In today’s business, competition in all export transactions takes place not only in the fields of product quality and pricing, but also in attractive payment terms offered by the exporter to the foreign buyer. Extending credit to foreign customers can be seen as a crucial means of enhancing export competitiveness. Export financing is made up of a set of different instruments and techniques to grant delayed payment for the goods or services sold to the importer. Based on the credit period, the relevant export finance tool-kit divides into short-term export financing and medium/long-term export financing.
Short-term export financing refers to payment periods or loans with a duration of up to 12 months; in some cases the period is extended to 18 months, although no generally accepted strict dividing-line exists between short-term and medium/long-term export financing. The terms of payment stipulated in the export contract are crucial for all export financing activities. For international transactions, the four primary options, ranked from (1) very secure to (4) most risky from the exporter’s perspective, are (1) cash-in advance, (2) letters of credit, (3) documentary collections, and (4) open account.
Some of these instruments, such as letters of credit, include coverage against the risk of nonpayment or default by the foreign importer. In other cases, such as the open account-option, additional export insurance or guarantees are needed to maintain a secure export transaction. The term trade finance is alternatively used as a blanket term for the whole range of financial instruments provided by commercial banks to facilitate international transactions in goods and services.
In the case of export sales with an open account payment condition, export factoring is a further option. Factoring firms usually buy the exporter’s entire book of foreign trade receivables and pay out the relevant amount, deducting a discount. In a similar manner based on a transfer of title, forfaiting is used if the exporter sells promissory notes signed by the foreign buyer. Many forfaiters are ready to include political risks in discounting the promissory notes and to buy longer-term accounts receivable at deeper discounts.
The main purpose of medium/long-term export financing is to finance sales of capital goods with payment periods from one to five years (medium-term export financing), and even longer in the case of plant construction, infrastructure projects, and development activities. The applicable financial instruments can be differentiated into three approaches:
- Traditional export financing is structured as a supplier credit scheme. In the export contract the supplier extends credit to the foreign customer, usually by negotiating a down-payment and a series of installments, and then asks for a supplier credit at his commercial bank. In this case, the seller is in charge of all problems caused by nonpayment of the importer because both contracts—the export contract with the importer and the loan contract with his bank— are clearly separated. Therefore the exporter is well advised to buy insurance coverage against the various potential risks of the export transaction. Often, hedging all of these risks may be a pre-condition to receiving a loan from a commercial bank.
- In a quite different approach, the commercial bank negotiates the credit contract directly with the foreign importer, usually upon recommendation of the exporter. In a so-called buyer credit, the exporter is paid immediately by the commercial bank from the loan proceeds as soon as the exporter has duly fulfilled the export contract. From the exporter’s point of view, the entire deal is transformed into a cash transaction in which the bank assumes all of the risk connected with the deal.
- In specific cases of cash-generating projects,
international project financing technique is applied. In structuring the financial flows of a large construction project, loan agreements are closed between banks and a special purpose project company that owns all project assets and controls all cash-outflows from the operating earnings of the specific project. Examples include infrastructure projects such as toll motorways, toll bridges, or power plants frequently structured as a BOT contract (i.e., build, operate, transfer). A comparable result can be achieved by including countertrade in the export financing options: in product buy-back transactions, payment for the construction of a plant is (partly) effected by delivering goods produced by this plant to the exporter.
Government assistance programs and national export credit agencies (ECAs) providing guarantee programs and loans, especially to small and medium sized exporters, are another significant issue in the field of long-term export financing. These play a particularly important role in the case of political and economic instability in the buyer’s country. If the buyer is located in a developing country, multilateral development banks provide funding to firms in the private sector for investing in private projects in developing countries.
When working with the different techniques and structures presented in this article as the typical building blocks of export financing, and when using them to finance a particular international transaction, one will see that there is only a low degree of standardization in different operations. Each individual deal is characterized by its own specific requirements stemming from the business partner or from their country, from the credit period or from the contract details. In most cases, a customized approach is required to arrive at a solution for the financial aspects of the transaction that is acceptable for all participants. This flexibility is the real challenge in successful export financing.
- Barovick, “Outsourcing Export Financing,” World Trade (v.16, 2003);
- International Trade Centre UNCTAD/WTO, Finance for Trade (International Trade Centre UNCTAD/WTO, 2006);
- United States, Foreign Operations, Export Financing, and Related Programs Appropriations Bill, 2007: Report Together with Additional Views (to Accompany H.R. 5522) (U.S. G.P.O., 2006)
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