CHAPTER 7

International Trade Finance and Promotion

INTRODUCTION

International trade is an important aspect of global business. This chapter explores various aspects of finance for international trade.

There are two major issues in the process of the financing of international trade:

1. The methods of payment used, and
2. The sources of finance for the exporter.

INTERNATIONAL TRADE PAYMENT

There are four main modes of payment used in international trade—cash in advance, letter of credit (L/C), documentary collection, and open account terms. The risk of bad debts for the exporter increases along this sequence.

Cash in Advance

Cash in advance refers to the payment that is received either before shipment or upon the arrival of the goods. It is a desired mode of payment in the following situations:

 

• The credit standing of the buyer is not known or is uncertain.
• The buyer belongs to a country that has political or economic instability.
• It is also used where the production needs a huge initial capital investment specifically for the product under contract.

However, buyers are usually reluctant to use this mode of payment because it blocks a large amount of their working capital till sale of goods takes place. The method is popular only where there is an order for custom-made goods.

Letter of Credit (L/C)

The letter of credit (L/C) is the most commonly used payment method in international trade. The L/C is a document of commitment made by the bank on behalf of its customer (the importer) in which the bank promises to honour its customer’s commitment to pay. It is a letter addressed to the seller, written and signed by a bank acting on behalf of the buyer, in which the bank promises to honour drafts drawn on itself if the seller meets the specific conditions that are given in the letter of credit. These conditions are usually the same as contained in an export contract or sales agreement.

 

An L/C has the following advantages for an exporter:

• It eliminates credit risk arising out of non-payment and reduces the risk of delayed payment due to exchange controls or other political reasons.
• It reduces uncertainty for the exporter as all requirements for payment are clearly given in the L/C itself.
• It helps to stabilize production for the exporter who has the assurance of payment even if the contract is cancelled for some reason.
• It is a safe and assured source of export financing if the L/C is irrevocable and confirmed.

An L/C has the following advantages for an importer:

• The L/C issuance often requires an importer to pre-deposit or have a saving account in the issuing bank.
• The importer is assured of the goods having actually been loaded on the ship and of their quality and quantity being in accordance with regulations.
• Any discrepancies in documentation are the responsibility of the bank, especially in the case of commercial L/Cs, for which banks deal in documents and not in goods.
• The L/C increases the importer’s bargaining power, and allows the importer to ask for a price reduction from the exporter.

Types of L/Cs

There are several types of L/Cs:

• Documentary L/Cs: They are issued in connection with commercial transactions. For this, the exporter must submit, together with the draft, any necessary invoices and other documents such as the custom invoice, certificate of commodity inspection, packing list and certificate of country of origin.
• Clean L/Cs: They are those which do not require any documents. A clean L/C may be used for overseas bank guarantees, escrow arrangements, and security purchases.
• Revocable L/Cs: These documents can be revoked or taken back without notice at any time up to the moment a draft is presented to the issuing bank. They do not carry any guarantee with them.
• Irrevocable L/Cs: They cannot be revoked without the specific permission of all parties concerned, including the exporter. Most credits between unrelated parties are irrevocable.
• Confirmed L/Cs: They are issued by one bank and confirmed by another, making it obligatory for both banks to honour any drafts drawn in compliance.
• Unconfirmed L/Cs: They are obligations of only the issuing bank. Naturally, an exporter will prefer an irrevocable letter of credit by the importer’s bank with confirmation by another (domestic or foreign) bank.
• Transferable L/Cs: They are those under which the beneficiary has the right to instruct the paying bank to make the credit available to one or more secondary beneficiaries. No L/C is transferable unless specifically authorized and it can be transferred only once. The stipulated documents are transferred along with the L/C. In effect, the exporter is the intermediary in a transferable credit, and usually has the credit transferred to one or more of its own suppliers. When the credit is transferred, the exporter is actually using the creditworthiness of the opening bank, thus avoiding having to borrow or use its own funds to buy the goods from its own suppliers.
• Back-to-back L/Cs: These documents are used simultaneously or together where the exporter, as beneficiary of the first L/C, offers their credit as security in order to finance the opening of a second credit. He may do this in favor of his own supplier of goods needed for shipment under the first or original credit from the advising bank. The bank that issues a back-to-back L/C not only assumes the exporter’s risk but also the risk of the bank issuing the primary L/C. If the exporter is unable to produce documents or the documents contain discrepancies, the bank issuing the back-to-back L/C may be unable to obtain payment under the credit because the importer is not obligated to accept discrepant documents of the ultimate supplier under the back-to-back L/C. Thus, many banks are reluctant to issue this type of L/C.
• Revolving L/Cs: They exist where the tenor (maturity) or amount of the L/C is automatically renewed as a result of the of terms and conditions contained in them. An L/C with a revolving maturity may be either cumulative or non-cumulative. When cumulative, any amount not utilized during a given period may be applied or added to a later period. If non-cumulative, any unused amount is simply no longer available. If a revolving L/C is used, it must be clearly stated so in the export contract.

Documentary Collection

Documentary collection is a method of payment under which the exporter retains ownership of the goods until payment is received or he is certain that it will be received. In this method of payment, the bank, acting as the exporter’s agent, regulates the timing and sequence of the exchange of goods by holding the title documents until the importer either pays the draft, termed documents against payment (D/P), or accepts the obligation to do so, termed documents against acceptance (D/A).

 

The two principal documents used in the process of documentary collections are a draft and a bill of lading (B/L).

1. The draft is a document written by the drawer (exporter) to the drawee (importer) and requires payment of a fixed amount at a specific date to the payee (usually the exporter himself). A draft is a negotiable instrument that normally needs to be physically presented as a condition for payment. A draft may be either a sight draft (payable upon presentation) or a time draft (payable on a specified future date).
2. A bill of lading is a document of title of the goods being shipped along with the documents for shipment and the carrier’s receipt for the goods being shipped. A sight draft is commonly used for D/P payment. However, for export sales that take several months in ocean transportation, exporters and importers may agree to use D/P of 30, 60, 90 or 180 days.

In practice, D/A are usually accompanied by a time draft ranging from 30 days up to perhaps two years, which is why time draft-based collections are also viewed as an important commercial or corporate financing approach that is granted by the exporter to the importer. The disadvantage of this method of financing is the high risk of receivable collection for the exporter. D/A is a riskier collection method than D/P because the importer can claim the title of goods under the ‘promise’ of payment rather than actual payment. For this reason, most bad debts accumulated in international trade have been transactions that used D/A as terms of payment.

Open Account

Under this method of payment, goods to be sold are first shipped and the importer is billed for them later. The method can be used only if the customer is reliable, as there is no guarantee of payment from the buyer and all risk is borne by the seller. Very often exporters who prefer less risky modes of payment lose business to competitors. Large global firms such as Mercedes Benz prefer to use the open account method as against the more expensive letters of credit. In recent years, open account sales have increased because of the increase in international trade, more accurate credit information about importers, and the greater familiarity with exporting in general.

TERMS OF TRADE

It is important for a firm to know the basic terms of trade in use for international trade. These are different from terms used in the domestic markets. The International Chamber of Commerce (ICC) issues INCOTERMS as standard terms of usage in international trade. The prominent terms of common usage are listed here.

Free on Board (FOB)

A price quotation in which the seller covers all costs and risks up to the point whereby the goods are delivered on board the ship in a designated shipment (export) port, and the buyer bears all costs and risks from that point on. This means that the buyer is responsible for the insurance and freight expenses in transporting goods from the shipment port to the destination port.

Free Alongside Ship (FAS)

A price quotation in which the seller covers all costs and risks up to the ship at the designated shipment (export) port. The buyer bears all costs and risks thereafter, including the loading of goods.

Cost, Insurance and Freight (CIF)

A price quotation in which the seller covers cost of the goods, insurance and all transportation and miscellaneous charges to the final destination port in a foreign country.

Cost and Freight (CFR)

This price quotation is similar to CIF, except that the buyer purchases the insurance—either because it can be obtained at a lower cost or because the buyer’s government insists on using local insurance to save foreign exchange. CIF and the Cost and Freight method are convenient for foreign buyers, since, they only have to add import duties, landing charges and freight charges to the original cost.

Delivered at Frontier (DAF)

This is a pricing quotation where the seller’s obligations are met when goods reach the border and are cleared for export. The buyer is responsible to arrange for goods to be picked by a forwarding agent after they have been cleared for export.

INTERNATIONAL TRADE FINANCE

External sources of export financing include both private sources and governmental sources. These sources offer different types of financing for exporters.

Private Sources

Private sources of trade financing include commercial banks, export finance companies, factoring houses, forfeit houses, international leasing companies, in-house finance companies and private insurance companies.

Bank Finance

Banks as a source of trade credit play an important role in the world of global finance in several different ways. Commercial bank financing for foreign trade business includes bank guarantees, bank line of credit and buyer credit.

 

• A bank guarantee is a financial instrument that guarantees a specified sum of payment to either the exporter or importer. Apart from regular bank guarantees, there are three other types of guarantees used in international trade. These include:
  • The loan guarantee, in which a loan is granted on the condition of security provided by the borrower.
  • A distraint guarantee, which helps a debtor to recover his seized assets;
  • A bill of lading guarantee, which ensures that the carrier will hand over the goods to the consignee when individual bills of lading are lost.
• A bank line of credit is a sum of money allocated to an exporter by a bank to finance its export business. This could also be meant to finance a specific export transaction from the foreign customer’s side, and allows the exporter to extend competitive credit terms to foreign customers.
• Buyer credit refers to credit extended by one or more financial institutions in the exporter’s country. This form of finance is mostly used to finance capital equipment purchases, but other goods with payment terms of up to one year can also be financed by buyer credits. Buyer credits are normally arranged under an export credit insurance programme.

Export Factoring

Export factoring is particularly suited for small and medium-sized exporters as it enables them to be more competitive by selling on open account rather than using more costly methods such as letters of credit. It involves the sale of export accounts receivable to a third party that assumes the credit risk. This technique can be used through factoring houses that not only provide financing but also perform credit investigations, guarantee commercial and political risks, assume collection responsibilities, and finance accounts receivables. In addition, these houses can perform such services as letters of credit, term loans, marketing assistance, and all other necessary services a small-to-medium-sized exporter cannot afford to handle. Often, a factoring house’s service charges are quoted on a commission basis. Commissions can range anywhere between 1 and 3 per cent of total transaction value. While factoring is a well-known export financing technique in the US, forfaiting has been widely used for export financing in Europe.

 

Forfaiting

This term is derived from the French term a forfeit. Forfaiting refers to purchasing an account receivable where the credit term exceeds the permissible limit for factoring. It is a transaction in which an exporter transfers responsibility of commercial and political risks for the collection of a trade-related debt to a forfaiter (often a financial institution), and in turn receives immediate cash after the deduction of its interest charge (the discount). The purchase of obligations arising out of the sale of goods and services where payment is due beyond the 90 to 180 days is covered in a factoring agreement.

 

The forfait market has two segments—a primary and secondary market. The primary market consists of banks and forfait houses that buy properly executed and documented debt obligations directly from exporters. The secondary market consists of trading these forfait debt obligations among themselves.

In general, a forfait financing transaction involves at least four parties to the transaction: an exporter, the forfaiter, the importer and the importer’s guarantor. The financial instruments in forfaiting are usually time drafts or bills of exchange and promissory notes. Forfaiting is used to finance the export of capital equipment where transactions are usually medium term (that is, three to eight years) at fixed-rate financing. The discount used by the forfaiter is based on its cost of funds plus a premium, which can range anywhere from 0.5 to 5 per cent, depending on the country of importation and level of risks involved.

Banker’s Acceptance

The banker’s acceptance (BA) is a time draft drawn on and accepted by one bank on another one. It is a method of inter-bank financing in which one branch is the financier and the other is the investor. The bank first creates the BA by accepting a draft presented by its customer (that is, the drawer), which it then discounts (it pays the drawer a sum less than the face value of the draft), and resells the BA to an investor in the acceptance market. A banker’s acceptance is a time draft (30, 60, 90 to 180 days after sight or date) drawn on and accepted by a bank. The fee charged by the accepting bank varies depending on the maturity of the draft as well as the creditworthiness of the borrower. BA is mainly used for the export trade in raw materials, components and general commodity financing. A deep, secondary market for bankers acceptances combined with the lack of reserve requirements often enables the bank to obtain funding for eligible transactions at a cost significantly lower than alternative sources.

 

Corporate Guarantee

A corporate guarantee is a method of finance where one company undertakes to pay the principal debts of another corporate house. The method is used when creditors ask the corporate or parent company to guarantee an obligation of one or more of its overseas subsidiaries or offshore affiliates that the creditor may consider not creditworthy for the export-related financing or credit limit.

 

Government Sources

Government sources of trade finance include export–import bank financing and foreign credit insurance.

Export–Import Bank Financing

Many countries have put in place export–import financing programmes to provide finance for exports, imports and overseas investments. The loans are low-cost for a medium-to-long-term period arranged in collaboration with larger commercial banks throughout the world. Their purpose is to encourage the export of capital goods and services, overseas investment, and major resource development. For example, South Korea’s Exim Bank offers such services as direct lending to both suppliers and buyers, re-lending facilities to foreign financial institutions, and the issuance of guarantees and export insurance.

In the US, the primary function of its Exim Bank is to give US exporters the necessary financial backing to compete in other countries. Today this is done through a variety of different export financing and guarantee programmes (for example, direct loans, discount loans, guarantees and export credit insurance) to meet specific needs. All these measures are designed to directly support US exports, whether the eventual recipient of the loans or guarantees are foreign or domestic firms. Generally, export–import banks do not compete with private sources of export financing. Their main purpose is to step in where private credit is not available in sufficiently large amounts at low rates or long terms to allow home country exporters to compete in a foreign market.

Foreign Credit Insurance

Many industrialized and developing countries have set up foreign credit insurance or guarantee programmes to assist their exporting companies. These programmes are usually run by and are dependent on the government. In the Unites States, such insurance programmes are offered by both Exim Bank and the Foreign Credit Insurance Association. In Canada, these services are provided by Export Credits Insurance Corporation (ECIC). In Asia, Japan’s International Trade Bureau (Export Insurance Section), Hong Kong’s Export Credit Insurance Corporation, India’s Export Credit and Guarantee Corporation Ltd, and Taiwan’s Central Trust of China all offer such programmes. In Latin America, similar programmes can be found, including in Compagnie Argentina de Seguros de Credito a la Exportacion in Argentina and Instituto de Resseguros do Brasil in Brazil.

Europe has an even longer history in providing export credit insurance. Les Assurances du Credit in Belgium, Export Credit Council in Denmark, Finnish Guarantee Board in Finland, Compagnie Francaise D’Assurance pour le Commerce Exterieur in France, Hermes Kreditversicherungs in Germany, and Istituto Nazionale delle Assicurazioni in Italy, for example, are all leading institutions offering foreign credit insurance and backed by their respective governments.

INTERNATIONAL TRADE CREDIT

The time lag between receipt of an order and receipt of actual payment makes the exporter look for different sources of credit. He needs credit for expenses on purchase of materials and components, processing, packageing and warehousing among various other kinds of cost.

Very often he has to extend credit to his overseas buyer and arrange for credit during this period. In order to meet these credit needs of the exporter, there are provisions for both pre-shipment and post-shipment credit.

• Pre-shipment credit is extended to enable the exporter to meet his working capital requirements for the purchase of raw materials and components, processing, packing, transportation and warehousing. It is a form of short-term finance and may be given in advance against an export order. In India, commercial banks who are members of the Foreign Exchange Dealers Association extend this form of credit under the Packing Credit Scheme of the Reserve Bank of India.
• Post-shipment credit is provided to the exporter to enable him to extend credit to his buyers in the international market. It therefore acts as an export promotion measure that enhances the exporter’s competitiveness. Post-shipment credit could be extended as buyer’s credit or as a line of credit.

Under the buyer’s credit system, an overseas buyer gets credit from either one financial institution or a consortium of financial institutions. This enables him to pay for the goods he imports without any actual transfer of funds taking place. The exporter may obtain the payment directly from the bank on presentation of relevant export documents. Buyer’s credit is generally advanced for capital goods.

In a situation where the exporter has several buyers, the financial institution in the home country extends a line of credit to another institution instead of dealing with each buyer separately. The credit is disbursed through the host country institution to the parties involved. This not only saves time in having to deal with individual buyers, it also puts the onus of judging the creditworthiness of the buyers on the home country institution.

TRADE PROMOTION IN INDIA

Foreign trade in India has been a regulated activity aimed at the conservation of scarce foreign exchange for necessary imports and achieving self-reliance in the production of as many goods as possible. India’s trade policy can be divided into five distinct phases.

1. The first phase from 1947 to 1948 saw restrictions on both imports and exports and was a continuation of wartime controls on trade, since there was a restriction on the use of sterling balances by the United Kingdom. The adverse balance of payments position also led to a devaluation of the rupee in 1949.
2. Liberalization of foreign trade was adopted as a goal of trade policy in the second phase from 1952–53 to 1956–57. Exports were encouraged by relaxing export controls, reducing export duties, abolishing export quotas, and providing export incentives. Import licences were also granted liberally, and led to a considerable increase in the import volume, but exports did not show much improvement. As a result, the foreign exchange reserves declined sharply and trade policy had to be reversed.
3. The third phase began in 1956–57, during which trade policy was re-oriented to meet the requirements of planned economic development. Import policy was very restrictive and import controls were used to further prune the list of imported goods. A vigorous export promotion drive was launched on the assumption that the balance of payments problem would be solved only through export promotion and diversification. It focused on expansion of traditional items of trade and the simultaneous addition of new ones, and on establishing import-substituting industries as well.
4. The fourth phase began after the devaluation of the rupee in 1966, which became necessary on account of a deteriorating balance of payments position. Despite implementation of the recommendations of the Mudaliar Committee, such as increased allocation of raw materials to export-oriented industries, income tax relief on export earnings, export promotion through import entitlement, removal of disincentives, and the establishment of an Export Promotion Advisory Council and a Ministry of International Trade, the balance of payments position continued to decline. The Government continued with a policy of import liberalization and export promotion in the period 1975–76 and followed it up with a revised policy in 1985 based on the recommendations of the Abid Husain Committee.
5. During the fifth phase, the Government adopted an overhauled trade policy in the wake of the programme of economic reform and liberalization adopted in 1991. This was the new trade policy of 1991. It was based on the rationale of reduced control and licences to be replaced by decontrol and opening up. Over a period of time, this has led to a change in the nature and volume of exports and imports accompanied by major changes in industrialization and foreign investment policy as well. The latest Indian trade policy has been announced for the period 2015–20. Salient features of the policy have been highlighted in the opening case of this chapter.

Organizations for Export Promotion

In order to help in exports, the Government established or sponsored a number of organizations to provide different types of assistance to exporters. At the helm of affairs is the Ministry of Commerce, which looks into various aspects of trade promotion and regulation.

The various autonomous bodies for export promotion and their functions are discussed here:

• The Export Inspection Council is a statutory body, responsible for the enforcement of quality control and compulsory pre-shipment inspection of various exportable commodities.
• The Indian Institute of Foreign Trade is engaged in activities like training of personnel in modern techniques of international trade; organization of research in problems of foreign trade; organization of marketing research, area surveys, commodity surveys and market surveys; and dissemination of information arising from its activities relating to research and market studies.
• The Indian Institute of Packaging undertakes research on raw materials and organizes training programmes for the packageing industry.
• Export Promotion Councils work for both advisory and executive functions under the Ministry of Commerce.
• Commodity Boards have been set up for the promotion, development, and export of commodities, such as spices, coir, and tea.
• The Export Development Authority looks into the promotion of various other commodities not under the earlier Boards. The Marine Products Export Development Authority (MPEDA) is responsible for the development of the marine products industry with special reference to exports. The Agricultural and Processed Food Products Export Development Authority, set up in 1986, serves as the focal point for agricultural exports, particularly the marketing of processed foods in value-added forms.
• The Federation of Indian Export Organizations (FIEO) is an apex body of various export promotion Organizations and institutions. It also functions as a primary servicing agency to provide integrated assistance to government-recognized export houses and as a central coordinating agency with respect to export promotion efforts in the field of consultancy services in the country.
• The Indian Council of Arbitration, set up under the Societies Registration Act, promotes arbitration as a means of settling commercial disputes and popularizes arbitration among traders particularly those engaged in international trade.

Export Incentives

Export incentives are a widely employed strategy of export promotion aimed at increasing the profitability of export. Some of these incentives are discussed here:

• The duty exemption/drawback scheme aims to compensate the exporter for the increase in cost borne by him on account of customs and excise duties. Duty exemption as an export promotion measure had its origin in India during the second five-year plan. Under this scheme, exporters are either exempted from the payment of duty while procuring inputs like raw materials and intermediates or, in cases where the duty is paid on the inputs, the duty is refunded. There are two types of drawback rates—an all industry rate applicable to a group of products and a band rate applicable to individual products not covered by the industry rate.
• The cash compensatory support (CCS) was a cash subsidy scheme designed to compensate exporters for un-rebated indirect taxes and to provide resources for product/market development. The CCS enabled the exporters to increase the profit or to reduce the price to the extent of the subsidy without incurring a loss. With the devaluation of the rupee in July 1991, the CCS was abolished.
• Another important incentive was the system of import replenishment (REP) licences, which were related to the free on board (FOB) value of exports. The REP was, for the most part, a facility that enabled exporters to import inputs where the domestic substitutes were not adequate in terms of price, quality, or delivery rates; it was also an incentive in so far as there was a premium on REP licences, which were transferable. The new trade policy of July 1991, renamed it the Exim scrip scheme. However, it was abolished with the introduction of the partial convertibility of the rupee since April 1992.
• The international price reimbursement scheme (IPRS) was designed to make available specified inputs to exporters at international prices. The scheme which was initially available to steel was later extended to aluminium, and there was also a proposal to extend to other items. The IPRS has been replaced by the engineering products exports (replenishment of iron and steel intermediates) scheme.

Marketing Assistance

A number of steps have been taken to assist exporters in their marketing effort. These include conducting, sponsoring or otherwise assisting market surveys and research; collection, storage and dissemination of marketing information; organizing and facilitating participation in international trade fairs and exhibitions; credit and insurance facilities; release of foreign exchange for export marketing activities; assistance in export procedures; quality control and pre-shipment inspection; identifying markets and products with export potential; and helping buyer-seller interaction. Some of the schemes and facilities which assist export marketing are mentioned here.

Market Development Assistance

An important export promotion measure taken by the Government is the institution of market development assistance (MDA). Assistance under the MDA is available for market and commodity researchers; trade delegations and study teams; participation in trade fairs and exhibitions; establishment of offices and branches in foreign countries; and grants-in-aid to Export Promotion Councils (EPCs) and other approved Organizations for export promotion on export credit by commercial banks. Approved cooperative banks also enjoy a subsidy out of the MDA. Most of the MDA expenditure in the past was absorbed by the CCS. The CCS helped the exporters to increase the price competitiveness of Indian products in foreign markets.

Market Access Initiative

In 2001, the Government announced the launching of the market access initiative scheme for undertaking marketing promotion efforts abroad on a country-product focus approach basis. This scheme is in line with market promotion and development schemes being implemented by many other countries. The Exim policy, 2002–07, further broadened the scope of this scheme to include activities considered necessary for focused market promotion efforts.

Foreign Exchange

Foreign exchange is released for undertaking approved market development activities, such as participation in trade fairs and exhibitions, foreign travel for export promotion, advertisement abroad, market research, procurement of samples, and technical information from abroad.

Trade Fairs and Exhibitions

Trade fairs and exhibitions are effective media for promoting products, and facilities are provided for enabling and encourageing participation of Indian exporters/manufacturers in such events. Foreign exchange is released for such purpose, the cost of participation is subsidized, and the Indian Trade Promotion Organization (ITPO) plays an important role in organizing and facilitating participation in trade fairs/exhibitions.

Export Risk Insurance

As international business is prone to different types of risks, measures have been taken to provide insurance covers against such risks. The export credit guarantee corporation (ECGC) has policies covering different political and commercial risks associated with export marketing, certain types of risks associated with overseas investments, and risks arising out of exchange rate fluctuations. Further, ECGC extends the export credit risks to cover commercial banks. Marine insurance is provided by the General Insurance Corporation and its subsidiaries.

Production Assistance/Facilities

Exports depend on exportable surplus and the quality and price of the goods. The Government has, therefore, taken a number of measures to enlarge and strengthen the production base, to improve the productive efficiency and quality of products and to make products more cost-effective. Measures in these directions include making raw materials and other inputs of required quality available at reasonable prices; facilities to establish and expand productive capacity, including import of capital goods and technology; facilities to modernize production; and provision of infrastructure for the growth of export-oriented industries.

Special Economic Zones (SEZs)

A special economic zone (SEZ) is a geographical region with special economic and other laws aimed at promotion of exports and foreign investment. The category SEZ covers a broad range of more specific zone types, including free trade zones (FTZ), export processing zones (EPZ), free zones (FZ), industrial estates (IE), export-oriented units (EOUs), export houses, free ports, and urban enterprise zones.

Export Processing Zones

Export processing zones (EPZs) are industrial estates which form enclaves within the national customs territory of a country and are usually situated near seaports or airports. The entire production of such a zone is normally meant for exports. These zones have well-developed infrastructural facilities, and industrial plots/sheds are normally made available at concessional rates. Units in these zones are allowed foreign equity even up to 100 per cent and are permitted to import capital goods and raw materials for export production without payment of duty. Domestically procured items are also eligible for duty exemption. The main objectives of an EPZ are to earn foreign exchange, generate employment opportunities, facilitate transfer of technology through foreign investment and, thereby, contribute to overall economic development.

India’s first EPZ was established at Kandla, Gujarat in 1965 as a multi-product zone. It has been followed by several others. Later, the government also introduced schemes for electronic hardware technology park (EHTP) units and software technology park (STP) units.

Free Trade Zone (FTZ)

A free trade zone (FTZ) is different from an EPZ. Goods imported to a free trade zone may be re-exported without any processing, in the same form. However, goods exported by units in an EPZ are expected to go through some additional manufacturing or other processing before being exported. A free port is a port in which imports and exports are free from trade barriers. A FTZ may be a part of or adjacent to a port; the rest of the port being subject to the national customs regulation.

Export-oriented Unit (EOU)

A 100 per cent export-oriented unit (EOU) unlike an EPZ is an industrial unit located anywhere in the country (duty tariff areas), which offers its entire production for export, excluding permitted levels of rejects. EOUs were allowed in industries which had export potential and the capacity to create additional export capacity.

Export Houses

An export house is a registered exporter established to boost exports and provide a channel for the products of the small scale sector. The Directorate General of Foreign Trade has different levels of recognition for established exporters in India. Export units located in Export Processing Zones(EPZs), Special Economic Zone(SEZs), Electronic Hardware Technology Parks(EHTPs), Software Technology Parks(STPs) are eligible for such recognition. Under this scheme, exporters are recognized as Export House, Trading House, Star Trading House and Super Star Trading House based on the value of their exports.

Special Economic Zone

India was one of the first Asian countries to recognize the effectiveness of export processing zone (EPZ) model in promoting exports, with Asia’s first EPZ set up in Kandla in 1965. With an aim to overcome the shortcomings experienced on account of the multiplicity of controls and clearances, absence of world-class infrastructure, and an unstable fiscal regime, and with a view to attract larger foreign investments in India; the special economic zones (SEZs) policy was announced in April 2000.

To instil confidence in investors and signal the government’s commitment to a stable SEZ policy regime, the Special Economic Zones Act was passed by Parliament in May 2005. The Act, 2005, supported by SEZ Rules, came into effect on 10 February 2006, providing for drastic simplification of procedures and for single window clearance on matters relating to central as well as state governments.

The main objectives of the SEZ Act are:

• Generation of additional economic activity
• Promotion of exports of goods and services
• Promotion of investment from domestic and foreign sources
• Creation of employment opportunities
• Development of infrastructure facilities

The SEZ Rules provide for different minimum land requirement for different classes of SEZs. Every SEZ is divided into a processing area where alone the SEZ units would come up and a non-processing area where the supporting infrastructure would be created.

Incentives and Facilities Offered to the SEZs

The incentives and facilities offered to the units in SEZs for attracting investments into the SEZs include:

• Duty-free import/domestic procurement of goods for development, operation and maintenance of SEZ units.
• Hundred per cent income tax exemption on export income for SEZ units, under Section 10AA of the Income Tax Act for the first five years, 50 per cent for the next five years and 50 per cent of the ploughed back export profit for the next five years.
• External commercial borrowing by SEZ units up to USD 500 million in a year without any maturity restriction through recognized banking channels.
• Exemption from central and state sales tax and service tax has now been subsumed into GST and supplies to SEZs are taxed at zero rate under the IGST Act 2017.
• Single window clearance for central and state level approvals.
• Exemption from the state sales tax and other levies as extended by the respective state governments.

The major incentives and facilities available to SEZ developers include:

• Exemption from customs/excise duties for development of SEZs for authorized operations approved by the Board of Approval (BOA)
• Income tax exemption on export income for a block of 10 years in 15 years under Section 80-IAB of the Income Tax Act
• Exemption from minimum alternate tax under Section 115JB of the Income Tax Act
• Exemption from central sales tax (CST)
• Exemption from service tax

Benefits of SEZs

SEZs carry multiple benefits, such as employment generation, boosting investment, augmenting exports, and building infrastructure of international standards. SEZs make local recruitments, and provide training for their operations. The gem and jewellery SEZ in Hyderabad, the textile SEZ of the Mahindras in Chennai, the Nokia SEZ in Sriperambedur, the Flextronics SEZ in Chennai, the Apache SEZ in Nellore, the Brandix Apparel SEZ in Vishakhapatnam, the Divi Laboratories SEZ in Andhra Pradesh and the Rajiv Gandhi Technology Park SEZ in Chandigarh are example of SEZs that have created employment in their respective zones.

SEZs also help to attract foreign investment which augments domestic investment. It is estimated that investment from SEZ developers will touch USD 60 billion by 2012, if all SEZ-approved projects are implemented.

CHAPTER SUMMARY

• There are a number of accepted payment forms in international trade, ranging from cash in advance, to letter of credit (L/C), documentary collection (such as D/P and D/A), to open account terms.
• Cash in advance is a method of payment which is received either before shipment or upon arrival of the goods.
• A letter of credit is a document issued by the buyer’s bank in which the bank promises to pay the seller a specified amount under specified conditions.
• L/C is particularly desirable for the exporter because it eliminates credit risk, reduces uncertainty and facilities financing, whereas for the importer it ascertains the quality and quantity of a purchase.
• Documentary collection is a payment mechanism under which the exporters retain ownership of the goods until payment is received or there is certainty that it will be received.
• Bill of lading is a document of title of the goods being shipped along with the documents for shipment and the carrier’s receipt for the goods being shipped.
• External sources of export financing include both private sources and governmental sources. These sources offer different types of financing for exporters.
• A bank guarantee is a financial instrument that guarantees a specified sum of payment to either the exporter or importer.
• Export factoring involves the sale of export accounts receivable to a third party, which assumes the credit risk.
• Forfaiting is purchasing an account receivable where the credit term exceeds the permissible limit for factoring.
• The time lag between receipt of an order and receipt of actual payment makes the exporter look for different sources of credit.
• In order to meet these credit needs of the exporter, there are provisions for both pre-shipment and post-shipment credit.

KEY TERMS

• Cash in advance
• Letter of credit
• Documentary collection
• Bill of lading
• Bank guarantee
• Export factoring
• Forfaiting
• Banker’s acceptance
• Corporate guarantee
• Pre-shipment credit
• Post-shipment credit
• Export promotion
• SEZ
• EOU

DISCUSSION QUESTIONS

1. Enumerate the main modes of payment for international trade transactions.
2. What is a letter of credit? How is it different from documentary collection?
3. List and explain the different types of letters of credit.
4. Distinguish between:
   1. Export forfaiting and export factoring
   2. SEZ and EOU
   3. Pre-shipment and post-shipment credit

EXAMINATION QUESTIONS

1. Write a short note on: (4 each)
   1. Export promotion organizations in India

      [B.Com (Hons.), 2010, 2011]

   2. EOUs

      [B.Com (Hons.), 2012]

   3. Role of SEZs in the Indian economy

      [B.Com (Hons.), 2012]

   4. Export incentives in Indian trade

      [B.Com (Hons.), 2010]

   5. SEZs

      [B.Com (Hons.), 2015]

2. What measures have been taken by the Indian government to promote foreign trade? Mention the various organizational set up for the same. (15)

   [B.Com (Hons.), 2014]

3. Distinguish between the following: (5, 5)
   1. FAS and FOB
   2. C&F and CIF

      [B.Com (Hons.), 2014]

4. Explain various modes of payment in foreign trade. (10)

   [B.Com (Hons.), 2015]

5. 1. Explain the objectives of SEZs/ EOUs. Assess their performance in India. (8)
   2. Explain the different methods of export–financing. What is the role of financial institutions for it? (7)

      [B.Com (Hons.), 2017]

6. What are the different methods of payment in foreign trade? (7)

   [B.Com (Hons.), 2016]

7. Write short notes on the following: (5, 5)
   1. Modes of trade finance
   2. Special Economic Zones (SEZs)

      [B.Com (Hons.), 2018]

8. Discuss how the EXIM Bank has helped in financing and facilitating foreign trade in India. (7)

   [B.Com (Hons.), 2017]