Countertrade Essay

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Countertrade is a system of trading that was developed to enable governments to minimize the economic imbalance of international transactions. Countertrade is not barter trade, although barter may provide an element of countertrade.

A single major international purchase contract may have a negative effect upon a country’s balance of trade, particularly for small nations or those with restricted access to hard currencies. To counter this imbalance, governments seek to moderate any trade bias by insisting upon a reciprocal mechanism that balances it, either immediately or in the future.

There are several scenarios that encourage the application of countertrade. The prime motivation appears to be trade facilitation, in that it enables trade that might otherwise be barred by a lack of convertible currency or foreign exchange, or other problems with international commercial credit.

Countertrade may be categorized into several forms that may be applied either discretely or in combination (the use of the term product in this article includes primary materials and manufactured goods as well as services):

  1. Direct offset: The seller agrees to purchase components or materials used in the manufacture or assembly of the actual products that they will be selling. This effectively reduces the cost to the buyer. This is commonly used in high-value markets such as military or aerospace. A good example of this was when McDonnell Douglas sold helicopters to the British government, but had to equip them with British Rolls-Royce engines.
  2. Indirect offset: This is used in similar market sectors to direct offset, but in this case, the importer requires the exporter to make a long-term investment or other commitment to the benefit of the importer’s economic infrastructure.
  3. Switch trading: Switch trading, sometimes known as swap, is when a third country uses its position as a trading partner with two other countries whose reciprocal trade is not in equilibrium. For example, the third country C purchases a product from A and sells another product to B to help balance the trade between A and B.
  4. Counter purchase: In this form, the exporter contracts to purchase goods, materials, or services that are not required to be incorporated in their products, thus reducing the effective cost of the products to the importer. This is seldom a direct value for value exchange and may also be for a longer period than that required for the execution of the primary contract.
  5. Barter trading: Barter is the straightforward trading of one product against another. The obvious drawback to this is that a product of sufficient commercial value to fulfill a barter contract probably already has a viable export market. Similarly, a product that does not have an export market is unlikely to be of sufficient interest for barter.

It must be remembered that barter trade is seldom in equilibrium, thus a broker will be involved to ensure that there is a terminal market for bartered products. A product that does not have a potential market is of little interest to a broker. The balancing of barter trade usually requires a complex series or “string” of trades. Note two terms that often cause confusion: agio, the broker’s premium paid by an exporter; and disagio, the commission paid by the exporter to the broker to recompense the broker for assuming the countertrade transaction risk. (In effect, the same payment from different points of view.)

Product Tolling

Tolling is the production of goods from raw materials supplied by the eventual buyer. This occurs when raw materials are not available to a production company or state, usually due to financial constraints. This usually comprises the entire content of the finished product, all of which remains the property of the supplier, although the cost of production may be paid in part by the product.

An example would be a fertilizer factory, where the buyer of the finished product supplied raw materials, corrosion inhibitor, and bags to the operator of a factory that was operating below economic output in another country. They would then pay for the processing in either cash or bagged fertilizer, or a combination of both.

This is closely related to buyback. Buyback is when either the whole or part payment is made with products manufactured either by machinery or equipment supplied by the seller, where the buyer of the machinery pays for it through product that is produced by the equipment. Examples might be the supply of agricultural equipment paid for by part of the harvest over a period of time, or a transport facility such as a pipeline, where some of the transported product will be used to pay.

Risks of Countertrade

Countertrade transactions seldom match in terms of value or timing. Obligations acquired by either the importer or the exporter from such transactions are usually outside the scope of their commercial expertise. Thus the successful conclusion of a countertrade contract often depends upon a skilled countertrade broker, who will add cost or decrease the value of the transaction.

Specific risks may include the following:

  1. Offset: Risk is low due to this form of countertrade normally being limited to governments and multinational enterprises (MNEs).
  2. Switch: Also being at governmental or MNE level, the risk is relatively low.
  3. Counter purchase: Balancing of the trade may not occur until a considerable time after the initial transaction, increasing risk of execution.
  4. Barter: Needs brokers with expertise in handling a string of contracts or turning a range of products into cash. They expect a substantial disagio for facilitating the deal and taking risk.
  5. Tolling: Has the risk that an already underfinanced producer may collapse or divert materials and products to meet conflicting needs.
  6. Buyback: Has the risk that the equipment may fail to produce sufficient product for payment in either the agreed or a viable time frame, or else the primary source may fail. However, these risks are to some extent moderated, since the quality of the end product should be improved by better production machinery, thus increasing its value.

Bibliography:

  1. G. Bowers and B. Bowers, “The American Way to Countertrade,” Countertrade and Barter Quarterly (February/March 1988);
  2. Barter News, issue 17, www.barternews.com (cited March 2009);
  3. Chong Ju Choi, Soo Hee Lee, and Jai Boem Kim, “A Note on Countertrade: Contractual Uncertainty and Transaction Governance in Emerging Economies,” Journal of International Business Studies (v.30/1, 1999);
  4. Global Offset & Countertrade Association, www.globaloffset.org (cited March 2009);
  5. London Countertrade Roundtable, www.londoncountertrade.org (cited March 2009);
  6. Dorothy A. Paun, Larry D. Compeau, and Dhruv Grewal, “A Model of the Influence of Marketing Objectives on Pricing Strategies in International Countertrade,” Journal of Public Policy and Marketing (v.16/1, 1997);
  7. UNCITRAL, Legal Guide to International Countertrade Transactions (United Nations, 1993).

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