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UNIT VI INTERNATIONAL TRADE

Presented by: Shah Hardik CIF 14

Why Trade?
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Non availability of specific factors of production in some countries. (Land, Labour, Capital and Entrepreneurship) Product differentiation in different countries. Differences in comparative cost between countries e.g. Law of comparative Advantage

What is International Trade?

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International trade is exchange of capital, goods, and services across international borders or territories.

Gains From International Trade

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International trade leads to mutual gain because it allows each country to specialize in the production of those things that it does best. Trade permits each country to use more of its resources to produce those goods that it can produce at a relatively low cost. With trade, it is made possible for the trading partners to consume a bundle of goods that it would be impossible for them to produce domestically. Trade encourages competition & efficiency.

Risks in International Trade

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Buyer insolvency (purchaser cannot pay); Non-acceptance (buyer rejects goods as different from the agreed upon specifications); Credit risk (allowing the buyer to take possession of goods prior to payment); Regulatory risk (e.g., a change in rules that prevents the transaction); Intervention (governmental action to prevent a transaction being completed); Political risk (change in leadership interfering with transactions or prices); War and other uncontrollable events; and Unfavorable exchange rate movements (and, the potential benefit of favorable movements) Hedging (Direct/indirect hedging through Banking Channels)

Role of Banks (Commercial / Central)

It is impossible to be in international trade without involving your bank for all the services they provide such as advice on financial issues and the potential risks involved. It is true that one critical hurdle is the lack of information on international trade processes, documentation and banking procedures necessary to carry on with business abroad. For result oriented and cost effective international trade, you will very definitely need access to accurate and timely information and a sound knowledge of banking. Continue

Role of Banks (Commercial / Central)

Attractions for banks in international trade; A. Profitability Overview of International Trade A. Flow of goods from seller to buyer B. Low Risk Nature-The Six Ss B. Flow of Payment from buyer to seller i. Short-Term C. In accordance with a contract of sale ii. Small iii. Secured Documentary requirements iv. Self-Liquidating Buyer - What documents does he needs? Seller - With what documents will he be v. Specific able to supply? vi. Selective Country of export - what documents are C. A large growing Market required under the regulations of the D. Well spread over market exporting country? E. Easy to Monitor Country of import - what documents are F. Cross Selling information required under the regulations of the importing country? G. Capital efficient
Continue

Role of Banks (Commercial / Central)

Wants / needs and problem of trading partners

Wants / Needs
1. 2. 3. 4. Contract fulfillment. Convenience. Credit. Advice and assistance

Partner
Buyer Wants

Problems
1. 2. 3. 4. 5. Am I going to get the goods? (in good condition / in time) Does the settlement method safeguard these risks? Before we payhow to check the goods are exactly those ordered? Any credit terms available Prefers to delay paying for the goods until they are sold. From where can I get information on the exporters creditability

Seller Needs

1. 2. 3. 4.

Contract fulfillment. Convenience. Prompt payment. Advice and assistance

1. 2. 3. 4.

Will I be paid? When will I be paid? How to minimize risk of non-payment? How to maintain secrecy of our supplier?

Role of Banks (Commercial / Central)

Basic agreement (International Trade Sale Contract)

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Preliminary Quotation & Commitment (Invoicing / order etc) The Merchandise (goods to be imported / exported) Packing (instructions regarding packing of imported / exported merchandise) Method of Settlement (Immediate or Credit / Advance / LC Collection???) Shipping Instructions (trans shipment partial shipment etc) Price and its components (INCOTERMS 2010) Delivery Mode ,Period, Place (Sea, Air, Road place of shipment and last date of shipment) Documents (Invoice, packing list, inspection report, certificate of origin, BL/AWB etc)

Methods of Settlement
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Considerations of trading partners;

Partner Buyer Consideration 1. 2. 3. 4. 1. 2. 3. 4. Goods in advance. Payment at the time of receipt of goods. Payment after receipt of shipping documents. Need bank finance. Payment in advance. Payment at the time of shipment of goods. Payment after delivery of shipping documents. Need bank finance.

Seller

Methods of settlement (Payments)

Direct between buyer and seller (trading partners) / Clean Payments 1. Open Account / Extended Terms 2. Advance Payments Indirect through involvement of banks 1. Documentary Collections 2. Documentary Credits

Methods of Settlement
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Clean Payments
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Clean Payments are characterized by trust. Either the Exporter sends the goods and TRUSTS the Importer to pay once the goods have been received (Open Account / Extended Terms), or the Importer TRUSTS the Exporter to send the goods after payment is affected (Advance Payments).

Documentary Collection
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A method of payment used in international trade whereby the Exporter entrusts the handling of commercial and financial documents to banks and gives the banks instructions concerning the release of these documents to the Importer. Banks involved do not provide any guarantee of payment. Documentary collection may be carried out in two following ways; Documents against Payment (DAP) / Sight Collection (SC) / Cash Against Documents (CAD) Documents are released to the Importer only against payment. Documents against Acceptance (DAA) / Term Collection (TC)

Documentary Collection
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Parties to a Collection General 1. Importer 2. Importers bank 3. Bank in exporters country 4. Exporter

International Terminologies (URC 522) 1. Drawee (Importer) 2. Collecting bank of proceeds (Importers bank) 3. Remitting bank of documents (Bank in exporters country) 4. Drawee (Exporter)

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Documentary Collection Mechanism

A. Flow of Goods
After the Importer and the Exporter have established a sales contract and agree on a Documentary Collection as the method of payment, the Exporter ships the goods. B. Flow of Documents After the goods are shipped, documents originating with the Exporter (e.g. commercial invoice) and the transport company (e.g. bill of lading) are delivered to a bank (Remitting Bank). The role of the Remitting Bank is to send these documents accompanied by a Collection Instruction giving complete and precise instructions to a bank in the Importers country (Collecting/ Presenting Bank). The Collecting/ Presenting Bank acts in accordance with the instructions given in the Collection Order and releases the documents to the Importer against payment (DAP/SC/CAD) or acceptance (DAA/TC), according to the Remitting Banks Collection instructions. C. Flow of Payment Payment is forwarded by Collecting / Presenting Bank to the Remitting Bank for the Exporters account and the Importer can now present the transport/title document to the carrier in exchange for the goods.

Mechanism of Documentary Flow The mechanics of a Documentary Collection are separated into the following three steps:

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Documentary Credit / Letter of Credit

The LC in its modern shape appeared for the 1st time in 1840s in London for the settlement of trade transactions.
A Documentary Credit (DC) is a written undertaking by a bank (Issuing Bank) given to the exporter (Beneficiary) at the request of the importer (Applicant) to effect payment (Reimbursement) up to a stated amount (Credit Amount) within a stated time period (Expiry date) against presentation of compliant documents (LC terms).

In other words, DC

is a conditional payment undertaking from

a bank

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Documentary Credit / Letter of Credit

International Terminologies (URC 522) 1. L.C applicant (Importer) 2. L.C Issuing bank (Importers bank) 3. Advising / Nominated / Negotiating / Presenting bank (Bank in exporters country) 4. Confirming Bank (Exporters other bank optional) 5. Beneficiary (Exporter) Importer Importers bank Bank in exporters country Exporters other bank (optional) Exporter

Parties to a DC/LC General 1. 2. 3. 4. 5.

Documentary Credits - Cycle

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Documentary Credits Mechanism

A. Issuance of Documentary Credit / Letter of Credit After the trading parties agree on a sale of goods where payment is made by Letter of Credit, the Importer requests that its bank (the Issuing Bank) issue a Letter of Credit in favor of the Exporter (Beneficiary). The Issuing Bank then sends the Letter of Credit to the Advising Bank. A request may be included for the Advising Bank to add its confirmation. The Advising Bank is usually located in the country where the Exporter does business and may be the Exporters bank, but does not have to be. Next, the Advising/ Confirming Bank verify the Letter of Credit for authenticity and sends it to the Exporter. B. Flow of Goods

Upon receipt of the Letter of Credit, the Exporter reviews the Letter of Credit to ensure that it corresponds to the terms and conditions in the purchase and sales agreement; that the documents stipulated in the Letter of Credit can be produced; and that the terms and conditions of the Letter of Credit can be fulfilled. Assuming the Exporter is in agreement with the above, it arranges for shipment of the goods.
C. Flow of Documents & Payments After the goods are shipped, the Exporter presents the documents specified in the Letter of Credit to the Advising/ Confirming /Negotiating Bank. Once the documents are checked and found to comply with the Letter of Credit (i.e. without discrepancies), the Advising/ Confirming Bank forward these documents to the Issuing Bank. The drawing is negotiated, paid or accepted as the case may be. In turn, the Issuing Bank examines the documents to ensure they comply with the Letter of Credit. If the documents are in order, the Issuing Bank will obtain payment from the Importer for payment already made to the Confirming Bank.

Parties Involved in Letter of Credit

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Types of Letter of Credit

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Revocable & Irrevocable Letter of Credit Confirmed Letter of Credit Sight Credit and Usance Credit Back to Back Letter of Credit Transferable Letter of Credit Stand by letter of credit

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REVOCABLE LETTER OF CREDIT

A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification. It is rarely used in international trade and not considered satisfactory for the exporters but has an advantage over that of the importers and the issuing bank. It should be indicated in LC that the credit is revocable. if there is no such indication the credit will be deemed as irrevocable

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IRREVOCABLE LETTER OF CREDIT

In this case it is not possible to revoked or amended a credit without the agreement of the issuing bank, the confirming bank, and the beneficiary. From an exporters point of view it is believed to be more beneficial. An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made

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CONFIRMED LETTER OF CREDIT

Confirmed Letter of Credit is a special type of L/C in which another bank apart from the issuing bank has added its guarantee. Although, the cost of confirming by two banks makes it costlier, this type of L/C is more beneficial for the beneficiary as it doubles the guarantee.

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SIGHT CREDIT & USANCE CREDIT

Sight Credit states that the payments would be made by the issuing bank at sight, on demand or on presentation. In case of Usance Credit, draft are drawn on the issuing bank or the correspondent bank at specified usance period. The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank

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BACK TO BACK LETTER OF CREDIT

Back to Back Letter of Credit is also termed as Countervailing Credit. A credit is known as back to back credit when a L/C is opened with security of another L/C. Counter credit is actually a method of financing both sides of a transaction in which a middleman buys goods from one customer and sells them to another

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TRANSFERABLE LETTER OF CREDIT

A Transferable Credit is one under which the exporter has the right to make the credit available to one or more subsequent beneficiaries. Credits are made transferable when the original beneficiary is a middleman and does not supply the merchandise himself, but procures goods from the suppliers and arrange them to be sent to the buyer and does not want the buyer and supplier know each other.

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STANDBY LETTER OF CREDIT

Initially used by the banks in the United States, the standby letter of credit is very much similar in nature to a bank guarantee. The main objective of issuing such a credit is to secure bank loans. Standby credits are usually issued by the applicants bank in the applicants country and advised to the beneficiary by a bank in the beneficiarys country.

Advantages of using Letter of Credit

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