Economic Perspectives• Mercantilism – National self interest (win‐lose)• Structuralism – inequalities in global structure/Marxism (dependency theory)• Liberalism – Market forces/democracy (win‐win)
Basic Economic Principles• David Ricardo– Absolute Advantage – Comparative Advantage• Heckscher–Ohlin– A capital‐abundant country will export the capital‐intensive good– labor‐abundant country will export the labor‐intensive good
Example: Comparative AdvantageThink of two countries that both make cards and pencils and use the same amount of time to make one unit of items. Country one can make 4 pencils if they specialize just in pencils at the expense of one card, but this country can also make ¼ of a card at the expense of one pencil. If country two makes only pencils, it will make 2 pencils at the expense of 1 card. If country two specializes only in cards, it will make ½ of a card at the expense of a pencil. Country one has a comparative advantage in pencils over country two (4 pencils to 2 pencils), whereas, country two has a comparative advantage in cards over country one (½ of a card to ¼ of a card). In Ricardos idea of comparative advantage, these two countries should specialize in what they do best. Source: http://en.wikipedia.org/wiki/Ricardian_economics
International Organizations• Bretton‐Woods Institutions (created to provide stability to the international monetary system)– International Monetary Fund (IMF) – International Bank for Reconstruction and Development (IBRD) – Now the World Bank Group• United Nations (replaced League of Nations)• General Agreement of Tariffs and Trade (GATT) –Now the World Trade Organization (1994 Uruguay Round)
Balance of Payments• Accounting record of all monetary transactions (goods, services, and financial assets) between a country’s residents and the rest of the world during a given period of time. – Private transactions (individuals and business firms)– Official transactions (government transactions)• BOP = CA + KA = 0
BOP Account Categories• Current Accounts – Merchandise Trade– Service Trade – Services of Capital: Interest Incomes, Dividends– Unilateral Current Transfers • Capital Accounts – U.S. private investments abroad – Foreign private investments in the US – Other investments/capital transactions• Official Accounts – (Changes in) US official reserve assets abroad: gold, SDRs, foreign currencies – (Changes in) foreign official assets in the US
GNP Vs. GDP• Gross National Product: Measures the output generated by a countrys enterprises (physically located domestically and abroad).• Gross Domestic Product: Measures the total output produced within a countrys borders ‐ whether produced by that countrys own firms or not.GDP is more commonly used when measuring a country’s economy.
Gross Domestic ProductGDP = C + I + G + (X—M)GDP = Gross Domestic ProductC = private consumptionI = gross investmentG = government spendingX = ExportsM = Imports
Real Exchange Rates• The purchasing power of a currency relative to another• Purchasing Power Parity (general price level)• Law of One Price (individual commodities)The following table, based on data from The Economists 2004calculations, shows the under (-) and over (+) valuation of the localcurrency against the dollar in %, according to the Starbucks tall latteindex and the Big Mac index.
Currency• Appreciation vs. Depreciation• Hard vs. Soft Currency• Triangular Arbitrage
Black vs. Gray Markets• Black market products are illegal (counterfeit) and outside the official economy (not paying taxes)• Gray market products are not illegal but violate written and/or unwritten agreements (unauthorized distribution channels)
Payment Methods• Methods of Payment in International Trade• Cash-in-Advance• Letters of Credit• Documentary Collections• Open Account• Consignment• Export Working Capital Financing• Government-Guaranteed Export Working CapitalLoan Programs• Export Credit Insurance• Export Factoring• Forfaiting• Government-Assisted Foreign Buyer Financing• Government-Backed Agricultural Export Financing• Foreign Exchange Risk Management
Cash in Advance• No risk to seller, very high risk to buyer.• Cost and ease of payment is low for both parties• Methods: wire transfer, credit cards and checks
Export Finance Tools• Letters of Credit: – Commercial Letters of Credit – Standby Letters of Credit • Documentary Collections • Financing: – Direct Bank Financing – Bankers’ Acceptances (BA) – Trade Acceptances – Ex‐Im Bank Working Capital Guarantee Program (WCGP) – Private Insurance – Private Export Funding Corporation (PEFCO)
Letters of Credit• Involves banks as an active party• Documents are exchanged for payment• Banks make determination to pay• Good for:– New Buyers– Mitigating certain risks– Buyer financing options
Letter of Credit• Standard credits– Revocable vs. irrevocable– Confirmed vs. unconfirmed• Specialized credits– Revolving – Standby • performance • financial– Transferable– Back‐to‐back– Assignment of Proceeds
L/C Flow5. Ship the Goods1. Contract SignedBuyer’s Bank (Issuing Bank)11. Release Documents10. Make Payment2. Apply for L/CImporter (Buyer)4. Advise L/C6. Submit DocumentsSeller’s Bank (Advising Bank)(Confirms L/C)Exporter(Seller)8. Payment / Acceptance7. Send the Documents9. Make Payment3. Issue the L/C
Documentary Collection• Banks facilitate, but not active parties– Buyer credit issues remain• Documents exchanged for payment– Buyer makes determination to pay, not bank• Good for:– Smaller amounts– Established relationships
Documentary Collections• Documents Against Payment (D/P)– Bank releases documents to the buyer/importer only against a cash payment in a prescribed currency• Documents Against Acceptance (D/A)– Bank releases the documents to the buyer/importer against acceptance of a bill of exchange (draft) guaranteeing payment at a later date.
Bill of Exchange• Sight Draft– Payment effected when complying documents are presented (documents must be correct)– May or may not occur immediately• Time Draft– Payable at a future fixed date (e.g 30, 60, 90 days)• Bankers Acceptance‐short term financing ‐30 to 180 days• Deferred Payment‐Like an acceptance, but with no draft
Bankers Acceptance• Draft must show: – Tenor (90 days sight)– Payee (ABC Company) – Drawee (Bank One)– Date – Amount – Signature – Endorsement (on back)
Bankers Acceptance Advantages• Creates U.S. receivable from U.S. Bank – No foreign risk• Sales tool– Allows buyer to finance at U.S. rates; Buyer has choice of terms (sight or time)• Cost can be fixed prior to quote (no surprises)• Cash management tool– B/A is a negotiable instrument– Can be used for funding/cash‐flow
Society for Worldwide Interbank Financial Telecommunication (SWIFT)• Worldwide financial messaging network which exchanges messages between banks and other financial institutions; Promotes common language for international financial transactions• Main format for L/C
Uniform Customs and Practice for Documentary Credits (UCP)• Private rules (not law) on the issuance & use of L/Cs• UCP 600: The latest revision by the ICCs Commission on Banking Technique and Practice• eUCP: UCP supplement for electronic commerce
Open Account• Used in ongoing relationships between buyer and seller where trust and creditworthiness is established• Seller might set credit limit for experienced buyers• Risk to seller is potentially very high, risk to buyer is very low• Costs are very low for both parties
Factoring• Selling receivable to a third party for cash• Requires detailed coordination, sometimes to extremes (two negotiations vs. one)• Can be either recourse or non‐recourse back to seller• Generally for receivables with 90 day or less tenor (time left for loan repayment)
Forfaiting• Selling receivable to a third party for cash• Requires detailed coordination, sometimes to extremes (two negotiations vs. one)• Can be either recourse or non‐recourse back to seller• Generally requires foreign bank avalization• Tenors typically range from 90 days to 7 years
Refinancing• Seller paid at sight• Refinancing transparent to seller• Arranged as bank‐to‐bank or bank‐to‐buyer• Terms are generally 30‐180 days
Consignment• Delivery of merchandise from an exporter (the consignor) to an agent (the consignee) under agreement that the agent sell the merchandise for the account of the exporter. • The consignor retains title to the goods until sold. The consignee sells the goods for commission and remits the net proceeds to the consignor.
Countertrade• Exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money• Includes barter, buy‐back or compensation, counter purchase, offset requirements, swap, switch, or triangular trade, evidence or clearing accounts
USG Finance Programs• Small Business Administration (SBA)• Export‐Import (Ex‐Im) Bank of the United States• Foreign Agricultural Service (FAS), USDA– GSM 102– GSM 103• Trade Development Agency (TDA)• Overseas Private Investment Corporation (OPIC)
USG Pre‐shipment Export Finance• Ex‐Im Bank Working Capital Guarantee Program (WCGP) – Working capital loans backed by Ex‐Im Bank guarantee (90% of loan amount, including principal and interest). Enables U.S. exporters (large and small) to facilitate the export of goods and services. • SBA Export Working Capital Program (EWCP)– Working capital loans for small businesses backed by SBA guarantee (guarantees repayment of up to $1.5 million or 90% of loan amount, whichever is less). Similar to the Ex‐Im Bank WCGP, however, no U.S. content or military/defense product and service restrictions.
USG Post‐shipment Export Finance• Short‐term: Accounts receivable insurance – Up to 180 days • Medium term: Financing– Finance foreign buyers purchasing US capital equipment– Up to 5 yrs • Long term: Financing– Buyer financing of very large object (aircrafts) and projects– > 10 million USD– > 5 yrs repayment terms
USG Restrictions• ExIm Bank– No military exports– Foreign content (must be 51% U.S. content+)– Restricted countries and “arms length”– Economic impact (adverse impact analysis)– Shipping (must ship on US registered vessels)– Environmental impacts• SBA– Up to 500 employees (can vary by NAICS)– No foreign content limitations or military sales– Insurance requirements
Export Credit Insurance• Also known as Foreign Receivables Insurance• Offers the ability to eliminate most foreign accounts receivable risk by obtaining insurance against that risk (political & commercial)• ExIm Bank: leading provider of insurance for U.S. companies with at least 50% U.S. content• Private Company option for those that don’t meet the U.S. content requirements
Export Credit Insurance Applicability• Recommended for use in conjunction with O/A terms and export working capital financing• Pros– Reduces the risk of non‐payment by foreign buyers – Offer open account terms safely in the global market• Cons – Cost of obtaining and maintaining an insurance policy – Risk sharing in the form of a deductible (coverage is usually below 100%)
Exchange Rates• Spot exchange rate (current)– Settlement is 1 or 2 business days from trade date. • Forward exchange rate – An exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
Hedging• “Insurance” to reduce FX exposure• Derivatives– Options– Futures (forward contracts)
Transfer Pricing• Charges made between related parties• Tax implications (use “arms‐length” principle)– Based on analysis of pricing in comparable transactions between two or more unrelated parties dealing at arm’s length
Trade Finance Resources• Country Limitations Schedule• Lenders List– Export Working Capital Guarantee• Licensed Insurance Brokers– Export Credit Insurance• International Credit Reports
International Pricing• Cost‐plus method vs. Marginal‐cost method• Additional export expenses:– Packaging– Foreign market research– Advertising/marketing– Translation– Consulting/legal fees– Foreign distributor product information and training– After‐sales service costs
International Credit Report Providers (sampling)• Dun & Bradstreet Information Services• Coface North America• Graydon Credit Management Services• Kreller Group International• Credit Risk Monitor• Owens OnLine, Inc. • Standard and Poor’s Compustat• Veritas Credit
Export Tax Credit Programs• Federal IC‐DISC• Federal R&D• State R&D