Sluggishness in trade dynamics with rise of freight cost

International trade takes place in a fast-changing world, where legal, political, economic, and technological factors are constantly evolving. Transactions happen in a dynamic market where prices can fluctuate rapidly, creating risks for both buyers and sellers. Evidence exists to bolster the hypothesis that trade sluggishness is caused by higher freight costs for merchants who consistently offer their goods at fixed prices.

Transport Costs (CIF and FOB).

International shipping involves huge risks such as natural disasters, cargo loss, piracy, human error, etc. As per rules of the International Chamber of Commerce (ICC), some International Commercial Terms (INCOTERMS) such as CIF, and FOB are used as transport costs to define the responsibilities of both buyers and sellers. Under CIF (Cost, Insurance, and Freight) terms, the seller arranges and pays for the freight charges, including any insurance costs during transportation. On the other hand, under FOB (Free on Board or Freight on Board) terms, the seller only bears the cost of loading the goods onto the vessel, while the buyer is responsible for covering the cost of freight and insurance.

Now the question remains: Is the CIF validation for all ports?

The CIF validation requirement varies based on factors such as the sale agreement terms, requirements of importing and exporting countries, and the nature of the goods being shipped. Under CIF, the seller arranges insurance coverage at their own cost for at least 110% of the invoice value to cover any risks for the buyer during shipping to the destination port.

Determinants of Transport Cost

Transport costs impact international trade and are influenced by geography, technology, infrastructure, fuel costs, and trade policies. Being landlocked can increase costs by 50% and decrease trade volumes by 30-60%. Technical advancements and fuel price changes also affect transport costs and trade volumes.

Landlocked countries, including Switzerland, face high transportation costs due to their geographic location. Investing in infrastructure can help reduce these costs. The trade response to lower transport costs depends on changes in transport costs elsewhere, known as "multilateral resistance.

"Transport Cost (Past Scene)

Transportation costs have decreased thanks to technological advances, infrastructure development, and new communication technologies. As per Jacks and Stuermer 2021's New Real Dry Bulk Index, maritime transport costs fell by 79% from 1850 to 2020. From 1974-2019, air and vessel transport accounted for 1.7% and 2.8% of the 'Free alongside Ship' export price, respectively. The ad-valorem component is 2.4% for air transport and 3% for vessel transport. Additive charges typically account for between 30% and 45% of the total cost of transportation when using an aircraft or a vessel (see Figure 3).This drop in the total cost of transportation may result from a decrease in "pure" transport costs or from a shift in trade (i.e., variations over time in the import baskets and the countries of origin).Trade composition impacts are relatively insignificant, but when they do occur, they usually accentuate the decrease in pure transit costs.

Transport Cost (Present Scene)

The cost of shipping goods across the Pacific Ocean at the end of 2021 is eight to nine times higher than before the COVID-19 pandemic, indicating the significant impact of the pandemic. Shipping costs for containers and dry bulk reached record highs in 2021, while tanker rates dropped significantly. The surge in container rates in late 2020 was due to an unexpected increase in demand. Prices remained high due to factors such as a global shortage of shipping containers, port congestion, delays, unreliable schedules, and increased fees. The strong demand for shipping has led to higher freight rates, but uncertainty in supply and concerns about the efficiency of transport systems and port operations are creating further challenges for the industry.

Container Freight Rates experienced significant fluctuations from January 2023 to March 2024. On October 26, 2023, freight rates reached their lowest point ever--a 40-foot container was going for only 1,342 US dollars. The worldwide freight cost has steadily risen since then, reaching a record-breaking high of over 4,200 US dollars in May 2024. The foundation of global trade in goods, and marine routes, has been impacted by two negative shocks. Both have to do with shipping interruptions in the Red Sea and the Panama Canal, two important sea lanes.

Due to a prolonged drought, the Panama Canal operator had to close some crossings, causing longer wait times. Large ocean carriers rerouted through the Cape of Good Hope, adding 12 to 20 days of travel time, and stopped Suez transits due to ship attacks in the Red Sea. These disruptions, affecting 2-15% and 1-25% of international seaborne trade in the Red Sea and Panama Canal respectively, have led to increased freight costs. The freight rate surge is still increasing globally. The Suez Canal is being avoided by container companies, which slows international freight and may clog ports. Asia-Mediterranean freight rates have doubled, and carriers are imposing surcharges ranging from $500 to $2,700 per container. Asia-North Europe freight rates have surged by 173%.

Red Sea security threats could quadruple prices, industry researchers said. In the meantime, significant shipping lines declared that starting in January, they would add surcharges to TEU containers, ranging from $700 to $1,500. As an illustration, on 1 January 2024, all ports in Europe (including those in India, Pakistan, Bangladesh, and Sri Lanka) were subject to a $500 per TEU "Peak Season Surcharge" (PSS) levied by the French corporation CMA CGM. Shipping costs have already significantly increased by the decision, and if it escalates into a protracted dispute, customers may have to pay more for imported goods, which would likely drive down inflation.

The increasing freight costs can be attributed to a sharp rise in demand for intermediate inputs due to increased manufacturing activity, coupled with limited shipping capacity caused by the COVID-19 pandemic and shortages in container shipping equipment. This has led to increased handling and detention costs, along with other surcharges and taxes.

Adverse Effect of the Red Sea Crisis on Bangladesh

The Red Sea Canal is the main route for trade between Asia and Europe, however transferring commodities through this channel has been made more difficult by the Houthi attack, which is supported by Iran, on commercial ships traveling along this route. The Red Sea crisis poses a serious economic conundrum for Bangladesh. With a faltering economy and the aftermath of the Russia-Ukraine war in 2022 causing interruptions in the Black Sea, the increase in freight costs, order cancellations, and possible supply chain disruptions present significant obstacles. Bangladesh's exports to Europe and America account for more than two-thirds of its total exports (61%), making it highly dependent on the Red Sea. In addition, the Red Sea is used for (8-10) % of Bangladesh's imports.

Due to security threats in the Red Sea posed by Iran-aligned Houthi militants in Yemen, six major container shipping companies are rerouting their vessels around Africa's Cape of Good Hope. This is leading to increased costs and delays. Bangladesh, which heavily relies on the Red Sea for trade, is also affected, with approximately 70% of its export-laden containers traveling through the Red Sea to reach the US East Coast, the EU, and Canada. Additionally, Bangladesh imports essential goods such as soybeans, wheat, and pulses from the US, Russia, Ukraine, and Romania.

The crisis in the Red Sea is significantly impacting Bangladesh's exports and economic recovery. The garment industry, which heavily relies on this route, is facing a shortage of containers and longer lead times, resulting in lost orders and increased production expenses. Higher freight costs are straining foreign exchange reserves and making it difficult to secure ships, further negatively impacting business. Due to strikes by Houthi rebels in Yemen, international shipping companies are rerouting (Figure 1) vessels around Africa's Cape of Good Hope to avoid the Red Sea. This will extend transportation duration, leading to increased freight costs. Bangladesh, with approximately $130 billion in trade, will also be affected as a significant portion of its trade passes through the affected waterway. The longer alternate route means higher fuel costs for vessels. Additionally, the cost of using the Red Sea has soared due to a 250% increase in war risk premiums by international maritime insurers.

Sluggishness in Trade Dynamics

UNCTAD reports increased demand for dry bulk commodities due to economic recovery and fiscal stimuli, resulting in higher dry bulk freight rates. However, COVID-19 restrictions and port congestion have caused vessel shortages, delays, and surcharges. Smaller regional container operators have been attracted by higher profits, but market uncertainties and volatile freight rates may make these services unsustainable. The rising freight prices have sparked debate about pricing transparency, market behavior, and concerns about increased market concentration. The increase in freight costs has slowed down trade for traders dealing with low-cost products, putting them at risk of loss. Finding a solution that benefits small dealers and manufacturers is crucial. All involved parties should consider the specific conditions to determine the suitability of CIF terms for a particular port. Seeking advice from legal and logistical professionals can ensure compliance and reduce risks associated with international trade.

Conclusion

The current Red Sea issue is a worldwide battle with far-reaching effects, not merely a localised one. Bangladesh is facing significant economic issues as a result of disrupted trade channels. To guarantee a secure and prosperous future for the countries caught in the crossfire, international cooperation and diplomatic efforts are essential to ending the conflict and preventing additional economic unrest. To create a sustainable global trading system, CIF helps streamline international trade logistics and ensures seamless transportation. Developing nations' support is crucial for building stronger, more resilient, and sustainable supply chains. Trade facilitation should improve infrastructure and hasten the shift to green logistics. Green logistics involve eco-friendly transportation and storage handling. Encouraging upper management to engage in bulk sales or negotiate framework agreements can benefit logistics companies. Services can be positioned as high-end by offering additional benefits such as priority handling, extended cut-off hours, dedicated assistance, and increased insurance coverage.

Dr. Soma Dhar is a research economist (Bangladesh), Deobojyoti Kumar is a PhD Scholar (Warsaw, Poland), and Dr. Vivek Kumar Singh is an assistant professor of Economics (UP India)