foreign trade - an introduction

Foreign Trade Trade Finance Chapter 01

Foreign TradeForeign Trade-MeaningBalance of TradeBalance of Payments-Meaning-AccountingForeign ContractsInternational Trade Agreement/InstitutionsMethods of Foreign TradeBanking FacilitiesRole & Objectives of Exim BankFree Port/Free Trade ZoneOff-Shore Banking OperationsEuropean Currency Unit


Introduction and Meaning

The foreign trade of a country refers to its import and export of merchandise from and to other countries under contract of sale. No country in world produces all the commodities it requires. The commodities which country produces in surplus, it exports, while those producing in deficit, it imports. In short, foreign trade refers to Exchange of goods and services between two or more different countries. Such trade is also known as International Trade.


Features and TypesForeign Trade is having following features.

Involvement of different monitory units.Imposition of restrictions in import and export. by various countries.Imposition of restrictions on release of foreign currencies existence of multiple regulation.

Foreign Trade is of 2 type:-a) Importb) Export


Features and Types

If the seller is abroad and the buyer is in the home country, exchange of goods between them is called Import.

If the seller is in home country and the purchaser is abroad, the Trade between them is called Export. A foreign trade can be further classified in to two according to visibility.

a) Visible b) Invisible.A trade which can seen i.e. exchange of goods,

merchandise is a visible trade. Where as, exchange of services between the purchaser and seller is invisible trade i.e. technical know-how, insurance etc.


DumpingWhen goods are sold in foreign market without

contract of sale it is known as dumping. The dumping has following types.1) Sporadic 2) Predatory 3) Persistent 4) Reverse dumping.

When manufacturer wants to dispose of goods in foreign market at low price, without harming its normal market, the dumping is sporadic.

To gain access in foreign market by selling goods at loss and to drive out the competitors refers to predatory dumping.

When a producer consistently sells at a lower price in one market than in another, it is called persistent dumping.

When manufacturer sells goods abroad at a higher price than at home, the practice followed is called reverse dumping.


Balance of Trade

Balance of trade refers to as the difference between a country’s import of merchandise and its exports thereof. This is also called the net difference between the value of commodities imported and exported. Balance of trade may be positive, surplus or negative deficit depending on situation of net position.

The positive, surplus position occur when export exceeds import and when import exceeds export the balance of trade is said to be deficit or negative.


Causes of Reduction/Enhancement in Balance of Trade

There are two main factors for variation in balance of trade position.

a) External Factors. b) Internal Factorsa)External Factors:

• The sudden rise in price of essential commodities like edible oil, drugs, medical equipments. Etc.

• Position of world• Wide inflation or recession.• Trade restrictions imposed by the developed countries

b) Internal Factors:• Domestic shortage of industrial and agricultural products.• Absence of high technology.• Inadequate knowledge of export market.• Neglect of export profitability.


Corrective Measures

To come out of unfavorable trade position, following corrective measures are required;

• Export Promotion: By keeping quality & price competitive

• Import Restriction: By imposing heavy tax & duty in import

• Finance: By borrowings overseas.• Monitory Measures: By putting restriction on bank’s

credit.• Fiscal Measures: By curtailing public expenditure• Devaluation: By devaluating country’s official rate of

exchange


Balance of Payment:- Meaning, Accounting

The balance of payment of a country refers to, a systematic record of all trade transactions, visible and invisible imports and exports during a given period. The balance of payment is a difference between international transfer of funds for a country’s imports and exports of goods and services for certain period. The accounting of balance of payment has two types viz. current account and capital account.

According to sec. 2(J) FEMA Act, 1999 Current Account includes private and government merchandise, invisible items like, Foreign trade, Services, Short term banking, etc.

While the capital account transactions includes private long and short-term assets, banking transactions and official loans, amortization, IMF and reserves and monetary gold contingent liabilities [sec. 2(e)]


Balance of Payment

The study of balance of payment can be summarized as below:Definition: The balance of payment of a country is a systematic record of all transactions between residents of that country and the residents of foreign countries during given period of time.Contents: It includes, Merchandise, visible and invisible trade, Errors and Omission to strike a balance between two sides of accounts.Use: The most important use is, it is guide for Government in framing it’s monetary, fiscal, exchange and other policies.


Balance of Payment

Broad Division: It is broadly divided into • Balance of payments on current account and• Balance of payments on capital account

Balances within the total: For the purpose of analysis the items are divided into five;a) Trade Balance b) Current Account Balancec) Basic Balance d) Net Liquidity Balance e) Official transaction Balance.


DisequilibriumIn balance of payments, debit and credit items

seldom balance. As a result, the balance of payment is either in surplus or in deficit. When a country happens to have a surplus balance in balance of payment over the years, inflows of foreign capital take place, for that the rates of interest are high and also there is confidence in the country’s currency. The confidence in country’s currency refers to no devaluation of that country’s currency is apprehended. When, on the other hand, a country has a deficit or unfavorable balance of payment its foreign exchange resources get depleted.


Correcting the DeficitAs said earlier, if country has an president deficit,

following corrective measures are to be taken by it’s Government •Import Curtail : When imports are restricted, the

position improves. But it has to be used wisely.

•Export Promotion :By way of packing credit facility, export bill purchase, insurance cover

etc.•Monetary Measures :By raising the (SLR) Statutory

Liquidity Ratio / or by open market operations by the Central Bank.


Correcting the Deficit

•Fiscal Measures : These relate to a government’s revenue and expenditure and include

budgeting for a surplus.

•Devaluation : This refers to a reduction by the government in the country’s official rate of exchange between it’s own currency and other currencies.


Foreign ContractsGoods are traded between two countries under contracts of

sale / purchase which contains price, mode of delivery etc. The foreign contracts can be studied by following points :•Mode of Delivery : The delivery may be actual or constructive. As the name suggest, actual delivery mean physical delivery of goods to buyer. In constructive type not the physical but the documents are handed over to the buyer. In foreign trade the delivery is always constructive.•Mode of Payment : Following are different types of payments :a) OD / DP : Payment on Demand/Payment against Documents.b) DA : Documents delivered after Acceptance through Bill of

Exchange.c) VP / CoD : Value Payable/ Cash on Delivery both these terms

related to post parcel delivery.


Foreign ContractsFreight and Insurance : In foreign trade in case of

freight and insurance certain abbreviations are used as:1. c.i.f. : Refers to the amount of insurance, freight are

included in invoice or contract of sale / purchase.2. c. & f. : Stands for cost and freight, mean that when

goods shipped under c.i.f. contract, freight should be prepaid.

3. f.o.b. : These letter stands for free on board. In this buyer names the vessel and specifies the date of delivery.

4. f.a.s. : This means free alongside ship and imply that seller is responsible for the delivery of goods within specific time.


International Trade InstitutionsFollowing chart represents some of the International Trade

Institutions / Agreements :Let’s look each of above in brief.

G.A.T.T.

ACU

Petro Dollars

OPEC

UNCTAD

EEC

International Trade

Agreements


G.A.T.T.G.A.T.T. is the abbreviation of the General

Agreement on Tariff and Trade, which was signed at Geneva by 23 countries in 1947, effective January 1948. It is a world organization designed to bring about maximum possible rate of growth in world trade by reducing tariff barriers among members countries. It believes in negotiation and throughout it, GATT works for reduction of barriers of trade. In 1967, the negotiation round called, Kennedy Round was the biggest ever tariff cutting deed. In September 1986, ministers of 100 countries got together in Uruguay and began 8th round of negotiation.


G.A.T.T.The round of talks concluded on 15th December,

1993. The concerned matters are :•Reducing specific trade barriers and improving market access.•Strengthening G.A.T.T. disciplines. •Trade Related Intellectual Property Rights (TRIPs).•Trade Related Investment Measures (TRIMs).•Trade in Service.

Mr. Arthur Dunkel, former Director General of G.A.T.T. submitted comprehensive document which is commonly known as, Dunkal Proposal on December 20th

1991. India signed this Pact on 15/4/1994 along with 124 other countries.


EEC and UNCTADThe European Economic Community (EEC) : The European community also referred as the European Common Market (ECM) come into being with Treaty of Rome in 1957, by six countries viz. France, Germany, Italy, Belgium, Holland and Luxembourg. The treaty provides free movement of goods, service and capital amongst member countries.United Nations Conference on Trade and development (UNCTAD) : This is a forum of the United Nations Organization, aiming at international economic co-operation in the areas of trade and aid. The UNCTAD is held every four years to seek ways to end disparities between the rich and poor nations. There have been so far four conferences. So for, the success of such meetings in achieving its objectives has been very limited.


OPEC & Petro DollarsOrganization of Petroleum Export Countries (OPEC) : The organization, which consist of Iraq, Iran, Saudi Arabia, UAR, Kuwait, Libya, Nigeria etc. aims at protecting the interest of the member countries by controlling the prices of petrol and petroleum products.Petro Dollars :The accumulation of currencies at the disposal of the oil exporting countries of Western Asia and other places, have been invested by the owner countries with American banks and / or in shares in multinational concerns in the U.S.A. Such deposits in dollars in the U.S.A. are referred to as oil or petro dollars.


Asian Clearing UnionAsian Clearing Union (ACU) : It was established on 9th

December 1947 by Reserve Bank of India, the Bangladesh Bank, the Bank Markazi of Iran, the Nepal Rastra Bank, the State Bank of Pakistan and the Central bank of Sri Lanka as the founder members. In April 1977, the union of Burma Bank joined the Union. It’s headquarters are at Teheran, Iran and its operations are conducted by Board of Directors and a manager. The objectives ofthis union are,•To facilitate payments for current international transactions within the ESCAP region.•To reduce / eliminate use of extra regional currencies to settle transactions by promoting the use of the participants currencies.•To contribute to the expansion of trade and promotion of monetary cooperation among the countries of the area.


ACU and IndiaSince 1984, all eligible payments between India

and other member countries except, Nepal, to be settled through the ACU. The payments excluded are as below :•Travel•Contracts made from an International Financial Institution like world bank.•Deferred payments facilities extended by one member country to another member country.Payments between India and Nepal are not eligible to be settled through ACU.


Benefits of ACU The advantages of ACU can be summarized as below :

Appreciable savings of the liquid foreign exchange reserves.Reduction of the working balances in the foreign exchange.Saving in the cost of settlement.Curtailment of the time needed before for settlement of transactions by the elimination of the intermediary correspondents in London or New York.


Euro MoneyIt is a monetary system of eleven European

countries, which started it’s functioning since January 1999. This is third strong currency after dollar (U.S.). This is the money against which there is neither gold banking nor any natural government. Some of the countries who’s joint efforts make this are, Italy, Germany, Belgium, Finland, Ireland etc. Other 5 mentioned nations not yet joined the Euro due to economic and political reasons are Great Britain, Denmark, Egypt, Sweden and France.


Conditions for Euro Money Agreement

Following are some of the conditions for this agreement :

The countries have to keep their Budget deficit, below 3% of G.D.P. i.e. Gross Domestic Product.

Countries should have government debts below 60% of GDP.

Inflation should not exceed 1.5%.

Rate of interest should not be more than 2%.


Foreign Trade : MethodsGoods may be traded or exchanged between

exporter and importer in any of the three ways :a)On Open Account Basis : Where the credit status of importer is high, the goods are sent direct to him in anticipation of payment in due course. Export on this basis is not permissible in India.b)Under Bill of Exchange : The exporter may draw bills of exchange on the importer for the value of the exports and collect the bills through bank.c)Under Letter of credit : The exporter may agree to export the goods only against a letter of credit opened in his favour.


Banking FacilitiesBanks can render assistance to Indian merchants

and manufacturers already engaged in or intending to enter in foreign markets in following ways :

• Bank can provide credit worthiness and status reports.• Bank can assist to Indian exporter who wish to go

abroad for export promotion, business tour etc.• Bankers can, when required provide the name, address

of foreign firms which may be interested in joint ventures in India.

• For importers bank can collect import bills drawn on them and arrange remittance.

• For exporters bank may render agency service.• Bankers also provide to importers and exporters

information about exchange control regulation, import license procedures to be followed etc.


Role of Exim BankExim Bank is short form of Export Import bank of

India. It is a public sector bank established on January 1st

1982 with authorised share capital of Rs.200 crores. The main objects of Exim Bank are :•Provide financial assistance to exporters.•Promoting foreign trade of India.•Coordinating the working of institutions engaged in financing export and import.•Assist Indian Joint Ventures in third world.•Concentrate on medium and long term finance.


Functions of Exim BankFollowing are some of the functions of Exim bank :

To provide financial assistance to exporters and importers.Granting loans and advances in and outside India.Refinancing usance export bills of banks.Granting obligation, jointly with banks on behalf of project exporters engaged in the execution of construction and turnkey contracts abroad.To act as a principal financial institution for coordinating the working of other institutions.


Objectives : Exim BankFollowing are some of the objectives which have

been setup before exim bank :

Granting loans and advances in India solely or jointly with commercial banks.

Granting loans and advances outside India.

Issuing bid-bonds and guarantees and other facilities in India or abroad.

Selling or discounting of export bills in the world market.

Maintaining of foreign currency accounts.


Objectives : Exim BankUndertaking and financing of research, surveys etc.

Providing technical, administrative and financial assistance.

Planning, promoting, developing and financing export oriented business, industries.

Financing export of machinery and equipment on lease basis.

Granting loans and advances to Indian joint Ventures abroad.


Supplier’s CreditIt is also called as seller’s credit, under this, funds

are provided on deferred payment terms to Indian exporters of plant, equipment and related services. This programme covers project export, which could be turnkey project or construction projects.

The credit is provided by Exim Bank in participation with commercial banks where individual contract value is not more than Rs.3 crores.

The exporter is required to submit the projected quarterly drawal of entire credit amount well in advance of it’s utilization. ECGC insures the exporters and in many cases additionally gives the guarantee to the negotiating bank.


Buyer’s CreditThis credit is extended by exim bank to buyers

abroad to enable them to import engineering goods and projects from India on deferred credit terms. This facility is to be secured by a letter of credit or bank guarantee or promissory note from government.

Exim Bank directly enter into an agreement with the overseas borrower outline the terms and conditions of the credit covering the export contract.


Facilities Provided by Exim BankFollowing are some of the facilities provided by

Exim Banks.Consultancy and Technology Services.Overseas Investment Financing Programme.Pre-shipment Credit.Export Oriented Units.Computer Software Exports.Export Marketing Fund.Export Product Development.Project Preparatory services.


Terms and ConditionsExim Bank has been operating a lending

programme subject to following terms and conditions :• The assistance may be direct or may be refinance to a

commercial bank.• Commercial banks lending for projects costing up to

Rs.2 crores are eligible for refinance.• The assistance rendered is usable for acquisition of

fixed asset.• No credit authorization from RBI or any reference to

IDBI is necessary.• The rate of interest is currently 9 % p.a.• The loan is repayable in 10 years including

moratorium period.


Free Port / Free Trade ZoneA free port is a port declared as such by the

government of the country where no quantitative restrictions on imports into or exports. A free port or a free trade zone is also conductive to entrepot trade i.e. imports not for domestic consumption but for re export.

In India, the idea of establishing free ports or free trade zones was first mooted in 1957 by the Export Promotion Committee. The object behind this was stimulation of exports.

At the moment there are two free trade zones in India, one at Kandla in Gujrat and other at Santa Cruz in Mumbai.

The electronic Export Processing Zone (EEPZ) at Santa Cruz, Mumbai has about 30 units set up in its area engaged in producing 100% export oriented electronic equipment.


Off-Shore BankingOff-shore banking is altogether new system of banking.

This system is operated through the off-shore banking units of overseas banks in under developed countries. The funds of an off-shore banking units are employed in financing capital intensive local projects or in turnkey projects undertaken by exporters of the host country. The profit made out of such banking operations maybe repatriated, usually tax free, to the parent bank.

Off-shore baking units are at present operating at Bahrain, Singapore, Hong Kong etc. There are 20 centers in world. The benefits to host country of such banking are as below :•Inflow of interest free foreign capital into the country.•Exemption from minimum reserve requirement.•License fees are generally low.•Close proximity to the important loan outlets or deposit sources .


IBU International Finance Ltd.

The first ever international financial organization sponsored by a corporation of Indian nationalized banks, such as Indian, Bank of Baroda and Union Bank of India. It was established in Hong Kong and started functioning in October 1980. This is a deposit taking organization with off-shore and other activities. The organization is eligible to accept deposits of Hong Kong dollars 50,000 and above.


ECUECU is abbreviation of European Currency Unit. It

has been recognized as a foreign currency officially by Italy, France, Belgium and Luxembourg and de facto by the United Kingdom, Eire, Netherlands and Denmark from January 2002. The EUC is a currency basket composed according to the ‘open basket’ formula of the eight EMS currencies plus sterling and Greek drachma.

There is also an inter-bank deposit market in ECU for ECU 10 billion or move for maturities up to one year or more. The ECU is quoted against U.S. dollars and cross rates are calculated against other currencies with very narrow spreads.

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