Exporting without LCs - a risky game

There are different types of settlement of payment against international trade with regards to import and export, namely payment in advance, letters of credit (LCs), documentary collection and open account.

In case of payment in advance, exporters remain safe from payment default by importers, since payment is received prior to the transfer of ownership of shipments.

The LC method is said to be the most secure instrument available to international traders.

LCs are commitments by banks on behalf of importers that payment will be made to exporters, provided that the terms and conditions stipulated in LCs are met.

In the context of Bangladesh, most imports are executed under the LC method. The Import Policy Order (IPO) of the government permits imports of industrial inputs and capital machinery without LCs for limited scale commercial imports.

But imports without LCs are rare.

However, with regards to exports of our country, exporters are forced to export on sales contracts with credit facilities to importers without payment safeguards, though they need input imports on LCs from suppliers nominated by importers.

 The situation is indeed miserable for the exporters.

Amidst COVID-19, in spite of completion of production, many brands cancelled export orders,  leaving exporters under severe pressures for settlement of huge back-to-back LCs payments.

Documentary collection is another method of payment for trade, on sales contracts, in particular.

Under the method, exporters entrust the collection of payments to their banks, which send documents to importers' banks, along with instructions for release of shipping documents.

There are two types of documents under the method. Documents released on receipt of payments are known as document against payment (DP). Documents are released against acceptance of documents for payment in future date, for exports on credit terms under sales contracts, which are known as document against acceptance (DA). 

In documentary collection, banks work as facilitators without commitment for payments. As said earlier, exports of our country are executed on sales contracts with credit terms.

Documents are released against acceptance by importers. Payment default by importers on payment due date is not taken care of by banks abroad.

There are many such records of occurrences if looked closely in export trade in Bangladesh.

Trade under open account is a method of movement of goods on credit terms under sales contracts. Within the regulatory framework of Bangladesh, open account trade is possible in compliance with specified instructions regarding tenure, endorsement of title documents, etc.

But in reality, it has been observed that export is executed on an open account credit period of 120 days under sales contracts. Such is also possible for import, on short term credit period of maximum 360 days.

Bangladesh has a fairly large export basket, sending out consumer goods, including a few durable items.

It is good if consumer goods are sold on cash. Despite easy market access, our exporters face competition from many countries, leading to executing export on sales contracts under credit (DA) terms with adverse conditions.

Exporters should make their payments secure through payment commitments from banks/insurance/trade financing entities/factoring companies/supply chain financiers abroad, with early payment options before maturity. Otherwise, the payment default of a shipment will result in closure of business.

Even though our export basket comprises a variety of products, we are heavily dependent on a few, with readymade garments covering more than 85 percent. The export industry is still dependent on Europe and North Americas. We have potential markets in Latin America, Africa and Central Asia, which are untapped.

Different bilateral trade agreements are reportedly underway for easy access to these markets.

Export trade on credit terms, under sales contracts, with no commitments by importers' banks, will not give effective support to exploring new markets. Rather we need post-shipment financing solutions.

We have a good track record in export with USA without GSP facilities, due to the availability of post-shipment financing.

Export helps create employment for a country like Bangladesh with huge manpower.

Employment through import substitution is possible, subject to protection through tariff and non-tariff barriers. But such protections cannot work in the long run.

Moreover, multilateral trade agreements may, by phases, make tariff imposition lose weight. Export sectors focus on mass employment, as was the case in the East Asian miracles.

So export is the only window to generate huge employment, especially in the aftermath of Covid-19.

To sustain in the buyer dominated market, exporters need to play risky games on sales contracts with a longer credit period, for which they should make separate arrangements with entities abroad to safeguard payments.

Bangladesh is still in the bracket of consumer goods exporter. For graduation to durable goods from consumer goods, we would need export credit agencies for financing support to exporters.

We can expect to graduate to that stage with diversification of jute/leather goods and light engineering goods, as an initial step.

Product graduation to durables need market expansion, for which trade-related agreements need to be established. This helps us import without taxes or at reduced taxes.

Cash flow operating cycle is vital for business. A longer operating cash conversion cycle leads to sufferings or cost-bearing borrowings for exporters. So, there needs to be a minimum cash conversion cycle for export transactions.

Considering financial flows, exporters need to address many issues in exporting on credit terms under sales contracts. Early payment arrangements from external sources without recourse need to be facilitated, and not just be limited to payment guarantee from reputed institutions abroad. The cost for these safeguards should also be bearable to exporters.

Amidst Covid-19, exporters have faced cancellation of orders, delayed payments, discounted payments and non-payments. If exports were executed on LCs, there would have been little scope for exporters to face such problems.

 Operating Payment undertaking by entities abroad for exports on credit terms under sales contracts would provide safeguards to exporters.

There are different international laws available as per UNCITRAL for sales contracts, but enforceability in the worst case scenario is not cost-effective for exporters, regardless of what experts have to say.

As such, we need tools to protect export earnings against exports on credit terms under sales contracts.

Hence, immediate policy support with regards to payment undertaking is needed for exports on credit terms under sales contracts, including early payment arrangement without recourse, based on actual working capital needs of exporters.

Mehdi Rahman, works in a development organisation, focusing on economic issues, as a Joint Executive Director