In this article we will discuss about the mechanism of financial assistance for promoting exports.
Exporters may avail pre-shipment credit, post-shipment credit, term loans, suppliers’ credit and buyers’ credit.
1. Pre-Shipment Credit:
Also known as packing credit, it is a loan given by a financial institution (either a commercial bank, or an Exim bank) to the exporter before shipment of an export order. The loan covers the cost of processing, manufacturing and packing of goods prior to shipment and working capital expenses towards rendering of services. Each export order is given a separate pre-shipment credit. The loan may be released in installments or as a lump sum, and banks are required to monitor end use of the loan.
Once the exporter enters into an export contract, he approaches a commercial bank with the export order, a letter of credit (if it has already been opened for that transaction), and a cost estimate for the export order. The estimate is given for the FOB (free on board) value of the exported goods.
Based on these documents, the bank gives a loan and credits the amount into a separate account. Though pre-shipment credit can be given only when the exporter provides the bank with the L/C (letter of credit) and an export order, the RBI permits a bank to offer a loan without either document being submitted. This is called a ‘Running Account’ facility.
Banks provide pre-shipment credit for consultancy services for setting up turnkey projects or joint ventures abroad covering technical and other staff employed, or purchase of materials, or export of computer software, or export of semi-precious and precious stones. The period of pre-shipment credit cannot exceed 180 days, though in exceptional cases, the period can extend up to 270 days. The loan can be given in the exporter’s domestic currency or in foreign currency.
Banks may liquidate pre-shipment credit in rupees out of the proceeds of bills drawn for export commodities (and thus converting pre-shipment credit into post shipment credit), the Exchange Earners Foreign Currency (EEFC) account, or the rupee resources of the exporter to the extent that exports have taken place. A foreign currency loan is called pre-shipment Credit in Foreign Currency (PCFC). A PCFC loan can be given in a currency that is not the invoicing currency for the export.
If the invoicing currency is euros, the Indian exporter can take the pre-shipment credit in dollars. The currency risk has to be borne by the exporter. When pre-shipment credit is required by the exporter in excess of FOB value, PCFC is available only for the exportable portion of the produce of agro-based products (tobacco, cardamom, pepper etc.). Repayment or liquidation of PCFC can be undertaken with export documents relating to any other export order covering the same or any other commodity exported by the exporter.
Therefore, export documents from another export contract can be substituted. According to RBI guidelines, PCFC is for export bills with a usance period of 180 days from the date of shipment. But if the overseas institution has no objection, even demand bills can be included. For exporters who have a good track record, banks can establish a running account facility in a PCFC scheme.
PCFC can be made available to both the supplier EOU (export oriented unit)/EPZ (export processing zone)/SEZ (special economic zone) unit and the receiver EOU/EPZ/SEZ unit. PCFC can be allowed only for deemed exports for supplies to projects financed by multilateral or bilateral agencies. Banks are not eligible for refinance from the RBI for export credit shown under the PCFC scheme.
Pre-shipment and post-shipment finance may be provided to exporters of all the 161 tradable services covered under the General Agreement on Trade in Services. Banks can offer rupee pre-shipment and post-shipment credit for export of supplies for projects aided or financed by agencies such as the World Bank, IBRD, and IDA. On July 1 2010, the Indian banking system shifted from using the prime lending rate (PLR) to the Base rate. With this change over, the RBI specified that the interest rates applicable for all tenors of rupee export credit advances would be at or above the Base Rate in respect of all fresh/renewed advances.
If the export order is cancelled or not executed, after the pre-shipment loan has been sanctioned and drawn, the exporter must repay the loan plus interest accrued on the loan, by purchasing the requisite foreign exchange through the bank in the domestic foreign exchange market.
The RBI offers export credit re-finance facility to Authorized Dealers. Banks can use foreign currency in ECFC accounts, RFC [D] accounts, and FCNR accounts, to give export credit in foreign currency. The foreign currency balances of depositors are held by banks in three schemes—the Exchange Earners Foreign Currency (ECFC) accounts, Resident Foreign Currency accounts (RFC [D]) accounts, and Foreign Currency (Non Resident) (FCNR) accounts. FCNR (B) deposits have a maximum maturity period of five years. Banks may arrange a Bankers Acceptance Facility (BAF) for re-discounting export bills without any margin.
When pre-shipment credit does not exceed 180 days, interest rate on the PCFC scheme and under the re-discounting of Export Bills Abroad (EBR) cannot exceed 6-month LIBOR + 0.75%, 6-month Euro LIBOR + 0.75%, or 6-month EURIBOR + 0.75%. When pre-shipment credit is above 180 days and not exceeding 360 days, interest per annum is interest rate for 180 days + 2% (200 basis points).
Banks can give pre-shipment credit in foreign currency by using foreign currency balances available in escrow accounts and Exporters Foreign Currency accounts, subject to two conditions:
i. The accountholders should be able to use the funds for their own requirements if they wish to do so.
ii. The rules regarding the maximum balance to be maintained in the account under the broad-based facility are not violated.
Banks can borrow foreign currency overseas from overseas banks and give this as foreign currency pre-shipment credit. However the interest payable by the exporter on such foreign currency loans should not exceed 6 month LIBOR plus 0.75%. Banks can borrow foreign currency from other Indian banks and give this as foreign currency pre-shipment credit.
The interest payable by the exporter on such foreign currency loans should not exceed either 6-month LIBOR + 0.75%, 6-month Euro LIBOR + 0.75%, or 6-month EURIBOR + 0.75%. Banks can use foreign currency funds generated from buy/sell swaps in the domestic foreign exchange market and give this as foreign currency pre-shipment credit. But this is subject to adherence by the bank to the Aggregate Gap Limit approved by the RBI.
Bills for Collection:
Once the goods have been exported, the exporter’s bank purchases the Bill of Exchange drawn up for the export order. When it is usance bill, the bank gives cash to the exporter, but receives the proceeds from the importer only on presenting the bill to him on the bill’s due date. Therefore the bank charges an interest rate on the amount given to the exporter, for the period till it realizes the bill. The Bill buying rate is the rate at which the bank purchases the usuance Bill. It is the spot rate plus forward premium (or minus forward discount). The forward premium (or discount) is that for the month closest to the bill’s due date.
Illustration:
On April 1, a commercial bank purchases a 30-day bill of exchange for $10,000 from an Indian exporter at a bill buying rate of Rs. 40/USD. The bank will present the bill to the importer’s bank and realize the amount on May 1. Till realization, the bank charges the exporter 10% p.a. What is the amount of interest?
Solution:
The bank gives the exporter (Rs. 40) ($10,000) = Rs. 400,000
Interest = (10%) (1/12) (400,000) = Rs. 3,333.33
2. Post-Shipment Credit:
Once the export order has been completed and the goods sent to the importer, the exporter may have to wait for receipt of money until the goods reach the importer. Post-shipment credit is an advance taken by the exporter from a financial institution, after goods have been despatched. The advance is based on the value of the bill under collection. For a Bill of Exchange of Rs. 1 million, the bank may give an advance of Rs 300,000 and charge an interest of 10% per annum, until the bill is realized.
The interest charged for the transit period should not exceed 6-month LIBOR + 0.75%, 6-month Euro LIBOR + 0.75%, or 6-month EURIBOR + 0.75%. For post- shipment credit on usance bills up to 6 months from date of shipment, interest charged should not exceed 6- month LIBOR + 0.75%, 6-month Euro LIBOR + 0.75%, or 6-month EURIBOR + 0.75%.
3. Term Loans:
The Exim bank offers term loans/deferred payment guarantees to 100% export-oriented units, units in free trade zones and computer software exporters. It provides term loans to small and medium enterprises to enable them to upgrade export production capability. The bank also provides term finance to Indian exporters of eligible goods and services, so that they can offer deferred credit to overseas buyers.
Deferred credit covers Indian consultancy, technology and other services. Such term loans are provided either by Exim bank alone, or in syndication with commercial banks. Exim bank gives loans to foreign entities for import of eligible goods and related services from India on a deferred payment basis.
4. Suppliers Credit and Buyers Credit:
Suppliers credit is a financing agreement in which the exporter offers credit to the importer. This is possible because he in turn gets the entire value of the export deal (re-financing) as a loan from a financial institution. In India the Exim bank provides the re-financing of suppliers credit.
Buyers credit is a non-recourse financing mechanism that helps Indian exporters get payment from a financial institution, by financing overseas buyers’ imports from India. It is a service offered by India’s Exim bank, through which the Indian exporter receives the amount from the Exim bank.
Trade Credit for Imports:
AD banks can approve trade credits for imports into India up to USD 20 million per transaction, with a maturity period up to one year. The maturity period is calculated from the date of shipment. The maturity period is calculated from the date of shipment.
Forfaiting:
Forfaiting is the purchase of financial obligations (such as a Promissory Note or a Bill of Exchange) in a deal involving the sale of capital goods, by a bank without recourse to the exporter. The term is derived from the French term ‘forfait’ meaning ‘the relinquishment of a right’—the exporter relinquishing his right to a receivable due at a future date in exchange for immediate cash payment, at an agreed discount.
Globally, the annual volume of forfaiting transactions exceeds USD 50 billion, and more than 300 banks are active in the forfaiting market. The top ten forfaiting markets are Argentina, Brazil, China, Egypt, India, Iran, Mexico, Peru, South Korea and Turkey.
Forfaiting is a fee-based service offered by banks. Since it is a non-recourse deal (the bank cannot approach the exporter in the event of non-receipt of funds from the importer), the forfaiting bank usually requires the deal to be collateralized by a guarantee in order to reduce credit risk. An importer of capital goods enters into a forfaiting deal to enable him to pay for the purchase in installments over a period, instead of having to pay the purchase price upfront.
There are four parties involved in a forfaiting deal – the importer, the importer’s bank (called avalizing bank), the exporter and the exporter’s bank (called forfaiting bank). An avalizing bank is one that gives guarantee for the importer. The importer of capital goods gets medium-term credit, and the exporter converts his Bill of Exchange (or promissory note) into cash.
Once the deal is finalized, the Indian company issues a promissory note to the equipment supplier for $1 million, promising to pay at the end of six months. If the Indian company does not enter into a forfaiting deal, it has to arrange for $1 million and make the payment at the end of six months. But if the Indian company enters into a forfaiting deal, it can defer payment for two years. The exporter gets his money upfront by discounting the promissory note with his bank.
The deal has allowed the exporter to be paid in six months and the importer to pay after two years. Thus, forfaiting is a process through which a bank (the importer’s bank) offers medium term credit to the importer. What about the exporter’s bank? It can choose one of two alternatives—it can hold the promissory note for six months, and present it to the importer for payment on the due date, or it can sell the promissory note in the secondary market. The new holder will present the promissory note to the importer for payment on the due date.
Benefits of Forfaiting:
From the exporter’s point of view, forfaiting is similar to factoring, as both convert financial obligations into cash. The crucial distinction is that factoring is a financial service offered for domestic financial obligations (in which both the buyer and seller are from the same country), while forfaiting is related to overseas financial obligations (the buyer and seller are in different countries).
The importer benefits as he gets more time to pay for the imports than as per the original import deal. In effect, the forfaiting bank gives the importer a medium-term loan. Forfaiting is an alternative form of finance and diversifies the importer’s borrowing capacity while enabling speedy conclusion of the contract. It provides fee-based income to the forfaiting bank.
What are the differences between an L/C and a forfaiting deal?
Difference between L/C and Forfaiting Deal:
i. An L/C is a document in international trade, and is a mandatory document in an international trade transaction. Forfaiting is a service provided by a bank for a cross- border sale of capital equipment. It is up to the importer to decide whether he wants to enter into a forfaiting deal.
ii. The importer arranges for issue of an L/C, while the exporter obtains forfaiting credit from his bank.
iii. The banks involved in an L/C issue are called the issuing bank and the advising bank. The banks involved in forfaiting are called the avalizing bank (importer’s bank) and the forfaiting bank (exporter’s bank).
iv. An L/C is a secure means of payment and provides short-term credit to the importer. On the other hand, forfaiting provides medium-term credit to the importer and immediate payment to the exporter.
v. An L/C is a standardized practice in international trade governed by the International Chamber Of Commerce’s UCP rules. Forfaiting is a non-standardized process.
Forfaiting in India:
The RBI permitted Indian banks to offer forfaiting in 1992. It was first offered by Exim bank in the same year. In 1997 the RBI permitted all Authorized Dealers to act as intermediaries between the Indian exporter and the overseas forfaiting agency. In 2001, Exim Bank formed a joint venture with a German bank (WestLB). The JV called, Global Trade Finance Pvt. Ltd. (GTF), commenced operations in September 2001. It was formed with the objective of providing market-oriented export finance solutions (factoring and forfaiting) to small- and medium-sized companies in India.
In 2010, the RBI permitted AD Category – I banks to enter into arrangements with international factoring companies of repute, preferably members of Factors Chain International, without the approval of RBI. They have to comply with foreign exchange rules and regulations specified in the directions relating to imports, and the Foreign Trade Policy in force at the time. But forfaiting is yet to catch on in India.
Indian exporters prefer the L/C because it is flexible, they are familiar with it and it can be used in any export transaction irrespective of the monetary value. Foreign banks offering forfaiting in India stipulate a minimum transaction size of US$ 1 million, which is too big for the average Indian exporter. Therefore, though the potential Indian market for forfaiting deals remains huge, the actual market is quite small.