COUNTERTRADE CONTINUATION

INTERNATIONAL
UNIT 3 SECTION
BUSINESS
6
Unit 3, section 6: Countertrade continuation

Countertrade continues to grow in importance because of the non-

convertibility of some countries currencies. This lack of convertibility have
forced some participants in international business transactions who want to
pay physical cash but cannot use the currency available to engage in this
barter-like agreement called countertrade. Just like its predecessor known as
barter, the principle of countertrade remains the same as trading goods and
services in exchange for other goods and services without the use of money.

By the end of the Section, you should be able to:

 identify the various types of countertrade
 explain the various procedures or arrangements found in countertrade
 describe debt swaps in its various forms and dimension
 know how to position your firm for countertrade.

Types of Countertrade
In barter trade arrangements, goods are exchanged directly for other goods
of approximately equal value. Such transactions can encompass the
exchange of a wide variety of goods and services and involves both the
developed and developing countries. For example, it could be the exchange
of 10,000 Brazilian tractors for some specific quantity of Ghana’s cocoa, or
the Chinese construction of four stadia for the 2008 African Cup of Nations
competition in Ghana for 30,000 metric tons of cocoa beans.

Straightforward barter transactions which were the norm some centuries ago
are not used today “because it is difficult to find two parties who are
prepared to make simultaneous exchange of goods or services of equivalent
value”. This is because human wants have now become more sophisticated
and varied.

Consequently, participants engaged in international business or trade

transactions have now resorted to the use of more complicated versions of
countertrade which often includes the exchange of goods and services partly
for money.
Below are some of the different forms of countertrade:

Counter Purchase or Parallel Barter Agreement

Counter purchase or a parallel barter arrangement is a reciprocal buying
agreement. This occurs when a country or a firm agrees to purchase a
certain amount of goods back from a country to which a sale is made.

For example, suppose a US firm sells some military hardware to China

which must be paid for in dollars. China then pays the US firm in dollars,
but in exchange the US firm agrees to spend some of its proceeds from the
sale on textiles produced by China. Thus although China must draw on its
foreign exchange reserves to pay the US firm, it knows it will eventually

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receive some of the dollars back from the US firm due to the counter
purchase agreement.

Such a counter purchase or parallel barter agreement can be particularly

advantageous if delivery or performance is dependent on some future event,
such as an agricultural harvest, or the pumping of crude oil. Frequently, the
exchange is not of precisely equal value, and therefore some amount of cash
will be involved. A special case of parallel barter is that of reverse
reciprocity, “whereby parallel contracts are signed simultaneously granting
each party access to needed resources from the other (for example, oil in
exchange for nuclear power plant)”. Such contracts are useful when long-
term exchange relationships are desired.

Buy-Back or Compensation Arrangement

Buy-back or compensation arrangement is another common form of
countertrade. Under this international business arrangement, one country or
firm agrees to supply technology or equipment that enables the other party
to produce goods before the price of the supplied equipment or technology
is repaid out of the goods’ sales proceeds. This arrangement often calls for
larger amounts of time, patience, money, and finished goods than
straightforward barter arrangements.

The buy-back or compensation arrangement originally evolved in response

to the reluctance of communist countries to permit ownership of productive
resources by the private sector, thus restricting foreign direct investment.
One example of such a buy-back arrangement was the arrangement entered
into by Levi Strauss Company of the Soviet Union, and Hungary.

The company transferred its know-how and the Levi’s trademark to

Hungary. The Hungarian firm began to produce Levi’s products locally.
Some of the output was sold domestically in Hungary, but the rest was
marketed in Western Europe not by Hungary [the producer] but rather by
Levi Strauss Company of Russia in compensation for its transferred
technology or know-how. Buy-back or compensation arrangements have
now encompassed all developing and industrialized nations.

Barter Clearing Account

Barter clearing account is a more refined system of barter in international
business which tries to reduce the effects of bilateralism and the immediacy
of such transactions. Under this arrangement, clearing accounts are
established to track all the debits and credits of international transactions.
The entries merely represent the purchasing power of each country or firm,
but which are not directly withdrawable in cash by any of them.

As a result, each country or firm can agree in a single contract to purchase

goods or services of a specific value. Although a barter clearing account

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may be out of balance on a transaction-by-transaction basis, this

international business arrangement stipulates that over the long term all
balances in the barter clearing account will be resorted.
Frequently, funds for the purchase of goods available under the barter
clearing account arrangement are tightly defined. In fact, such funds have on
several occasions been labelled as “apple clearing dollar funds.” Sometimes,
additional flexibility is given to the barter clearing account by permitting
switch-trading, in which credits in the account can be sold or transferred to a
third party. Such switch-trading can provide creative and vibrant
intermediaries with opportunities for some other trade deals by identifying
such clearing account relationships.

Offset Purchases
Offset purchases are international business arrangements that are most
frequently found in the defence-related sector, and in the sales of large-
scale, high-priced items such as aircraft or ships. Offset purchase
arrangements are designed to “offset” the negative effects of large purchases
from abroad on the current account of a country. For example, a country
purchasing aircraft from the United States might require that a certain
proportion or some portions of the aircraft be produced and assembled in the
purchasing country. Such requirement is often a condition for awarding the
contract, or is issued as the main determining factor in international contract
decisions. Offset arrangements can take on many forms, such as co-
production, licensing, subcontracting, or joint venture.

Debt Swaps
Debt swaps are mainly used as a financial tool in international business
transactions. These debt swaps are carried out particularly with less-
developed countries in which both the government and the private sector
face large debt burdens.

These debtors are unable to repay their debts anytime soon after large
international business transactions or purchases. Therefore, such debtors
have increasingly resorted to the exchange of their debts for something else.

Types of Debt Swaps

Five types of debt swaps are most prevalent. These are:
 Debt-for-debt swaps;
 Debt-for-equity swaps;
 Debt-for-product swaps;
 Debt-for-nature swaps; and
 Debt-for-education swaps.

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Debt-for-Debt Swaps
Debt-for-Debt swaps take place when a loan held by one creditor is simply
exchanged for a loan held by another creditor. For example, a U.S bank may
swap Argentine debt for Chilean debt with a German bank. Through this
mechanism, debts for holders are able to consolidate their outstanding loans
and concentrate particular countries or regions.

Debt-for-Equity Swaps
These 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 future access to foreign exchange for
dividend remittance and capital repatriation.

Debt-for-Product Swaps
Under debt-for product swaps, debt is exchanged for products or goods.
Usually, the transaction requires that an additional cash payment be made
for the product. For instance, first Interstate Bank of California concluded
an arrangement with Peruvian authorities whereby a commitment was made
to purchase $3 worth of Peruvian products for every $1 of products supplied
by Peru against debt.

Debt-for-Nature Swaps
Debt-for-nature-swaps is one form of debt swaps with major environmental
implications. Under such international business arrangements, developed
countries or reputable foreign creditor-banks buy what are otherwise
considered to be nonperforming loans in their books at substantial discounts,
and return the debt to the country in exchange for the preservation of some
natural resources in the debtor country.

These creditor-banks like these debt-for-nature-swap deals because they

recoup some of the money they had written off in respect of some debtor
developing countries for the purpose of environmental conservation. Some
developing countries like these debt-for-nature-swaps because they are able
to retire their mounting debts; but other countries do not like them because
they believe they are selling their natural resources to some foreign
countries or entities.

The stark truth, however, is that now pressing global environmental

concerns are been addressed by applying debt-for-nature swaps. For
example, Conservation International, an American environmental
conservation group, paid Citicorp $100,000 for $650,000 of Bolivian debts,
and then returned the debt relief to Bolivia in exchange for an arrangement
to turn 4-million acres stretch of the Amazon Basin into a wildlife
sanctuary, including the payment for its upkeep. Growing global

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environmental concerns combined with mounting difficulties of debt

repayments are likely to increase the swaps of debt for environmental or
other social causes.

Debt-for-Education Swaps
Debt-for-education swaps are a means to reduce the debt burdens of
developing countries by enabling more developing country students to study
abroad. This international trading arrangement greatly enhances the
international orientation, foreign language training, and cultural sensitivity
of the global educational system.

Preparation for Countertrade

Countertrade specialists are mainly non-working staff of the international
corporations, and yet conduct the majority of international countertrade
transactions. Recently, however, international business entities are
increasingly considering carrying out countertrade transactions in-house. If
this trend can be maintained, the need for steep discounts may decrease, and
the profitability of countertrade may improve.

Conducting Countertrade in-house

Developing an in-house capability for handling countertrade at the
international level should be done with great caution. First, the country or
international company should determine the import priorities of its products
to the host country or firm to which it intends to sell to. Goods that are
highly desirable and / or necessary for a country demanding countertrade are
less likely to be subject to stringent trade controls by the host country than
goods considered luxurious or ostentatious.

Host Country Arrangements for Countertrade

Next, the home country or firm needs to identify the countertrade
arrangements and regulations that exist in the host country to which it is
exporting to. An awareness of, and the alternatives available to the various
countertrade demands will strengthen the home country’s or company’s
bargaining position at the pre-contract stage. Obtaining this information is
also important to incorporate possible countertrade costs early into the
pricing scheme.

At this stage, the most favoured countertrade arrangement from the buyer’s
perspective should be identified by the home country or company. The
home country or company should find out why this particular arrangement
is the most favoured one by the buyer, and explore whether other forms of
transactions would similarly meet the objectives of the countertrading
partner. To do this end, the goals and objectives of the countertrading
parties needs to be determined.

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SWOT Analysis of Countertrade

The next step is to match the strength of the home country or firm with the
current and potential countertrade situations. This requires an assessment of
the home country’s or corporate capabilities and resources. Any internal
sourcing needs that might be used to fulfil a countertrade contract should be
determine. This means the raw materials or intermediate products that could
be obtained from a countertrade partner, rather than current suppliers.

However, this assessment should not be restricted to the internal corporate

use of countertrade product. The company should also determine whether it
could use, for example, its distribution capabilities or its contracts with other
customers and suppliers to help in its countertrade transactions. At this
point, the company can decide whether it should engage in countertrade
transactions.

Accounting and Taxation in Countertrade

The accounting and taxation aspects of the countertrade transactions should
be considered, because they are often quite different from usual procedures.
The use of accounting or tax professionals is essential to compliance with
difficult and obscure tax regulations in this area.

Next, all the risk involved in countertrade must be considered. This means
that the goods to be obtained need to be specified, that the delivery time for
the goods needs to be determined, and that the reliability of the supplier and
the quality and consistency of the goods need to be assessed. It is also
helpful to explore the impact of countertrade on future prices, both for the
specific goods obtained and for the world market price for the category of
goods.

Evaluation of Countertrade Products

In conjunction with the evaluation of the countertraded products, which
should be specified in as much details as possible rather than left open, the
corporation needs to explore the market for the product. This includes
forecasting future market developments, paying particular attention to
competitive reaction and price fluctuations. It is also useful at this stage to
determine the impact of the countertraded product on the sales and profits of
other complementary product lines currently marketed by the firm. Possible
repercussions from outside groups should be in investigated.

One should also evaluate the length of the intended relationship with the
countertrading partner and the importance of the relationship for future
plans and goals. Such parameters may be decisive, because they may
override short-term economic benefits. Management can then make the final
decision as to whether the transaction should be handled within or outside of
the firm.

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Summary
We have learned that countertrade arrangements include counter purchases
or parallel barter, buy-back or compensation arrangements, barter clearing
accounts, offset purchases, and debt swaps. And five main types of debt
swaps have been identified. Finally, we have enumerated the various
arrangements for, or the preparation towards countertrade.

Please, refer to other texts in the references provided for further information
on the meaning and importance of this topic. Put down any important notes
you come across in the blank sheet provided below for face-to-face
discussions with your course lecturer.

Now assess your understanding of this Section by answering the following

Self-Assessment Questions (SAQs). Good luck!

Activity5.6
 List three forms of countertrade
 The five forms of dept swaps are..............
 What is counter-purchase?
 What is a buy-back or compensation arrangement?

Did you score all? That’s great! Keep it up.

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