FINANCING EXPORTS AND IMPORTS
Financing Exports and Imports
Export / import financing
This portion with the most common methods of financing exports or imports. Unlike most domestic business, global business often occurs between two parties that do not know each other very well and who may be physically separated from each other by thousands of miles. Lack of a relationship, extended distances time differences, communication problems, and differing legal systems all tend to aggravate the problem of receiving payment for merchandise shipped. We now review the various payment options available to the exporter and importer.
cash: The best of all worlds be for the exporter to receive payment prior to shipping goods. Unfortunately, it would be a tare importer who would be willing to part with money without first seeing the merchandise.
Open Account: With this option, the exporter ship merchandise and sends the importer an invoice, allowing some period of time for the importer to make payment. But what would a U.S. exporter do if an importer in Hong Kong refused to make payment? The exporter would first have to find the importer in Hong Kong (assuming the importer and the merchandise were still there) and then proceed to sue importer under Hong Kong law. Understandably, because of the potential for problems, few exporters will ship merchandise unless they have the importer' money up front.
At this point there seems to be an impasse; under cash and open account options, either the importer or exporter is exposed to severe financial risk. Fortunately, there are ways around this dilemma. That two of the properties of the ocean bill of lading are that it is negotiable and that it is evidence of ownership. These properties result in two other methods of collecting funds that minimize the financial risk of exporting and importing.
Documentary Collection: Sometimes referred to as documents against payment, the documentary collection method uses financial intermediaries (usually banks) to facilitate the collection of funds.
- The buyer and seller agree on the terms of a contract, including the buyer's obligation to pay on delivery (sight) of the required documents, including the ocean bill of lading.
- The seller ships the merchandise and has a collecting bank named as the consignee on the ocean bill of lading. The seller (drawer) draws a draft (also called a bill of exchange), payable by the drawee on sight of the documents. The draft and all documents are delivered to a U.S. bank.
- A U.S. bank sends the documents with instructions to the collecting bank in the foreign country (Hong Kong).
- When the cargo arrives in Hong Kong, the steamship company notifies the consigner (collecting bank). The collecting bank advises the buyer that the cargo is in and that payment is due. The buyer accepts the draft and makes payment. The collecting bank then endorses the ocean bill of lading to the buyer, which permits the buyer to remove the cargo from the pier. The collected funds are then forwarded to the seller.
Operating in conjunction with the banking intermediaries, the seller is able to control the merchandise until payment is made. In the event that the buyer does not come forward to accept the draft and make payment (a nonacceptance), the seller is left with only a few options; ship the merchandise back to the United States, try to find another buyer in the foreign market, abandon the cargo at the pier, or attempt to renegotiate the contract with the original buyer in the hope of arriving at a selling price that will cover costs.
Since the documentary collection process presents some degree of risk for the seller, it is probably best reserved for use between subsidiaries of the same company or with a customer with whom the seller has had a long history of excellent relations.
Letter of Credit: The letter of credit overcomes the risk inherent in a documentary collection. The letter of credit is an undertaking by a bank to make payment to the seller (exporter) upon completion of the tasks set forth in the letter. The tasks usually include the presentation of required shipping and export documents. As in the documentary collection, the ocean bill of lading is the key document.
The reader will observe that the parties to the letter of credit may be the same as those to a documentary collection. There is, however, a big difference between the relationships. With a documentary collection, the banks are merely financial intermediaries; with a letter of credit arrangement, the banks are parties to the transaction.
- The buyer and seller agree on the terms of a contract, including the buyer's obligation to furnish the seller with a confirmed, irrevocable letter of credit.
- The applicant (buyer) applies to a bank in his or her area for a letter of credit. (Banks evaluate an application for a letter of credit the same way they evaluate a loan application.)
- If the foreign bank approves the letter of credit application, it will issue its letter of credit, guaranteeing payment to the seller if the terms of the letter are met. At this point, the issuing bank becomes a party to the transaction. The letter of credit is then forwarded to a corresponding bank in the vicinity of the seller.
- The corresponding bank (the advising bank) advises the selling company that it is the beneficiary of the issuing bank's letter of credit. The confirming bank adds its guarantee of payment to that of the issuing bank's. The net effect of the transaction so far is that the seller is dealing with two banks, both promising to make payment upon delivery of the specified documents (the arrangement between the applicant and the issuing bank is of no interest to the seller).
- The seller ships the merchandise and presents the confirming bank with the documents specified in the letter of credit. When the confirming bank accepts the documents, the seller will be paid.
- The confirming bank forwards the documents, including the ocean bill of lading consigned to the issuing bank. The issuing bank then endorses the bill of lading over to the buyer.
The reader might wonder what happens if the buyer refuses to make payment to the issuing bank. The answer is that this is a problem for the issuing bank; that is, as long as the seller has provided the documents specified in the letter of credit, the transaction is completed and the seller is entitled to payment.
Forfaiting: Although not common in the United States, forfaiting is widely used to finance export transactions in Europe. Essentially, forfaiting involves the exporter discounting bills of exchange or promissory notes received as an obligation to pay from an importer. Normally, the importer must provide for a third party, that is, a bank, to guarantee payment. Most forfaiting involves capital goods of high value with payments spread out from 18 months to as many as 10 years.
Export Receivable Factoring: The export receivable factor method of trade financing, when it can be arranged, gives the exporter the benefit of being able to sell on what amounts to open account terms but with the guarantee of predictable cash flows from the sale. Export orders are preapproved by the factor. When the merchandise is shipped by the exporter, the invoices and related documentation are assigned to the factor. The factor pays the exporter with a discounted amount and accepts the responsibility of collecting the receivable.
Countertrade: The basic idea of countertrade is to pay for goods or services with other goods or services. The earliest and most fundamental form of counter trade is barter a direct exchange of goods of approximately equal value between parties with no money involved. such transactions can encompass the exchange of a wide variety of goods, for example, bananas for cars or airplane parts for training, and are carried out both in developing and industrialized countries.
Counter trade transactions have always arisen when economic circumstances made it more acceptable to exchange goods directly rather than to use money as an intermediary. Conditions that encourage such business activities are lack of money, lack of value of or faith in money, lack of acceptability of money as an exchange medium, or greater ease of transaction by using goods.
Increasingly, countries are deciding that countertrade transactions are more beneficial to them than transactions based on financial exchange alone. A primary reason is that the world debt crisis has made ordinary trade financing very risky. Many countries, particularly in the developing world, simply cannot obtain the trade credit or financial assistance necessary to pay for desired imports. Heavily indebted countries, faced with the possibility of not being able to afford imports at all, hasten to use countertrade in order to maintain at least a trickle of product inflow. Furthermore the use of countertrade permits the covert reduction of prices and therefore allows the circumvention of price and exchange controls.1
A second reason for the increase in countertrade is that many countries are again responding favorably to the notion of bilateralism. Thinking along the lines of you scratch my back and I'll scratch yours,'' they prefer to exchange goods with countries that are their major business partners.
Countertrade is also often viewed by firms and nations alike as an excellent mechanism to gain entry into new markets. The producer often hopes that the party receiving the goods will serve as a new distributor, opening up new international marketing channels and ultimately expanding the original market.
Conversely, because countertrade is highly sought after in many enormous but hard currency poor emerging market economies such as China and the former Eastern bloc countries as well as in other cash strapped countries in South America and the Third World engaging in such transactions can provide major growth opportunities for firms. In increasingly competitive world markets, countertrade can be a good way to attract new buyers. By providing countertrade services, the seller is in effect differentiating its product from those of its competitors.2
Finally, countertrade can provide stability for long-term sales. For example, if a firm is tied to a countertrade agreement, it will need to source the product from a particular supplier, whether it wishes to do so or not.
Types of Countertrade
Increasingly participants in countertrade have resorted to more sophisticated versions of exchanging goods that often also include some use of money. One such refinement of simple barter is the counter purchase or parallel barter agreement. To unlink the timing of contract performance the participating parties sign two separate contracts that specify the goods and services to be exchanged. In this way one transaction can go forward even though the second transaction needs more time. Such an arrangement can be particularly advantageous if delivery performance is dependent on a future event for the harvest. Frequently the exchange is not pf precisely equal value therefore some amount of cash will be involved. However despite the lack of linkage in terms of timing an exchange of goods for goods does take place. A special case of parallel barter is that of reverse reciprocity, whereby parallel contracts are signed granting each party access to needed resources. Such contracts are useful when long time exchange relationships are desired.
Another common form of countertrade is the buy back or compensation arrangement. One party agrees to supply technology or equipment that enables the other party to produce goods often include larger amounts of time money and products than straight barter arrangements4. They originally evolved in response to the reluctance of communist countries to permit ownership of productive resources by the private sector especially by foreign private sectors5. One example of such a buy back arrangement is an agreement entered into by Levi Strauss and Hungary. The company transferred know how and the Levi's trademark to Hungary. A Hungarian firm began to produce Levi's products. Some of the output was sold domestically and the rest was marketed in Western Europe by Levi Strauss in compensation for the know how. In the past decade buy back arrangement have been extended to encompass many developing and newly industrialized nations.
Another form of more refined barter which tries to reduce the effect of bilateralism and the immediacy of the transaction is called clearing account barter. Here clearing accounts are established to track debits and credits of trades. These entries merely represent purchasing power however and are not credits of trades. These entries merely represent purchasing power however and are not directly withdrawable in cash. As a result each party can agree in a single contract to purchase goods or services of a specified value. Although the account may be out of balance on a transaction by transaction basis the agreement stipulates that over the long term a balance in the account will be restored. Frequently the goods available for purchase with clearing account funds are tightly stipulated. In fact funds have on occasion been labeled ''apple clearing dollars or horseradish clearing funds. Sometimes additional flexibility is given to the clearing account by permitting switch trading in which credits in the account can be sold or transferred to a third party. Doing so can provide creative intermediaries with opportunities for deal making by identifying clearing account relationships with major imbalances and structuring business transactions to reduce them.
Another major form of countertrade arrangement is called offset. These arrangements are most frequently found in the defense related sector and in sales of large scale high-priced items such as aircraft and were designed to offset the negative effects of large purchases from abroad on the current account of a country. A final newly emerging form of countertrade chiefly used as a financial tool consists of debt swaps. These swaps are carried out particularly with less developed countries in which both the government and the private sector face large debt burdens. Because the debtors are unable to repay the debt anytime soon debt holders have in creasingly grown amenable to exchange of the debt for something else. The following five types of swaps are most prevalent debt for debt swaps debt for equity swaps debt for product swaps debt for nature swaps and debt for education swaps.
A debt for debt swap is when a loan held by one creditor is simply exchanged for a loan held by one creditor. For example a U.S. bank may swap argentine debt for Chilean debt with European bank. Through this mechanism debt holders are able to consolidate their outstanding loans and concentrate on particular countries or regions. Debt for equity swap arise when debt is converted into foreign equity in a domestic firm. The swap therefore serves as the vehicle for foreign direct investment. Although the equity itself is denominated in local currency, the terms of the conversion may allow the investor further access to foreign exchange for divide remittances and capital repatriation6. In some countries these debt for equity swap have been very successful.
A third form of debt swap consists of debt for product swaps. Here debt is exchanged for products. Usually these transactions require that an additional cash payment be made for the product. For example first Interstate Bank of California concluded an arrangement with Peruvian authorities whereby a commitment was made to purchase $3 worth pf Peruvian product of every $1 of the products paid for by Peru against debt7.
An emerging form of debt swap id that of the debt for nature swap. Firms or entities buy what are otherwise considered to be nonperforming loans at substantial discounts and return the debt to the country in exchange for the preservation of natural resources. As repayment of debt becomes more and more difficult for an increasing number of nations the swap of debt for social causes is likely to increase.
Debt-for-education swap have been suggested in the U.S. government by one of the authors as a means to reduce the debt burden and to enable more U.S. students to study abroad which could greatly enhance the international orientation foreign language training and cultural sensitivity of the U.S. education system8.
With the increasing sophistication of countertrade the original form of straight barter is less used today. Most frequently used is the counterpurchase agreement. Because of high military expenditures offsets are the second most frequently used form. firms at least -the relatively low use of barter, findings confirmed by other research.