companies (SMEs).
Southern Common Market – Mercosur
The Southern Common Market (Mercosur for its Spanish initials) is a regional integration process, initially established by Argentina, Brazil, Paraguay and Uruguay, and subsequently joined by Venezuela, currently suspended, and Bolivia which is still complying with the accession procedure.
Since its creation in 1991, the Mercosur main objective has been to promote a common space that generates business and investment opportunities through the competitive integration of national economies into the international market. As a result, it has established multiple agreements with countries or other blocks, granting them, in some cases, the status of Associated States – it becomes the situation of the South American countries (Chile, Colombia, Ecuador, Peru, Guiana e Suriname). They participate in activities and meetings of the block and have trade preferences with the States Parties.
Mercosur has also signed commercial, political and cooperation agreements with a diverse number of nations and organizations on all five continents.
Local Currency System (SML)
Over the past few decades, Latin American countries have created four institutions in order to contribute to financial and regional cooperation: the Reciprocal Payments and Credit Agreement (CCR) (1965), the Latin American Reserve Fund (Flar) (1978), the Local Currency Payment System (SML) and the Single Regional Payment Clearing System (Sucre) (2009).
Launched in October of 2008, the SML was developed by the governments of Argentina and Brazil. Years later, Uruguay (2014) and Paraguay (2018) joined the group.
The SML is a payment system that can be used for:
- International trade operations of goods – up to 360 days from the date of shipment – and services associated with these transactions, such as freight and insurance, involving individuals and legal entities resident, domiciled or headquartered in the region.
- Retirements and pensions, between SML countries, considering that the official social security (paying entity) and its beneficiary (recipient) are residents, domiciled in these countries.
Objectives
The system was created to reduce hard currency transfers, foster financial integration by increasing direct local currency transactions and reduce the costs of importers and exporters with financial transactions, in order to promote, above all, the participation of small and medium-sized companies in bilateral trade.
Characteristics
- It is a cross-border system integrated to Central Banks – CBs – payment platforms.
- Transactions are originated in value transfers of local banks and concluded by compensations between those CBs.
- CBs do not assume reciprocal nor credit risk with financial institutions.
- It is optional and complementary to actual payment systems.
- Traditional trade documents are maintained with an exception for the Export Registration which must be filled in local currency.
- It is not a risk hedging mechanism. It eliminates the foreign exchange risk for exporters.
What are the benefits of SML?
For companies, is expected a cost reduction resulting from the exchange rate in the interbank market (lower than that of the over-the-counter market and inaccessible to small and medium exporters) and a non-variation of the rate due to the volume of the transaction settled through the SML. Additionally, reduced bureaucracy and indirect costs, such as bank fees and expenses related to foreign exchange contracts.
On the other hand, financial institutions are benefited by more practicality, similar costs to those of existing operational processes and no need for dollar liquidity. In the case of central banks, the absence of exchange rate and credit risk stands out, as well as the simplification in the recording of operations.
The SML Process
In order to demonstrate how the system functions, an example of an operation is shown:
Exporter side
- The exporter issues a fiscal export note in its local currency.
- The exporter must provide its bank details to the importer (financial institution, IBAN – International Bank Account Number, tax ID).
- The exporter will receive the amount of the operation in its local currency.
Importer side
- The importer must document the foreign trade transaction in the exporter local currency and channel through a financial institution.
- The FI should register the operation in the Central Bank – CB – in the exporter local currency.
- The payment should be realized in the importer local currency considering the SML exchange rate published daily by the local CB.
The SML exchange rate is calculated in accordance with the provisions established in the Operating Regulations of the SML signed between CBs. Its value is calculated between the local currency value in relation to the dollar and the corresponding rate of the foreign country in question, in relation to the US dollar. The SML exchange rate is daily published in CBs websites.
The SML Statistics in Mercosur
Considering the Mercosur as a block, it represents the 5th largest economy in the world and the most solid commercial alliance in the region. According to the website Mercosur.int, during 2019, the block recorded exports of goods for USD 33,483.9 billions and imports for USD 37,838.4 bi.
During the same year, the Local Currency System – SML – registered 7,844 export operations with an approximate value of USD 576 million and 197 imports of USD 58 million. Exports represent 1.7% of the volume of foreign trade in the region and 0.15% in relation to imports.
In the Mercosur, there are 317 Financial Institutions – FIs – authorized to function by each Central Bank. In order to operate in the Local Currency System, FIs need the approval of their supervision. At the moment, 22% are enabled. This data shows that there is still field for development.
In the traditional system of international payments, based on the use of the US dollar, financial institutions offer different financing mechanisms – denominated in foreign currency – to companies such as pre-financing and financing of exports and letters of credit or financing of imports. In comparison, the local currency system does not offer such alternatives, lacking financing tools as it is merely and exclusively a payment mechanism.
Downfall of trade
According to an Apr 2020 publication of the International Monetary Fund – IMF, the forecast for Gross Domestic Product – GDP – for the world is a deterioration of 1%. In the case of Latin American countries is expected a decline of 5%, while for the most important partners in the Mercosur alliance, Argentina and Brazil, the outlook is a downturn of 5,7% and 5,3% respectively.
Together, Brazil and Argentina generate 78,1% of the exports and 87,7% of the imports of the Mercosur as a block. In Brazil there are 8,9 million of small and medium – SMEs – companies and in Argentina, the number of these companies is 1,066 million. Since they contribute with a significant portion of the Gross Domestic Product – GDP – and formal employment, they are considered the backbones of the economies.
Until now, the pandemic and confinement did not affect all sectors in the same way. As a consequence, the number of rejected business checks has increased as well as the requests for judicial recovery and bankruptcy applications. Conscious of the importance of SMEs, governments are adopting fiscal and monetary measures to support entrepreneurs which can be the key to obtain a better pace to recover their economies.
A horizon of opportunities
However the benefits exposed, the Local Currency System – SML – shown a low level of utilization compared to the volume of business registered in the Mercosur as a whole. Improvements in terms of financial tools and exchange hedging through derivative instruments should offer incentives for its use.
According to Susana Ecclestone, Executive Director of the British Argentine Chamber of Commerce-BACC:
In an age when the standardization of digital trade and inclusion are on top of the trading agenda, Guillermo’s analysis of the Local Currency System (SML) brings to light the benefits of alignment and interoperability to guarantee smooth trade processes and operations.
As a Director of a Bilateral Chamber of Commerce, I welcome systems, innovation and technologies that simplify transactions, are cost effective and promote inclusive imports and exports. Thanks to Guillermo for elaborating on a solution-focused system in place since 2008 that facilitates international trade and business. We hope that international trade can benefit from the experience, challenges and opportunities the SML has brought to Mercosur”.
Since the common market is a competitive environment with special conditions for intrazone businesses, along with the chance to transact in local currency with lower costs, the Local Currency System – SML – resurfaces as an alternative to recover trade flows not only in the Mercosur but also in other regions of the world which can implement it.
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This article was written by a member of TFG’s 2020 International Trade Professionals Programme. Find out more here.
Disclaimer: The views that have been expressed on this page are that of the author, which may or may not be in line with their company, Trade Finance Global or London Institute of Banking and Finance’s view.
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