Bill of Lading

In international trade shipping occupies an important place as a mode of transport.  The document evidencing the carriage of goods by sea is the ‘bill of lading’.

A bill of is a document issued by the shipping company or its agent, acknowledging the receipt of goods for carriage, which are deliverable to the consignee or his assignee in the same condition as they were received.

A bill of lading is an international document in the sense that the rules embracing them have international ramifications.  An attempt was made to evolve a set of rules relating to bills of lading, so that the rights and liabilities of ship owners and shippers are subject to rules of general application.  The International Law Association in their meeting held at The Hague made the first attempt in this direction in 1921.  These rules were embodied in the articles of an International Convention at Brussels in 1924.  The rules, known as Hague Rules, were given the legal status in India by incorporating them in the Carriage of Goods by Sea Act, 1925 and in England in the Carriage of Goods by Sea Act, 1924 of England.

The Hague rules were amended by a Protocol signed in 1968.  In England, the Carriage of Goods by Sea Act, 1971 was passed to give effect to it.  United Nations Commission on International Trade Law (UNCITRAL) brought out a set of new rules, which came to be known as the Hamburg Rules.  Neither the Hague Rules nor the Hamburg Rules are a statute.   They gain the status by their incorporation in the enactments of the countries concerned.  The parties concerned may also adopt them by making them a part of the conditions of the bill of lading.

In India, the following two statutes govern the issue of bill of lading:

1 Carriage of Goods by Sea Act, 1925.

2 Bill of Lading Act, 1956.

As already stated, the Carriage of Goods by Sea Act incorporates the Hague Rules.

Transport Documents

The carriage of goods in international trade involves more than one mode of transport.  Goods are carried up to seaport or airport by land and from there they are transported to the buyer’s country.  The goods may again be transported by land/rail to reach the buyer’s place.  Carriage by each mode of transport is covered by a separate contract of carriage.  But the modern trend is the move towards multimodal transport, providing for the continuous obligation of the carrier for more than one mode of transport.  Articles of UCP dealing with transport documents are as follows:

Article 19 – Multimodal Transport Document

Article 20 – Bill of Lading

Article 21 – Non-negotiable Sea Waybill

Article 22 – Charter Party Bill of Lading

Article 23 – Air Transport Document

Article 24 – Raod, Rail or Inland Waterway Transport Documents

Article 25 – Courier Receipt, Post Receipt or certificate of Posting

Article 26 – Clauses “on deck”, “shipper’s load and count”, “said by shipper to contain” and charges additional to freight

Article 27 – Clean Transport Document.

World Bank Group

The World Bank Group consists of five closely associated institutions, each institution having a distinct role to play in the mission to fight poverty and improve the living standards for people in the developing world.  The institutions are:

1 International Bank for Reconstruction and Development (IBRD)

This aims to reduce poverty in middle-income and credit worthy poorer countries by promoting sustainable development through loans, guarantees and advisory services.

2 International Development Association (IDA)

This provides highly concessional financing to the world’s poorest countries in the form of interest free credits and grants.

3 International Financial Corporation (IFC)

This aims to promote economic development through the private sector.

4 Multilateral Investment Guarantee Agency (MIGA)

This helps to promote foreign direct investment in developing countries by providing guarantees to investors against non-commercial risks.

5 International Centre for Settlement of Investment Disputes (ICSID)

This helps encouraging foreign investment by providing international facilities for conciliation and arbitration of investment disputes.

Initially, IBRD was nicknamed as World Bank.  The term now has become official shorthand for IBRD and IDA.  Both IBRD and IDA function similarly except for their target group of beneficiaries.  They share the same staff, report to the same senior management and apply same standard when evaluating projects.  Therefore, when the term World Bank is used it refers to both the institutions.  When the term World Bank Group is used it refers to all the five institutions.

The three institutions IBRD, IDA and IFC are linked together by common Board of Governors.  Separate Board of Governors exists for MIGA.  ICSID has Administrative Council.  Heading the management of all the five institutions is the President of the Group.

International Monetary Fund

Even before the Second World War ended, the Allied countries began to devote serious thought and efforts in developing a system that would end the chaotic conditions prevailing and pave the way for an orderly conduct of international trade and promote good monetary relations among the countries.  They worked with the objectives of finding a system, which would

1 help in removing the restrictions of trade,

2 ensure free convertibility of currencies (which was suspended during the inter-war period due to the multitude of exchange controls) and maintain stability in exchange rates among the currencies.

In these efforts the USA (represented by Mr. H.D. White) and the UK (represented by Lord Keynes) had a greater role to play.

In June 1944, representative of 44 Allied powers met at Bretton Woods, new Hampshire, USA, to give concrete shape to their ideas.  The agreement reached at this meeting provided for establishing two institutions, which came to the known as the ‘Bretton Woods Twins’.  The institutions set up were the International Monetary Fund (IMF) and the International bank for Reconstruction and Development (World Bank).

Objectives

The Articles of Agreement of the IMF set out the following as the objectives of the Fund:

1 To promote international monetary co-operation through a permanent institution, which provides the machinery for consultation and collaboration on international monetary problems.

2 To facilitate the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.

3 To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

4 To assist in the establishment of a multilateral system of payments in respect of currency transactions between members and in the elimination of foreign exchange restrictions, which hamper the growth of world, trade.

5 To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive to national or international prosperity.

6 In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balance of payments of members.

Thus the role of the IMF if mainly two fold: It is an organization to monitor the proper conduct of the international monetary system.  Second, it is a source of liquidity for countries in need of foreign exchange to finance temporary balance of payments deficits.

Letter of Credit

Letter of Credit is one of the important methods of payment in international trade.  Letter of credit operations are governed by the provisions of the Uniform Customers and Practice for Documentary Credits (UCP).

Meaning

A documentary letter of credit is an arrangement whereby a bank, at the request and in accordance with the instructions of a customer (importer), is to make payment to or to the order of a third party (exporter) or is to pay, accept or negotiate bills of exchange drawn by such third party or authorizes such payment or negotiation by another bank, against stipulated documents, provided that the terms and conditions of the credit are complied.  Simply stated, a documentary letter of credit is an arrangement whereby the bank undertakes to pay drafts drawn in accordance with the terms of the credit.

Article 2 of the UCP defines a letter of credit as to mean “any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honor a complying presentation”.

The full implication of the definition can be perceived when we combine in one, the definitions of the terms ‘credit’, ‘honor’, ‘presenter’, ‘presentation’ and ‘complying presentation’ given under the same Article.  Attempting that exercise, a letter of credit can be defined as:

“any arrangement, however named or described, that is irrevocable and therefore constitutes a definite undertaking of the issuing bank to:

 

1 pay at sight if the credit is available by sight payment; or

2 incur a deferred payment undertaking and pay at maturity, if the credit is available by deferred payment; or

3 accept a bill of exchange (draft) drawn by the beneficiary and pay at maturity if the credit is available by acceptance;

to the beneficiary, bank or other party that delivers documents under the credit to the issuing bank or nominated bank, in accordance with the terms of the credit, the applicable provisions of these rules and international standard banking practice”.

Two major changes introduced by the current edition of UCP in the definition of letter of credit are:

1 reference to revocable letter of credit has been eliminated and all credits are made irrevocable; and

2 in addition to complying with the provisions of UCP, the parties are required to comply with international standard banking practice.

Interbanks Dealings

INTERBANK Deals refer to purchase and sale of foreign exchange between the banks.  In other words, it refers to the foreign exchange dealings of a bank in the interbank market.

Cover Deals

Purchase and Sale of foreign currency in the market undertaken to acquire or dispose of foreign exchange required or acquired as a consequence of its dealings with its customers is known as the ‘cover deal’.  The purpose of cover deal is to insure the bank against any fluctuation in the exchange rates.

We have seen that is quoting a rate to the customer the bank is guided by the interbank rate to which it adds or deducts its margin, and arrives at the rate it quotes to the customer.  For example, if it is buying dollar from the customer spot, it takes interbank buying rate, deducts its exchange margin and quotes the rate.  This exercise is done on the assumption that immediately on purchase from the customer the bank would sell the foreign exchange to interbank market at market buying rate.

Since the foreign currency is a peculiar commodity with wide fluctuations in price, the bank would like to sell immediately whatever it purchases and whenever it sells it goes to the market and makes an immediate purchase to meet its commitment.  In other words, the bank would like to keep its stock of foreign exchange near zero.  The main reason for this is that the bank wants to reduce the exchange risk it faces to the minimum.  Otherwise, any adverse change in the rates would affect its profits.

In the case of spot deals the transaction is quite simple.  If the bank has purchased USD 10,000, it would endeavor to find another customer to whom it can sell this.  If it succeeds, the profit would be the maximum because the bank determines both buying and selling rates and the margin between the rates is the maximum. It is cannot find another customer it sells in the interbank market where the rate is determined by the market conditions.  The margin is narrower here.

Balance of Payments

Foreign Exchange is required to settle to economic transaction the country has with other countries.  These economic transaction are captured n its balance of payment statement.

A business entity communicates to the outsiders periodically the results of its operations in the form of financial statements such as profits and loss account and balance sheet.  These statements summarize the effect of the economic transactions carried out by the entity during the period specified.  The economic transactions relate to the exchange of values by the entity with the outsiders.

Residents of country indulge in economic activities with the residents of other countries.  These activities include import/export of goods and services, investments made abroad, interest on such investments, etc.  These economic transactions have their impact on the domestic economy in the form of addition/depletion of resources, increase/decrease in purchasing power, etc.  Consequently, they exert influence over other macro factory like inflation, growth and employment.  The monetary and fiscal policies of the government are in turn influenced by these factors.  At the national level, it would be useful to compile a statement summarizing all these transactions.  In fact every country prepares such a statement known as the Balance of Payments.

Balance of Payments is a record of the value of all transactions between residents of a country with outsiders.  It constitutes the result of demand for and supply of foreign exchange for various purposes.  Since the forces of demand and supply, balance of payments determine the rate of exchange between currencies is the fundamental factor in determining the exchange rates.  A change in the balance of payments of a country will affect the exchange rate of its currency.

Execution of Forward Contracts

By definition, the time and amount of foreign exchange to be delivered are predetermined under a forward contract and the customer is bound by this agreement.  So, theoretically, there should not be any variation and on the due date of the forward contract the customer will either deliver or take delivery of the fixed sum of foreign exchange agreed upon.  But, in practice, quite often the delivery under a forward contract may take place before or after the due date, or delivery of foreign exchange may not take place at all.  The bank generally agree to these variations provided the customer agrees to bear the loss, if any, that the bank may have to sustain on account of the variation.

Let us now analyze the possibilities of the fate of a forward contract.  The foreign exchange may be delivered on the due date as per the forward contract.  Or, the delivery may take place earlier or later than the due date.  Alternatively the customer may request cancellation of the contract.  This request for cancellation may be made on the due date, before the due date of later than the due date.  Yet another alternative is that the customer may request postponement of the date of delivery under the forward contract.  This request for postponement may be made on the due date, earlier than the due date or after the due date.

Forward contract may end up in any of the following ways:

1 Delivery on the due date

2 Early delivery

3 Late delivery

4 Cancellation on the due date

5 Early cancellation

6 Late cancellation

7 Extension on the due date

8 Early extension

9 Late extension

Exchange Exposure and Risk

The terms exchange exposure and exchange risk is often used interchangeably, but they have their independent meanings.  It is through the exchange exposure that a firm faces exchange risk.

Exchange Exposure and Exchange Risk

Exchange Exposure is defined as the extent to which transactions, assets and liabilities of an enterprise are denominated in currencies other than the reporting currency of the enterprise itself.  The reporting currency is normally the national currency of the parent company.  Exposure arises because the enterprise denominates transactions in a foreign currency or it operates in a foreign market.  The exposure is measured by the value of assets and liabilities or transactions denominated in foreign currency.

Exchange risk is defined as the net potential gains or losses, which can arise from exchange rate changes due to the foreign exchange exposure of an enterprise.  It is possible that an adverse exchange rate movement may turn an otherwise profitable deal into a loss.  For instance, if an export deal is struck with a profit margin of 10%, and meanwhile the foreign currency in which the deal is denominated depreciates by 15%, the result would be a loss of about 5%.  It is also possible that the unexpected movement in the exchange rate is favorable and brings windfall profits.  The concept of exchange risk covers both the possibilities.

Difference Between Exposure and Risk

Exposure relates to the total value of assets, liabilities or cash flows of an enterprise denominated in foreign currency, which exchange risk relates to the excess or shortfall in the cash flows or value of assets or liabilities likely to arise on account of exchange rate fluctuations.  Thus exposure relates to the absolute value of an asset or liability involved, and the risk relates to the changes in the value.  It is the exposure that leads to risk through exchange rate changes.

Exchange Risk

An enterprise engaged in export/import trade will be affected by the change in the rate of exchange between the domestic currency and the currency in which the transaction is designated.  For instance, an Indian company which exported to France readymade garments when the Euro was quoted at Rs. 56.00 per euro will suffer a loss if the euro depreciates to Rs. 54.50 per euro by the time the Export proceeds are realized.

An international company which has a subsidiary abroad has the assets and liabilities of such subsidiary denominated in the local currency concerned, i.e., the currency of the country where the subsidiary is situated.  The overall financial position of the parent company would be affected by any change in the exchange rate between the domestic currency of the parent company and the currency of the country where the subsidiary is situated.

In both the cases mentioned above, it is essential tat the business concern keeps track of the extent to which its funds are involved/exposed to the risk of exchange rate fluctuations and the extent of loss/gain that is likely to arise an account of the fluctuation in exchange rates.

Asian Clearing Union

The approved method of payment both in respect of exports and imports to/from the members of the Asia Clearing Union is Asian Currency Unit.  This annexure provides the regulations relating to dealing with Asian Clearing Union by the authorized dealers.

The Asian Clearing Union (ACU) is an effort towards securing regional co-operation amongst the members of the United Nations, Economic and Social Commission for Asia and Pacific (ESCAP) and thereby contributing to the expansion of trade and economic activity among the countries of the region.  It is a system for clearing payments among the participant countries on a multilateral basis.  At present the countries participating in the ACU are Bangladesh, India, Iran, Myanmar, Nepal, Pakistan and Sri Lanka.  The clearing operations commenced on 1^st November 1975.

Objectives

ACU has been established with the following objectives:

1 To facilitate payments for currency international transactions with ESCAP region on a multilateral basis;

2 To reduce the use of extra-regional currencies to settle such transactions by promoting the use of the participant’s currencies.

3 To effect thereby economies in the use of foreign exchange and a reduction in the cost of making payments for such transactions.

4 To contribute to the expansion of trade and promotion of monetary co-operation among the countries of the area.

Operations

All the transactions among the participating countries barring the following are eligible for routing through the ACU :

1 Payment between Nepal and India;

2 Payments that are not on account of current international transactions as defined by the Articles of Agreement of the International Monetary Fund, except to the extent mutually agreed upon between two or more participants;

3 Such other payments as may be declared by the Asia Clearing Union to be ineligible for being channelised through the clearing facility.

For transactions between the participating countries, the instruments of payment should be denominated in Asia Clearing Union Dollar (ACU Dollar).  An ACU dollar is equivalent in value to the US dollar.

Commercial Banks

All the financial requirements of an exporter, from the time he enters into a sale contract and starts working on it and till he receives final payment from the importer, are met by commercial banks.  The facilities available from banks are generally divided into two broad heads: 1 Pre-Shipment Finance and 2 Post-Shipment Finance

1 Pre-shipment Finance or packing credit is the advance granted to the exporter to procure, process, manufacture, pack and prepare the goods for export.  In other words, it is the facility extended to the exporter before and till the goods are shipped for export.

2 Post-shipment Finance refers to the credit facilities extended to the exporter from the time goods are shipped and till the export proceeds are realized.  Post-shipment finance my take any of the following forms:

a) Negotiation of a bill drawn under a letter of credit;

b) Purchase of a bill not drawn under a letter of credit;

c) Advance against bill sent for collection and

d) Advance against duty drawback.

Financing Exports

The statutory basis for regulation of exports from India is the Foreign Trade (Development and Regulation) Act, 1992, which has replaced the Imports and Exports (Control) Act, 1947.  The Government is empowered to ban the export of certain goods from India and/or restrict export in quantity, value, etc., by subjecting them to licensing procedures.

In exercise of the powers conferred under Section 30 of the Act, the Central Government has notified the Export and Import Policy valid for a period of five year, 1^st September 2004 to 31^st March 2007.  During the currency of the policy, the Central Government may make any amendments to it.  Such amendments will be published by means of Public notices issued by the Director General of Foreign Trade.

Exports from the country are generally free.  Item-wise information on the exportability of the product should be verified from the book titled “ITC (HS) Classification of Export and Import Items” published by the Director General of Foreign Trade.  The goods may be classified under any of the following categories :

1 Free – items that can be exported without any restriction;

2 Restricted – items that can be exported only under a license or permission;

3 State Trading – items export of which can be done only through the specified

State Trading Enterprise;

4 Prohibited – items that cannot be exported.

Most items fall under the category of free goods.

Methods of Payment in International Trade

At the time of entering into the contract for export, the importer and exporter agree as to when and how the payment will be made by the importer to the exporter.  Depending upon the relative bargaining power of the importer and exporter, and having in view the requirements of the exchange control in the countries concerned, payment for the international trade may take place in any one of the following methods:

1 Advance Remittance

The exporter may require that the importer should make full payment in advance for the goods to be exposed.  This is possible where the goods enjoy seller’s market.  The exporter would dispatch the goods after he receives the full payment from the importer.  Or, he may even manufacture the goods only after he receives the payment.  This is the most beneficial term of payment that the exporter can export, but it is at the cost of importer.

The importer has to fully rely on the integrity of the exporter and his capacity to execute the order in time.  The transaction is financed solely by the importer, which entails additional cost to him.  He shoulders the entire risk of the transaction.  The credit insurance that is available to an exporter is not available to an importer.  Because of these factors exchange regulations in many countries place restrictions on advance remittance against imports.

2 Cash on Delivery

For small items sent by post or courier, the term may be cash on delivery (COD).  A part amount may be recovered by the exporter in advance and for the balance the article may be sent on COD basis.  The importer should make payment to the courier at the time of receiving the goods.  This is not a popular method of settlement for export of regular goods.

3 Open Account

The situation recommending open account business is the reverse of that for advance remittance.  Under this method goods are dispatched directly to the buyer who takes delivery of them without making payment.  He is free to dispose of the goods as he pleases.  It is arranged that he will make payment to the seller at a predetermined future date, say, two months after each shipment.  Open account as a method of settlement is possible where the commodity commands buyer’s market.

While the open account business is most advantageous to the importer, the exporter bears the entire risk and meets fully the financial requirement of the trade.  The exporter loses control over the goods and relies on the integrity of the importer to receive payment.  The credit risk to some extent is minimized because many countries have developed credit insurance schemes to protect exporters.  In India we have Export Credit Guarantee Corporation undertaking this function.  But exchange control regulations in India place severe restrictions on open account business for exports.

4 Consignment Sale

The exporter may have his selling agents abroad to whom the goods are dispatched.  They receive the goods without making any payment.  The selling agents on behalf of the exporter sell the goods and as and when the sale proceeds are received they are remitted to the exporter.  Throughout, the goods remain at the risk of the exporter.  The difference between open account system and consignment sale is that in the former case it is an absolute sale to the importer while in the latter case the importer receives the goods on behalf of the exporter.  The ownership of goods in the case of consignment sale remains with the exporter.  Consignment sale is prevalent in export of traditional goods from India.

5 Documents against Payment

The methods mentioned above are biased in favor of either party, viz., the exporter or the importer.  A need arose for such a system which would enable the exporter not to part with the goods or the control over the goods till he receives payment and the importer does not pay until he gets the possession or control over the goods.  A method which could fulfill this condition was the exporter drawing bill of exchange on the importer for the good exported.  The goods are dispatched to the importer’s country but the relative documents are sent through a bank for collection.  The bank hands over the documents to the importer only on receiving from the latter the value of the goods as advised by the exporter.  Hence, this method is known as documents against payment or DP in short.

The bill of exchange system of collecting the export proceeds is no doubt impartial when compared to open account system and advance remittance system.  Still the exporter faces the risk of non-payment by the importer.  Even if the exporter does not lose control of the goods, in case of repudiation by the importer, he has to bear additional costs.

6 Documents against Acceptance

This is similar to the previous method with the difference that the documents will be accompanied by a usance bill of exchange, which gives a specific period of time for the importer to make payment.  The collecting bank to the importer will release the export documents when he accepts the bill of exchange.  Hence, this method is known as documents against acceptance, or DA in short.

No payment is made by the importer when he accepts the bill and receives the documents.    He can get possession of the goods by using the export documents.  He will pay the amount due on the bill to the collection bank on its due date.

DA bills are drawn when the exporter wants to extend credit to the importer for a specified period.  For instance, 90 days DA will enable the importer to receive the documents immediately, but pay after a period of 90 days.  DA bills are more risky to the exporter than the DP bills because he loses control over the goods before he receives payment for them.

7 Letter of Credit

When the exporter draws a bill of exchange on the importer he faces the risk of repudiation of the contract by the importer.  A superior method of settlement of debt was devised which could assure the exporter that if he exports the goods as per the contact entered into with the importer and produces evidence to that effect, he would receive payment without default.

Letter of Credit is an undertaking by the importer’s bank that if the exporter exports the goods and produces documents as stipulated in the letter, the bank would make payment to the exporter.  Thus the obligation of the importer under the contract is supplemented by superior obligations of a bank to make payment.  The exporter now looks to the bank, which opened the letter of credit for payment instead of relying on the importer.

Letter of Credit has been acknowledged to be the best form of payment for international trade.

International Trade - Regulatory Framework

Both import and exports are subject to regulatory requirements prescribed by the government.  Any importer or exporter is expected to know the regulations relating to foreign trade and abide by them.  Of the numerous statues that have a bearing on export transaction, those having direct relevance for any export or import are the following:

      1 Foreign trade (Development and Regulation) Act

     2 Foreign Exchange Management Act

     3 Customs Act

Foreign Trade (Development and Regulation) Act

Foreign Trade (Development and Regulation) Act vests the Central Government with the authority of regulating foreign trade of the country and formulating the foreign trade policy.  Under the authority derived from the Act, the Central Government announce the Foreign Trade Policy which indicates (a) what goods can be imported into or exported from the country, (b) the conditional ties, if any, attached to such import or export, and (c) various schemes of export promotion and import facilitation.  The current policy is for five years form September 2004 to march 2009.

Under the policy all the goods are free for imports/exports unless specifically restricted.  Free for imports/exports means that no license is required for importing/exporting such goods.  Few items placed under restricted category require licensing for imports/exports.  A small number of items are totally banned from imports/exports.

The administration of the Foreign Trade Policy is the responsibility of the Directory General of Foreign Trade (DGFT) at New Delhi assisted by Joint and Deputy Director Generals at other important cities in the country.

Foreign Exchange Management Act

Foreign Exchange Management Act (FEMA) regulates the flow of money into the country and from the country in settlement of international transactions.  Reserve Bank of India administers FEMA through commercial banks licensed by it as authorized dealers in foreign exchange.  Exporters are required to realize the foreign exchange only through authorized dealers.  Importers are required to route their transactions only through authorized dealers.  They can obtain the required foreign exchange to pay for their imports from the authorized dealers.

Customs Act

Goods going out of the country on export or entering the country on import should get customs clearance by complying with the procedures prescribed under the Customs Act.