How Big Are Risks in Foreign Trade?

Foreign trade involves risks. Exporters have a risk when buyers don’t pay for the goods. Importers may pay for the  goods but may not receive them or receive damaged, non-standard goods or goods that are totally different from those that were agreed upon.

HOW BIG ARE RISKS IN FOREIGN TRADE?-One way of reducing the risks is to use a letter of credit or a ‘documentary credit’. This provides payment guarantee to the seller and the buyer can make the payment when the goods are received. But this safe tool is used in only 15% of foreign trade transactions.

Increasing competition, falling profits, ongoing economic crises, very low prices of goods produced in emerging countries and China, are making selling and dealing with risks more difficult every day.

Also, cultural barriers, fraud, terrorism, instability in a lot of countries,  governments’ monetary policies, quotas, tariffs and protectionism are adding on the problems.

In situations where Letter of Credit documents were in perfect order but defective or fraudulent goods were delivered by the seller to the purchaser, bankers will not be involved. In fact the UCP recommends that banks do not interfere with such disputes.

The UCP, Uniform Customs and Practice is a set of rules on the issuance and use of L/Cs. UCP is in effect in more than 175 countries.

The International Chamber of Commerce  standardized the rules on documentary credits on the USP. Between 1933 and 2007, seven revisions were made. The current version is UCP600.

FINANCIAL RISKS = Exchange-rate risks: “Exchange Risks can be defined as “the difference between the exchange rate when a contract is signed, and the rate when payment is made.”

When local currency appreciates, export goods become more expensive, exports decrease. But if imported raw materials or other imported ingredients are used in production, or production is outsourced, the goods may cost less.

Be Prepared For the Financial Risks - Consider hedging on receivables due several months or payments to be made later. Especially when volatile currencies and volatile or high interest rates are involved, you may protect your receivables by hedging instruments. Options, futures/forwarding contracts help traders to protect or even increase expected returns.

False documents that comply with LC terms are presented by the seller to the advising = confirming bank. The confirming bank then pays and sends the documents to the issuing bank. The buyer believes that the cargo has been loaded and is on its way to its destination. In many cases, it is only when the vessel is at the destination port that the buyer discovers that the cargo, as contracted, has not been loaded on board.