Q. Explain different methods of International Payment.
Ans. There are various methods of settling transactions in international marketing. These methods involve different degrees of risk for exporter and importer. These methods differ in degree of flexibility in terms of payment schedules. Main methods of payment in international marketing are:
1. Cash in Advance: In this method, exporter asks the importer to make payment in advance before the shipment of goods. The exporter is relieved of the task of collection of funds from importer. The exporter has no risk of bad-debts as he receives due amount in advance and can also use these funds in business. For importer, payment in advance involves cash flow problem and risk. It is possible that the exporter may not send the goods, may make excessive delay in delivery of goods or may supply low quality goods. So, this method of payment is beneficial for exporter and to the disadvantage of importer. If the exporter is in dominating position due to his unique innovative products or due to good demand of his products then he will insist on the importer for making payment in advance. Further, if credit-worthiness of importer is less or there is political or/and economic crisis in importer’s nation then exporter will ask the importer to make payment in advance.
2. Letter of Credit (L/C): Letter of credit is issued by the importer’s bank on the demand made by importer. When importer sends an order with the exporter, then exporter will ask importer to send letter of credit. It is a sort of guarantee give by importer’s bank to exporter or his bank to pay the specified amount. As L/C is issued and signed by the importer’s bank, it creates trust in the mind of exporter and he feels secure regarding his payment. Importer’s bank will issue letter of credit to importer only after getting itself satisfied about the credit-worthiness of importer. The issuing bank of L/C will ask the importer to make some cash deposit or to pledge something as security and/or also ask for collateral security. The issuing bank of L/C will also charge some commission depending upon the value of L/C from the importer. The letter of credit also facilitates the exporter in getting pre-export finance against it. L/C is an obligation of the issuing bank but it is also treated as financial responsibility of the importer.
Importer will request his bank to issue letter to credit. In this letter, importer’s bank promises to make payment to exporter’s bank on behalf of importer, subject to fulfilment of certain terms and conditions. Letter of credit is valid up to the date of expiry. If importer’s bank is not well known in the exporter’s country or there is economic or political crisis in the importer’s nation then exporter may insist on confirmed letter of credit.
● Types of Letter of Credit
1. Revocable Letter of Credit: This letter of credit can be revoked or terms of letter of credit can be changed without consulting the exporter. It provides no protection to exporter as terms of such letter can be changed to the disadvantage of exporter. It is not a popular form of letter of credit as it can be invalidated at any time.
2. Irrevocable Letter of Credit: In this type of letter of credit, the terms and conditions can not be changed unless both parties agree to such change. It cannot be revoked by importer nor can its terms be changed to the disadvantage of exporter without his consent. It provides sense of security to the exporter regarding recovery of payment. This type of L/C is widely used.
3. Transferable Letter of Credit: This type of letter can be transferred to third party by exporter or holder of such letter. It is a negotiable instrument.
4. Non-Transferable Letter of Credit: This type letter of credit cannot be transferred by exporter to third party. It is non-negotiable. If exporter transfers it to third party then issuing bank will not be responsible for its payment.
5. Confirmed Letter of Credit: In some cases, issuing bank of importer may not be well known or political/economic situation of importing country may not be stable then exporter may require that the letter of credit should be confirmed by the designated bank in the exporter’s country. The exporter’s bank will despatch this L/C to the designated bank for its confirmation. On receiving confirmation from designated bank, the exporter is relieved and gets assurance about credit-worthiness of importer’s bank. Confirmed and irrevocable letter provides maximum security to the exporter.
6. Unconfirmed Letter of Credit: If letter of credit is not confirmed by designated bank of exporter’s natuon or exporter/exporter’s bank do not send L/C for confirmation, it is called unconfirmed L/C. If exporter and importer have long business relations or importer’s issuing bank is well known, then letter of credit is not sent for confirmation.
7. Ancillary/Back to Back Letter of Credit: It is a type of assisting L/C based on original L/C. The exporter in whose favour L/C has been issued, may request his bank, to issue another L/C, (on the security of original L/C) in favour of his supplier of raw material/components, etc. This type of L/C helps the exporter to get pre-shipment finance against the L/C received from the importer. If exporter has to purchase raw material/components from any supplier on credit then exporter can request his bank to issue L/C against the security of original L/C. This newly L/C helps the exporter in procuring raw material/components on credit.
8. With Recourse Letter of Credit: This letter of credit is issued with a condition that if exporter’s bank is not able to recover the amount from importer’s bank, but has already made payment to exporter, then exporter’s bank can demand the refund of already paid amount alongwith interest from exporter. The exporter’s bank, instead of taking action against importer’s bank, claims refund from exporter. So exporter does not feel secured in such case. Due to this reason, such letter of credit is not much popular.
9. Without Recourse Letter of Credit: In this type of letter of credit, if the exporter’s bank is not able to recover the amount from importer’s bank, but has already paid to the exporter then exporter’s bank cannot claim refund of money from exporter. The exporter’s bank can take legal action against importer’s bank for the recovery of amount already paid to exporter. In this type of L/C, exporter feels safe.
10. Revolving letter of Credit: This type of L/C is popular among such exporters and importers who indulge in regular and continuous foreign trade transactions. Instead of providing letter of credit for each business transaction separately, importer provides a single letter of credit of large amount and of long duration. This large amount is like ceiling limit. With each business transaction, a separate L/C is not sent. Exporter bank makes payment to exporter for every business transaction till the ceiling or time period of L/C is exhausted. It makes payment in foreign trade transactions very convenient. If the individual trade transactions are of small amount but are very frequent then revolving L/C is very suitable.
● Advantages of Letter of Credit
(i) The exporter is relieved of risk of bad-debts.
(ii) The exporter gets the payment immediately after handing over shipment documents to his bank.
(iii) The exporter can arrange pre-shipment funds against the security of letter of credit.
(iv) It is more beneficial to importer in comparison to the method of advance payment.
(v) All terms and conditions are written in letter of credit. Exporter’s bank and importer’s bank also become party to this letter. So this document becomes more authentic and clear. Hence, chances of dispute are minimized.
(vi) Importer feels assured about timely delivery of goods as exporter is under obligation to despatch the goods for shipment before the expiry of validity period of letter of credit, otherwise the exporter cannot get amount against L/C.
(vii) Importer can get better terms by sending letter of credit.
(viii) The clearance from exchange control authorities becomes easier due to involvement of exporter’s bank and importer’s bank. The authorities feel that provisions of foreign exchange regulations have been duly compiled.
● Limitations of Letter of Credit
(i) Validity period of letter of credit is very short.
(ii) It is complicated method of payment as it involves excessive formalities. The terms and conditions of trade have to be written in L/C in the initial stage only, which may be difficult for exporter and importer.
(iii) If there is any discrepancy in documents presented by exporter, i.e., these documents are not in confirmity with terms and conditions then importer’s bank can withhold the payment although goods have already been shipped by exporter.
(iv) Revocable letter of credit offers little security to exporter as it can be revoked anytime.
(v) Importer’s bank, exporter’s bank and confirmating bank (Designated Bank) make huge charges which inflates the transaction cost of foreign trade.
3. Bill of Exchange (Draft): It is an important instrument used in international trade to make or receive payment. In export-import transactions, exporter writes the bill instructing the importer or his agent (importer’s bank) to make specified payment on specified date. The exporter is drawer of the bill and importer/importer’s bank is drawee of the bill. The importer/importer’s bank accepts this bill by signing it and returns the accepted bill to the drawer of the bill. This bill is treated as Bill Receivable (B/R) for the exporter and Bill Payable (B/P) for the importer. The bill of exchange can be of two types — sight bill and time bill. Sight bill is different from time bill.
Sight bill is payable by the drawee on its presentation, while the time bill is payable after a specified time period. In case of time bill, it is payable on due date. Due date/maturity date of bill is computed by adding the specified time period and 3 grace days to the date of issue of bill. The drawer of bill (in case it is a time bill) can get it discounted from his bank. In this case, after deducting discount charges, bank will make immediate payment to the holder of the bill. If the bill is discounted from the bank, then the bank (holder of the bill on due date) will receive the payment of the bill from the drawee on its due date.
In case of sight bill, documents of title are handed over to importer only after receiving the payment, so exporter is secure in case of sight bill. Here, no credit period is allowed to importer. In case of time bill, documents of title are handed over to importer before receiving the payment. So, time bill is risky for exporter, but it is to the advantage of importer. Here, credit period is allowed by exporter to importer. If the bill is accepted by the importer, then it is called trade acceptance, and if the bill is accepted by the importer’s bank, then it is called banker’s acceptance. In international trade, generally exporters insist the importers for bank’s acceptance to generate more trust and to get secure about its payment.
4. Open Account: In case of open account method, exporter makes the shipment of goods, sends all documents to importer and allows credit for a specified period to importer. In the method, letter of credit or banker’s acceptance are not required. Title of goods is transferred from exporter to importer without receiving any assurance from importer. This method is used when importer enjoys good credit-worthiness, there is long trade relationship between exporter and importer, exporter is financially sound, and there is no economic/political crisis in importer’s nation. But this method is very risky for exporter, as in the absence of banking channel (Lack of L/C, banker’s acceptance) and trade acceptance (Bill of exchange), it is very difficult for exporter to recover the amount in the situation of default in payment. Exporter has no other way to recover his amount except to take legal action, which is generally costly, lengthy and cumbersome. When there is excessive competition in foreign market, the exporter has to sell goods through open account due to risk of losing the client.
5. Consignment Method: In this method, exporter makes shipment of goods to foreign consignee. These goods are shipped at the cost of consignor. The exporter retains the title of goods until these are sold and bear the whole risk. The consignee acts as agent of exporter and sells goods on behalf of exporter. The foreign consignee will make payment only when he has sold the goods and has recovered the amount. The foreign consignee will make payment only when he has sold the goods and has recovered the amount. The foreign consignee will remit the amount after deducting his expenses and commission. If goods remain unsold then foreign consignee may send the goods back to exporter at the exporter’s expense. So the exporter has to wait for payment for long time and further he may not get any payment if goods remain unsold. So this method involves huge risk to the exporter. The exporter sends goods on consignment only when the foreign consignee is very trustworthy and there is good demand for exporter’s products in foreign market.
6. Counter-trade: Counter-trade is a trade agreement that has a requirement to import as a condition to export. Counter-trade is a bilateral trade agreement between two nations, under which a nation imports from another country on the condition that other country will also imports products of same value from the first country. This type of trade agreement does not require foreign exchange, hence it does not put any burden on balance of payments of a country. It is a type of barter trade.
Counter trade is a trade practice which is based on barter trade and is used by trading partners who lack in foreign exchange. In counter trade, exporter accepts goods or services from the importer in partial or full payment of his products. If the exchanged goods are not of equivalent value then balance is carried forward in the books of both parties and will be settled in future counter trade transactions. The payment in future trade transactions may involve some conflict between exporter and importer due to various reasons viz. fluctuations in exchange rate, delay in delivery, defective packaging, discrepancy in documents, change in regulations of exchange control, economic or political crisis, etc. The legal remedy for settlement of disputes is very complicated, costly and time consuming as both parties belong to different nations and have different legal set-up. Counter-trade does not involve any such problem.
● Types of Counter-trade
(1) Barter Trade: It is the simplest form of counter-trade. In barter trade, direct exchange of goods/services takes place between two nations without cash. It can be at the same point of time or the two transactions can be at different points of time but within a specified time period.
(2) Counter-purchase: In this agreement, a firm agrees to purchase specific goods from the country to which sales are made. Suppose a US firm sells goods to Indian company. Indian company has to make payment in US dollars, but US firm instead of receiving the export proceeds in cash, agrees to spend the export proceeds on import of some specific commodity from Indian company in a specified time period. Money exchange takes place in accounting books only. In reality, money does not change hands.
(3) Switch Trading: In this type of counter-purchase agreement, exporter is given counter-purchase credits in consideration of goods sold by him. These counter-purchase credits can be sold/transferred to any third party. Suppose, exporter does not want to import any product against these counter-purchase credits, then he can sell these counter-purchase credits to any trading house, that wants to import goods from that nation.
General Agreement on Tarrifs and Trade (GATT) and later World Trade Organisation (WTO) has criticised counter-trade as it restricts the free flow of goods from one country to another country. Under counter-trade, benefits of competition do not reach the ultimate consumers.
7. Gold: In the past, payments in international trade transactions were made mainly through gold. But now gold as a mode of payment has only theoretical importance.
