BUAD633—INTRODUCTION TO INTERNATIONAL FINANCE

Week One Lecture : Dr Barngetuny

INTRODUCTION

Objectives International Finance

➢ To make the students well aware about the formalities associated with
International trade and Finance
➢ To make the students aware of the documentation of International Trade and
➢ To make the students aware of the FOREX Management and Export
Promotion Schemes.

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INTRODUCTION-CONT.

--The world economics are changing rapidly and most countries of the world
including developing countries are gearing up to the challenges of competing in
a highly integrated global marketplace.
--In such a situation, the issue of “international Trade” is attaining much
attention of the government authorities, traders and policy makers in recent
years.
--For the developing countries, specifically a country like Kenya, growth
requires a steady in flow of imported capital and intermediate goods, and this,
in turn necessitates foreign exchange to pay for them. To this end, this lesson
explains in detail the framework of International Trade, its characteristics,
limitations and international corporations in trade finance, practices and the
international situations that assist the international trade operations.

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INTRODUCTION-CONT.

Basis of International or Foreign Trade

Foreign trade is based on the theory of comparative cost advantage which
states that every nation exercises certain kinds of benefits from the production
of a particular type of commodity whose resources are exclusively available in
that nation or available in other nations in very less amounts. For example,
Iraq and the similar nations have comparative advantage over the production of
crude oil. Hence, it can export it to other nations and earn huge profits.
Similarly, Kenya specializes in the production of Coffee, and Tea . No country
is self-sufficient, and it has to depend on other nations to obtain the required
inputs be it machines, labor, raw materials or even finished products.

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INTRODUCTION-CONT.

Comparative Advantage: Even if one person is

better, i.e., more efficient, at producing all goods
than another person, trade can still be profitable for both.

Two goods, wine and cloth

Two people, Fred and Ginger

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INTRODUCTION-CONT.

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INTRODUCTION-CONT.

Thus, the need for foreign trade arises due to the following factors:
1. All nations of the world have to depend on the other nations as it cannot
produce every things by itself in a lower cost.
2. A country may get the resources and manpower to produce all types of
commodities, but it may be able to get that commodity at a cheaper rate from
the other nation who specializes in the production of that commodity.
3. Similarly, a country may produce some goods at a cheaper rate than the
other nation and may try to export it to other nations at a higher rate if there is a
surplus.

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INTRODUCTION-CONT.
Difficulties in International Trade
➢ Distance: Due to long geographical distances between the nations, goods are
either sent through rail, road or sea or air. All these modes of transport are
expensive and may face the dangers of sea or air perils such as explosions or
accidents etc. There may be a delay in the delivery of goods that may lead to
the spoilage of certain perishable goods. Distance creates higher transport costs
as well as more risks.
➢ Different languages; Different languages are spoken in different nations.
Hence, the buyers and the sellers may not be able to communicate with each
other effectively. They may have to depend on the translators that are not
always reliable.
➢ Risk in transit: Foreign trade involves high risks than the home trade.
Many of the risks can be covered by insurance but still, the danger persists.

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INTRODUCTION-CONT
Difficulties in International Trade-Cont.
➢ Lack of information about foreign businessman: A seller is always
worried about the credit-worthiness and the financial standing of the
prospective buyer as there is no strong proof of the buyers’ ability to pay. Thus,
there is the risk of bad debt for the seller.
➢ Import and export restrictions: Every country charges a high rate of
custom taxes and duties on the import of the goods. Also, businessman are
required to fill various documents and formalities to complete the transactions.
Foreign trade policies and procedures vary from nation to nation and also from
time to time.
➢ Study of foreign markets: Every foreign market has its own features. There
are different price interactions, demand supply interactions, government
policies, marketing methods, customs laws, weights etc. It is very difficult to
collect all the information accurately about the foreign markets.
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INTRODUCTION-CONT.

Difficulties in International Trade-Cont.

➢ Problems in payments: Every country has its own currency and exchange
rates with which the transactions can completed. These exchange rates keep on
changing. Remittance of money in foreign trade involves much time and
expense. There are also huge risks of bad debt.
➢ Intense competition: There is a huge competition between the sellers of the
different nations involved in exporting the same commodity. The one who
succeeds in influencing the buyers from the advertisements and other incentives
stands out as the winner of the market. Thus, heavy and useless expenses are
incurred in these activities.

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CHARACTERISTICS OF INTERNATIONAL TRADE

Territorial Specialization
International trade among the countries is possible only because each country
has certain resources that can be well utilized for the production of certain type
of commodity that is not available in other countries or available in very less
quantities. Hence, each country has some sort off comparative cost advantage
that means each country can produce a good at a lower price than the other
country and hence, can export that.
International Competition
Producers from different nations are always in a race with one another to sell
their products in as much quantity as possible. Thus, advertisements, sales
promotion activities are very helpful in these types of selling techniques.

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CHARACTERISTICS OF INTERNATIONAL TRADE-CONT.

Separation of Sellers from Buyers

Each country is separated by a large geographical distance and hence, the
buyers and the sellers are unable to meet each other physically. They contact
each other through mass communication devices such as telephones, internet,
video conferencing etc.
Long Chain of Middleman
Since the buyers and the sellers are unable to meet each other, they have to rely
on long chain of middleman to complete their international transactions. It does
increase the cost of the goods of the buyers and hence, the imported goods are
much expensive.

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CHARACTERISTICS OF INTERNATIONAL TRADE-CONT.

Mutually Acceptable Currency

All the nations, except countries of Europe, have their own currencies and other
modes of payment. Hence, it is not possible to have a common currency for
exchange between nations. Thus, dollars, pounds are selected for this purpose
and hence, they are called “hard currencies”. These currencies are acceptable
all over the world.
International Rules and Regulations
Each buyer and seller involved in the international trade have to complete the
guidelines and norms set up the custom authorities of the others country. They
have to follow the restrictions of that nation.

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CHARACTERISTICS OF INTERNATIONAL TRADE-CONT.

Government Control
The government of every nation exercises effective control over the export and
import trade of the nation. Hence, various types of formalities and documents
have to be submitted to the government.

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INTERNATIONAL TRADE THEORIES

A number of theories have been developed by economists as basis of

International Trade, some of these are as follows:
1. Theory of Comparative Cost Advantage: According to this theory, a
country tends to specialize in the production of those goods for which it has got
a comparative cost advantage, or where it costs are lower than in other
countries.
2. Factor Proportions Theory: This theory is also known as Factor
Endowment Theory; which was developed by Heckcher and Ohlin. This theory
suggests that a country will specialize and export that product which is more
intensive in that factor (a two-country, two commodity and two-factor model)
which is more abundant. It will import those goods which, on the other hand,
are more intensive in that factor of production which is scarce in that country.

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INTERNATIONAL TRADE THEORIES-CONT.

3. Human Capital Approach Theory: This theory also known as Skills

Theory of International Trade, advocated by Becker, Kennen and Kessing.
According to this theory, labor can be classified into skilled and unskilled labor.
A developing country which has more abundant supply of unskilled labor will
specialize and export labor intensive products. Imports, on the other hand, will
consist of goods which are more skill intensive.
4. Natural Resource Theory: This theory was proposed by Vanek, J. The basic
hypothesis of this theory is that a county will export those products which are
more intensive in that natural resource with which it is more relatively
endowed.

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INTERNATIONAL TRADE THEORIES-CONT.

5. Research and Development, and Product Life-Cycle Theories: A number

of economists, especially Vernon have contributed the development of this
theory. It suggests that industrial countries allocate more resources to R and D
programme, to develop new products. These countries will enjoy monopoly
benefits in the initial stages of production, and will access to foreign markets,
leading to trade between the developed and developing countries as well as
trade among the industrialized countries themselves.
6. Economies of Large–scale Theory: A company operating in a country
where the domestic market is large; will be able to reach a high out-put level,
by reaping the benefits of large-scale production. The lower cost of production
will increase the competitiveness of the company enabling it to make an easy
entry into the export markets.

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INTERNATIONAL COOPERATION IN TRADE FINANCE

The global financial crisis, which has resulted in slowdown in economic

growth, has also impaired the access to trade finance. As a result, cost of
finance had increased by over 3-4% in international markets, last year, even for
exporters considered to be good.
Many Governments have quickly sought to mitigate the potential impact of the
crisis on their domestic economy and export sector, through various measures,
albeit in varying degrees and forms. The main actions taken by Governments
can be grouped in two categories:
(i) To increase banks’ liquidity to alleviate liquidity pressure including for trade
finance;
(ii) To enhance the long-term competitiveness of the country’s exports by
developing and expanding export promotion programs.

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INTERNATIONAL COOPERATION IN TRADE FINANCE-
CONT.

The commitment of G-20 leaders calling for collective fight against

protectionism, and the action by Multilateral Agencies to counter the shortage
in trade finance indicates the need for international cooperation in trade
finance.

Export Credit Agencies (ECAs), particularly in developing countries, have

assumed greater role to channel trade finance to firms. In some countries,
Government has channeled the trade credit enhancement measures through the
ECAs. Exchange of information and institutional cooperation are the two
important strategies for enhancing trade finance and trade amongst the trading
partners.

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INTERNATIONAL COOPERATION IN TRADE FINANCE-
CONT.

--Multilateral / regional development finance institutions should play a pivotal

role in rebuilding confidence amongst member governments, banks and
financial institutions in the region, through provision of well targeted credit
enhancements, policy support, and capacity building initiatives. These may
include technical assistance / advice on trade finance policy, loans for creation
of finance-related infrastructure, and support in creation and strengthening of
institutions that support trade finance transactions.
--Rules-setting organizations, like WTO, may have to provide necessary
comfort to banks and financing institutions (that are providing finance and
guarantees), especially from developing countries, and set flexible policies for
developing countries that encourages concessional trade financing; it may be
appreciated that the priority task would be to enhance the capacity in
developing countries to mitigate the effects of increased perception of risks.
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Trade Composition

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Export as an Engine of Growth

Countries have achieved rapid economic development through export led

growth strategy. Export growth not only contributes directly to economic
growth but also permits more imports, and a rapid modernization of production.
The result is efficient domestic industry that meets the market test of
international competition.
--“Global development experience of the past few decades shows that a policy
regime with fewer barriers to trade, both tariff and non-tariff and which
provides equal incentives for exports as well as production for the domestic
market enable countries to achieve not only impressive export growth but also
rapid and sustainable economic growth”.

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Impact of Exports in the Development Process

Export led growth is an appealing strategy for developing nations. In the early
stages of development, a country needs to import real capital (machines), which
often entails borrowing in a foreign currency. Export allows barrowing of
nation to earn the foreign currency required to service its external debt. This
strategy is often successful – the U.S.A is perhaps the best example that
followed such a strategy in its early stages of development—at least over the
short run.

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CONT.
An important consideration is an important for policy-makers when promoting
development is to improve “Export Competitiveness”. While export
competitiveness starts with increasing international market shares, it goes far
beyond that it involves diversifying the export basket, sustaining higher rates of
export growth over time, up grading the technological and skill content of
export activity, and expanding the base of domestic firms able to complete
internationally so that competitiveness becomes sustainable and is accompanied
by rising incomes.
Competitive exports allow countries to earn more foreign exchange and so to
import the products, services and technologies they need to raise productivity
and living standards. Greater competitiveness also allows countries to diversify
away from dependence on a few primary commodity exports and move up the
skills and technology ladder, which is essential for increasing local value added
and sustaining rising wages.
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Export Benefits
The Export benefits may vary by company and product\service. They are:
➢ There is potential for greatly increased company turnover.
➢ Economies of scale are achieved
➢ Potential levels of profitability are much increased.
➢ The product or service offered is more competitive it reflects overseas
market needs and conforms to a wider legal environment.
➢ Companies became much more integrated with market they serve and this
encourages higher standards and the use of more high technology.

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Export Benefits-Cont

➢ Diversification of risk. Company risk and business risk is not confined to

one market.
➢ The company becomes more competitive in all areas of the business.

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Export Risk
➢ Repatriation of profits from the target country may be constrained or
forbidden
➢ Fluctuation in exchange rate may decrease or eliminate profits, or even in
losses.
➢ The export market evolves a longer time scale of payment. This may be 90
or 180 days or even some years.
➢ Product launch in an overseas market is more costly and complex in
comparison with a domestic launch.
➢ Trade barriers are politically and economically manipulated

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Export Risk-Cont.

➢ Economic and political risk is much more.

➢ Instability in the target market/country can lead to losses from war or civil
strife or nationalization by the foreign government.
➢ In case of non-payment other contractual problems, there may be questions
of jurisdiction, i.e. Kenyan courts may not be able to enforce contracts between
parties in different countries.

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Export Promotion Measures

Advanced License Scheme
An advance license is now granted for the duty-free import of raw material,
components, intermediaries, consumables, and parts, spares, including
mandatory spares and packing materials.
Such licenses are subject to the fulfillment of a time bound export obligation
and value addition as may be specified. Advance licenses may be based on
either value or quantity. an exporter may apply for a value based or quantity
based advanced license.

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International Price Disbursement Scheme (IPRS)

This was introduced to make available to exporters raw materials at

international prices. In the case of raw materials, notified by the Government as
coming under the IPRS, the difference between the international prices as
notified by the government and the domestic price, is reimbursed to the
exporters.

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Drawback of Duties
There is a substantial element of customs duty paid on imported components,
as well as excise duty on the indigenous purchase. In the manufacture of many
export products, these are evaluated on a yearly basis, and the exact quantum of
this drawback duties is published by the Ministry of Finance. Accordingly, they
are refunded to the exporter after the completion of the export.

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Fiscal Benefit
The government has exempted export profit s from tax under agriulural
machinery, etc. Act to promote exports and enable the exporters to plough back
into the export trade, their profits for higher exports. For an exporter who is
engaged in the sale of goods, both in the export and domestic market, the
proportion of profits is now taken in the same ratio of the export turnover to
total turnover items like petroleum products, fertilizers, news print, sulphur,
nonferrous metal, etc., on the rupee payment basis. It has helped to diversify
kenyan exports to these countries and balance the trade by substantial exports
from India on a rupee basis.

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Legal Dimensions of Exports

The exports have to deal with different legal systems. an exporter selling his
products to an overseas buyer of the USA, for example, may well have some
influence either on the terms and conditions of the contract entered into
between him and the importer. The conflicting laws can be settled in advance
by incorporating specific provisions in the contract for the supply of goods and
services.

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Type of Legal Issues in International Trade

The basic legal issues can be classified as:
a) those relating to export-import contract:
b) those relating to relationships between the exporter and his agent
c) those relating to products (trademark, patents etc.)
d) those relating to letter of credit

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INTERNATIONAL COOPERATION IN TRADE FINANCE-
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Issues Relating to Export Import Contract
These issues are almost universal in their application: wiz. parties, description
of products, quality price, currency, packaging, schedule of delivery, inspection,
documents, passing of risk, settlement of dispute, etc.
Issue Relating To Relationships Between:
The Exporter &His Agent Agency contract is a legal documents establishing
commercial relationship between the principal and the agent. Agency contract
incorporate the conditions mutually agreed upon. While negotiating an agency
agreement, the exporter should be careful on the following matters:i. Parties to
contract ii. Contractual products for which the agency is concluded. iii. The
territory for which the sole agency is being granted. customers to be contracted
iv. Acceptance of rejection of orders secured by the agent. v. Payment of
agents’

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Issue Relating to Products
This is related to law dealing with trademarks, product liability, packaging and
promotion requirements. Trademarks are used to differentiate a product and
symbolize the quality and stimulate the desire to buy. Product liability of the
world have laid down rules regarding the packaging of items, especially
toiletries and pharmaceuticals, which generally include chemical composition
of the product, net weight, date of manufacturing and the date of expiry. if any
special precautions are to be taken while using the product, that also must be
indicated on the package. Most countries of the world have laid down rules
regarding the packaging of items, especially toiletries and pharmaceuticals,
which generally include chemical composition of the product, net weight, date
of manufacturing and the date of expiry. If any special precautions are to be
taken while using the product, that also must be indicated on the package.

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Barriers to International Trade

Tariffs A tariff is a tax imposed by government on goods and services coming
into a country. They increase the price of the goods being imported. Tariffs
were created by the government to protect local businesses from low-priced
competitive products.
An example would be a shirt made in China now costs a department store
$53.80. ($40.00+$8.80=$48.80, plus shipping and handling which costs $5.00
per shirt.) The shirt would now cost the Kenyan consumer $108.00 making the
Kenyan shirt a better deal.

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Currency Fluctuation
Every county has its own currency, and its patrons know how to use it but
everything you know about your own currency changes when you are dealing
with another country. The rate given by one country for another countries
currency is called the currency exchange rate. The daily exchange rate for the
rest of the world is made according to the rates used when two banks trade
between different countries. Rates of currency are always fluctuating and that
can be a major barrier to trade because the buyer could end up paying way
more than intended. When a country’s currency is devalued in relation to
another countries currency it means the country with the lower value can sell
more because the other country saves money. However, it discourages the
devalued country from buying the goods and services from the country with the
higher currency value because they would pay more for less.
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Investment Regulations
Investors are non-Kenyan who must comply with the provision of the
investment Kenya Act, which requires them to file a notification when they
commence a new business activity in Kenya or each time, they acquire control
of an existing Canadian business. The investment will be reviewed if both the
investor and the vendor are from a country that is not a World Trade
organization member and if the value of the business being acquired in Kenya
is over 5 million. If the investor’s country is a WTO any direct investment in
excess of 223 million is reviewable.

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Environmental Restrictions
A large portion of Kenyan’s economy depends on its natural resources. Foreign
insects and diseases could destroy entire industries and seriously harm the
Kenyan economy.
Restrictions are now placed on imports to protect Canadian crops from
contamination. The Kenyan law requires that all food, plants, fish, animals, and
their products that are brought into Kenya must comply with Kenyan standards.
Kenya is a signatory to the convention on International trade in endangered
species of wild fauna and flora. This agreement is against the trade on 30 000
wild animals and plant species.

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Foreign Relations and Trade Sanctions

Kenya uses trade sanctions to influence polices or actions of other nations.
Also attempts to stop human right violations by imposing sanctions instead of
using force. Kenya tends to join with other nations who share the same views to
implement sanctions jointly. The United Nations Act incorporates into Kenyan
law the decisions are passed by the United Nations Security Council.

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Safety Regulations
The government regulates and administers commerce and trade in specified
goods under the fallowing acts *Food and drug act *Meat inspection act
*Health of animal's act *Hazardous Products act *Customs act.
All of these acts affect both domestic and foreign imports. Each of these acts
sets up many regulations. These regulations could act as barriers to trade for
foreign exporters who may need to make costly changes in their manufacturing
procedures to conform to Kenyan standards

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Immigration Policies
The Kenyan economy benefits from immigrants' skills and financial
investments. Visitors Kenya welcomes visitors. People coming to Kenya spend
money on goods, services, or products they purchase to take home.
Immigrants People wishing to relocate from their home country to Kenya must
have a Visa. Immigrants with a Kenyan Immigrant Visa are allowed to work or
live anywhere in Kenya. After having the Visa for three years they can apply
for citizenship.

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Import Composition

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Impact of the crisis on Trade Credit

The global economic crisis also impacted trade credit. A number of banks,
global buyers and firms surveyed independently by the World Bank,
International Monetary Fund (IMF) and Bankers Association for Finance and
Trade (BAFT), have felt that lack of trade credit and other forms of finance,
such as working capital and pre-export financing, has affected growth in world
trade.
In addition, the costs of trade credit have substantially gone up and are higher
than they were in the pre-crisis period, raising the challenge of affordability of
credit for exporters. Higher funding costs and increased risk continue to put
upward pressure on the price of trade credit.

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Currently, as the financial crisis intensified, the spreads on trade finance

increased by a factor of three to five in major emerging markets, like China,
Brazil, Kenya, Indonesia, Mexico, and Turkey.
For example, the spread (over the six-month LIBOR) for Turkey jumped to 200
basis points in November 2018 from 70 basis points in the third quarter(Q3),
while Brazil’s spread almost trebled in 2018 (from 60 bps to 175 bps); Kenya’s
spread increased from 50 bps to 150 bps during the same year.
Similarly, spreads for several Sub-Saharan countries jumped from 100 basis
points to 400 basis points.

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Small and Medium Enterprises (SMEs) and exporters in emerging markets

appear to have faced the greatest difficulties in accessing affordable credit.
Increased uncertainty initially led exporters and importers to switch from less
secure forms of trade finance to more formal arrangements. Exporters
increasingly asked their banks for export credit insurance (ECI) or asked
importers to provide Letters of Credit (LCs).
Importers were asked to pay for goods before shipment and exporters sought
more liquidity to smooth their cash flow. Further, the realization of export
proceeds was not taking place on the due date. This led firms to trim down
inventories, and direct the funds so generated to meet their working capital
requirements.

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Payment Methods for International Trade

Prepayments
• The goods will not be shipped until the buyer has paid the
seller.
• Time of payment : Before shipment
• Goods available to buyers : After payment
• Risk to exporter : None
• Risk to importer : Relies completely on exporter to ship
goods as ordered

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Letters of credit (L/C)

• These are issued by a bank on behalf of the importer
promising to pay the exporter upon presentation of the
shipping documents.
• Time of payment : When shipment is made
• Goods available to buyers : After payment
• Risk to exporter : Very little or none
• Risk to importer : Relies on exporter to ship goods as
described in documents

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Drafts (Bills of Exchange)

• These are unconditional promises drawn by the exporter
instructing the buyer to pay the face amount of the drafts.
• Banks on both ends usually act as intermediaries in the
processing of shipping documents and the collection of
payment. In banking terminology, the transactions are
known as documentary collections.

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Consignments
• The exporter retains actual title to the goods that are
shipped to the importer.
• Time of payment : At time of sale by buyer to third party
• Goods available to buyers : Before payment
• Risk to exporter : Allows importer to sell inventory before
paying exporter
• Risk to importer : None

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Open Accounts
• The exporter ships the merchandise and expects the buyer
to remit payment according to the agreed-upon terms.
• Time of payment : As agreed upon
• Goods available to buyers : Before payment
• Risk to exporter : Relies completely on buyer to pay
account as agreed upon
• Risk to importer : None

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Comparison of Payment Methods

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Trade Finance Methods

Accounts Receivable Financing
¤ An exporter that needs funds immediately may obtain a
bank loan that is secured by an assignment of the
account receivable.
Factoring (Cross-Border Factoring)
¤ The accounts receivable are sold to a third party (the
factor), that then assumes all the responsibilities and
exposure associated with collecting from the buyer.

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Letters of Credit (L/C)

¤ These are issued by a bank on behalf of the importer
promising to pay the exporter upon presentation of the
shipping documents.
¤ The importer pays the issuing bank the amount of the
L/C plus associated fees.
¤ Commercial or import/export L/Cs are usually
irrevocable.
¤ The required documents typically include a draft (sight
or time), a commercial invoice, and a bill of lading
(receipt for shipment).
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Letters of Credit (L/C)-Cont.

¤ Sometimes, the exporter may request that a local bank
confirm (guarantee) the L/C.

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Medium-Term Capital Goods Financing (Forfaiting)

¤ The importer issues a promissory note to the exporter to
pay for its imported capital goods over a period that
generally ranges from three to seven years.

¤ The exporter then sells the note, without recourse, to a

bank (the forfaiting bank).

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Countertrade
¤ These are foreign trade transactions in which the sale of
goods to one country is linked to the purchase or
exchange of goods from that same country.
¤ Common countertrade types include barter,
compensation (product buy-back), and counterpurchase.
¤ The primary participants are governments and MNCs.

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Banker’s Acceptance (BA)

¤ This is a time draft that is drawn on and accepted by a
bank (the importer’s bank). The accepting bank is
obliged to pay the holder of the draft at maturity.
¤ If the exporter does not want to wait for payment, it can
request that the BA be sold in the money market. Trade
financing is provided by the holder of the BA.
The bank accepting the drafts charges an all-in-rate (interest rate)
that consists of the discount rate plus the acceptance commission.
¤ In general, all-in-rates are lower than bank loan rates.
They usually fall between the rates of short-term
Treasury bills and commercial papers. 60
Working Capital Financing
¤ Banks may provide short-term loans that finance the
working capital cycle, from the purchase of inventory
until the eventual conversion to cash.

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CONT

• Due to the inherent risks of international trade,

government institutions and the private sector offer
various forms of export credit, export finance, and
guarantee programs to reduce risk and stimulate
foreign trade.

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