Export Financing Essay

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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:

  1. 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.
  2. 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.
  3. 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.

Bibliography:   

  1. Barovick, “Outsourcing Export Financing,” World Trade (v.16, 2003);
  2. International Trade Centre UNCTAD/WTO, Finance for Trade  (International Trade Centre UNCTAD/WTO, 2006);
  3. 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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